Firm-bank Linkages and Optimal Policies in a Lockdown

64 Pages Posted: 30 Jul 2021 Last revised: 18 Jan 2023

See all articles by Anatoli Segura

Anatoli Segura

Bank of Italy

Alonso Villacorta

University of California, Santa Cruz - Department of Economics

Date Written: July 27, 2021

Abstract

We develop a novel framework featuring loss amplification through firm-bank linkages.
We use it to study optimal government support in a lockdown that creates heterogeneous
revenue losses to firms that must borrow from banks. Firms’ increase in debt reduces
their output due to moral hazard. Banks need safe collateral to raise funds. Without
government support, aggregate risk constrains bank lending, amplifying output losses.
Optimal support provides sufficient aggregate risk insurance and is implemented with
firm-specific transfers, fairly-priced guarantees on bank debt, and procyclical firms’ taxation
to achieve a fiscal surplus target. Our results shed light on suboptimality features in the
actual policy responses.

Keywords: Covid-19, lockdown, firms' debt, moral hazard, bank equity, aggregate risk, government policies

JEL Classification: G01, G20, G28

Suggested Citation

Segura, Anatoli and Villacorta, Luis Alonso, Firm-bank Linkages and Optimal Policies in a Lockdown (July 27, 2021). Bank of Italy Temi di Discussione (Working Paper) No. 1343, Available at SSRN: https://ssrn.com/abstract=3896297 or http://dx.doi.org/10.2139/ssrn.3896297

Anatoli Segura (Contact Author)

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184
Italy

Luis Alonso Villacorta

University of California, Santa Cruz - Department of Economics ( email )

Santa Cruz, CA 95064
United States

HOME PAGE: http://https://sites.google.com/site/alonsovillacorta/

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