Firm Quality Dynamics and the Slippery Slope of Credit Intervention

Wenhao Li and Ye Li

No 33796, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: A salient trend in crisis intervention has emerged in recent decades: Government and central banks offered funding directly to nonfinancial firms, bypassing banks and other credit intermediaries. We analyze the long-term consequences of such policies by focusing on firm quality dynamics. In a laissez-faire economy, firms with high productivity are more likely to survive crises than those with low productivity. The government funding support saves more firms but cannot be customized based on firm productivity, dampening the cleansing effect of crises. The policy distortion is self-perpetuating: A downward bias in firm quality distribution necessitates interventions of greater scale in future crises. Our mechanism is quantitatively important: we show that if policy makers ignore such distortionary effects on firm quality dynamics, the resultant credit intervention would almost double the optimal amount.

JEL-codes: E50 E60 G01 G18 (search for similar items in EconPapers)
Date: 2025-05
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Published as Wenhao Li & Ye Li, 2026. "Firm Quality Dynamics and the Slippery Slope of Credit Intervention," Review of Economic Studies, vol 93(5), pages 3337-3371.

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