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Support for Small Businesses amid Covid-19

Goodhart, C. A. E., Tsomocos, Dimitrios P. and Wang, Xuan (2020) Support for Small Businesses amid Covid-19. CEPR Discussion Paper (15055). Centre for Economic Policy Research (CEPR).

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Abstract

A sizeable proportion of enterprises, especially SMEs, in receipt of financial assistance from the government, will fail to repay. In this paper we asked whether, and to what extent, it may be beneficial to apply a screening mechanism to deter those mostly likely to fail to repay from seeking such financial assistance in the first place. The answer largely turns on the relative weights attached for the objectives of stabilisation as compared with allocative efficiency. For this purpose, we develop a two-sector infinite horizon model featuring oligopolistic small businesses and a screening contract in the presence of a pandemic shock with asymmetric information. The adversely affected sector with private information can apply for government loans to reopen businesses once the pandemic has passed. First, we show that a pro-allocation government sets a harsh default sanction to deter entrepreneurs with bad projects from reentering and improves aggregate productivity in the long run, but the economy suffers persistent unemployment in the near term. However, a pro-stabilisation government sets a lenient default sanction or provides full guarantees to reach full employment in the short term, but the economy will be shifted to a lower equilibrium in the long run. The optimal default sanction balances the trade-off between allocation and stabilisation. Then, we derive an analytic measure of "Stabilisation Proclivity" and characterise the parameter space and the macro-financial frictions that render the government either more pro-allocation or more pro-stabilisation. Finally, we solve for the optimal default sanction numerically and conducts comparative statics for various policy analyses.

Item Type: Monograph (Discussion Paper)
Official URL: https://cepr.org/active/publications/discussion_pa...
Additional Information: © 2020 The Author(s)
Divisions: Financial Markets Group
Subjects: H Social Sciences > HD Industries. Land use. Labor
H Social Sciences > HJ Public Finance
J Political Science > JF Political institutions (General)
H Social Sciences > HC Economic History and Conditions
JEL classification: D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D82 - Asymmetric and Private Information
E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E44 - Financial Markets and the Macroeconomy
G - Financial Economics > G3 - Corporate Finance and Governance > G38 - Government Policy and Regulation
H - Public Economics > H8 - Miscellaneous Issues > H81 - Governmental Loans, Loan Guarantees, and Credits
Date Deposited: 11 Aug 2020 13:18
Last Modified: 11 Aug 2020 23:10
URI: http://eprints.lse.ac.uk/id/eprint/106131

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