Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/229664
Authors: 
Goodhart, Charles
Tsomocos, Dimitrios
Wang, Xuan
Year of Publication: 
2021
Series/Report no.: 
Tinbergen Institute Discussion Paper No. TI 2020-044/IV
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.
Subjects: 
COVID-19
Government Guarantees
optimal default sanction
unemployment
productivity
Adverse Selection
private information
screening
JEL: 
H81
D82
E44
Document Type: 
Working Paper

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