Support for Small Businesses Amid COVID-19

Tinbergen Institute Discussion Paper 2020-044/IV

41 Pages Posted: 3 Aug 2020 Last revised: 22 Jan 2021

See all articles by Charles Goodhart

Charles Goodhart

London School of Economics & Political Science (LSE) - Financial Markets Group

Dimitrios P. Tsomocos

University of Oxford - Said Business School and St. Edmund Hall

Xuan Wang

VU University Amsterdam; Tinbergen Institute

Multiple version iconThere are 3 versions of this paper

Date Written: January 13, 2021

Abstract

A sizeable proportion of enterprises, especially SMEs, assisted by the government, will fail to repay. Should a screening mechanism then be applied to deter those most likely to default from seeking such financial assistance? The answer depends on the relative weights attached to the competitive objectives of stabilisation and allocative efficiency. For this purpose, we develop a two-sector equilibrium model featuring oligopolistic small businesses with asymmetric private information and a screening contract. The sector adversely affected in a pandemic can apply for government loans to reopen later. A pro-allocation government sets a harsh default sanction to deter entrepreneurs with bad projects thereby improving productivity in the long run, at the cost of persistent unemployment, whereas a pro-stabilisation government sets a lenient default sanction. The optimal default sanction balances the trade-off between allocation and stabilisation. Finally, we solve for the optimal default sanction numerically and conduct comparative statics.

Keywords: COVID-19, Government Guarantees, optimal default sanction, unemployment, productivity, Adverse Selection, private information, screening

JEL Classification: D82, E44, G38, H81

Suggested Citation

Goodhart, Charles A.E. and Tsomocos, Dimitrios P. and Wang, Xuan, Support for Small Businesses Amid COVID-19 (January 13, 2021). Tinbergen Institute Discussion Paper 2020-044/IV, Available at SSRN: https://ssrn.com/abstract=3655076 or http://dx.doi.org/10.2139/ssrn.3655076

Charles A.E. Goodhart

London School of Economics & Political Science (LSE) - Financial Markets Group ( email )

Houghton Street
London WC2A 2AE
United Kingdom
0207 955 7555 (Phone)
0207 242 1006 (Fax)

Dimitrios P. Tsomocos

University of Oxford - Said Business School and St. Edmund Hall ( email )

Park End Street
Oxford, OX1 1HP
Great Britain
+44 1865 288 932 (Phone)
+44 1865 288 805 (Fax)

Xuan Wang (Contact Author)

VU University Amsterdam ( email )

De Boelelaan 1105
Amsterdam, ND North Holland 1081 HV
Netherlands

HOME PAGE: http://https://sites.google.com/view/xuan-wang

Tinbergen Institute ( email )

Gustav Mahlerplein 117
Amsterdam, 1082 MS
Netherlands

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