Stabilization vs. Growth

Miguel Faria-e-Castro, Pascal Paul and Juan Sanchez

No 2026-006, Working Papers from Federal Reserve Bank of St. Louis

Abstract: Should firms in financial distress be saved to stabilize an economy, even if less productive ones are kept alive, possibly reducing economic growth? To assess this fundamental stabilization-vs.-growth trade-off, we develop a new dynamic general equilibrium model with business cycles, endogenous growth, and innovation externalities. We discipline key parameters using microeconomic data and an instrumental-variable approach that links firm productivity growth to R&D expenditure. Based on the calibrated model, we find that economies that save distressed firms with credit guarantees, debt restructuring, or loan evergreening experience lower volatility but also slower growth. Even though welfare is higher in an economy without such interventions, the various "soft credit" regimes can still arise as equilibrium outcomes when a benevolent government intervenes in credit markets under discretion.

Keywords: business cycles; endogenous growth; financial frictions (search for similar items in EconPapers)
JEL-codes: E43 E44 E60 G21 G32 (search for similar items in EconPapers)
Pages: 70 pages
Date: 2026-04-16
New Economics Papers: this item is included in nep-bec, nep-dge and nep-fdg
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DOI: 10.20955/wp.2026.006

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