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Firm-bank linkages and optimal policies in a lockdown

Anatoli Segura () and Alonso Villacorta ()
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Anatoli Segura: Banca d’Italia
Alonso Villacorta: University of California Santa Cruz

No 1343, Temi di discussione (Economic working papers) from Bank of Italy, Economic Research and International Relations Area

Abstract: We develop a novel framework featuring loss amplification through firm-bank linkages. We use it to study optimal intervention in a lockdown situation that creates cash shortfalls for firms, which must resort to bank lending. Firms’ increased debt reduces their output due to moral hazard. Banks need safe collateral to raise funds. Without intervention, aggregate risk constrains bank lending, amplifying output losses. Optimal government support provides sufficient aggregate risk insurance, and is implemented through transfers to firms and fairly-priced guarantees on banks’ debt. When aggregate risk is not too large, such guarantees can be financed through a procyclical taxation of firms’ profits.

Keywords: Covid-19; cash shortfall; firms' debt; moral hazard; bank equity; aggregate risk; government interventions. (search for similar items in EconPapers)
JEL-codes: G01 G20 G28 (search for similar items in EconPapers)
Date: 2021-07
New Economics Papers: this item is included in nep-ban, nep-ias and nep-rmg
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