Firm Quality Dynamics and the Slippery Slope of Credit Intervention

96 Pages Posted: 1 Dec 2020 Last revised: 6 May 2025

See all articles by Wenhao Li

Wenhao Li

University of Southern California - Marshall School of Business; National Bureau of Economic Research (NBER)

Ye Li

University of Washington - Foster School of Business

Multiple version iconThere are 2 versions of this paper

Date Written: April 23, 2025

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. 

Keywords: credit intervention, heterogeneous firms, firm quality, central bank, crisis dynamics

JEL Classification: E5, E6, G0, G18

Suggested Citation

Li, Wenhao and Li, Ye, Firm Quality Dynamics and the Slippery Slope of Credit Intervention (April 23, 2025). USC Marshall School of Business Research Paper, Available at SSRN: https://ssrn.com/abstract=3737511 or http://dx.doi.org/10.2139/ssrn.3737511

Wenhao Li

University of Southern California - Marshall School of Business ( email )

701 Exposition Blvd
Los Angeles, CA California 90089
United States

HOME PAGE: http://www.wenhao-li.com

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Ye Li (Contact Author)

University of Washington - Foster School of Business ( email )

Box 353200
Seattle, WA 98195
United States

HOME PAGE: http://https://yeli-macrofinance.com/

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