Zombie Lending and Policy Traps

Viral Acharya, Simone Lenzu and Olivier Wang

No 29606, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We build a model with heterogeneous firms and banks to analyze how policy affects credit allocation and long-term economic outcomes. When firms are hit by small negative shocks, conventional monetary policy can restore efficient bank lending and production by lowering interest rates. Large shocks, however, necessitate unconventional policy such as regulatory forbearance towards banks to stabilize the economy. Aggressive accommodation runs the risk of introducing zombie lending and a “diabolical sorting”, whereby low-capitalization banks extend new credit or evergreen existing loans to low-productivity firms. If shocks reduce the profitability gap between healthy and zombie firms, the optimal forbearance policy is non-monotone in the size of the shock. In a dynamic setting, policy aimed at avoiding short-term recessions can be trapped into protracted low rates and excessive forbearance, due to congestion externalities imposed by zombie lending on healthier firms. The resulting economic sclerosis delays the recovery from transitory shocks, and can even lead to permanent output losses.

JEL-codes: E44 E52 G01 G21 G28 G33 (search for similar items in EconPapers)
Date: 2021-12
New Economics Papers: this item is included in nep-ban, nep-cba, nep-fdg, nep-mac and nep-mon
Note: CF EFG ME
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