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Public and private efforts to reduce COVID-19 infection levels have led to a sharp drop in economic activity around the world. In an attempt to mitigate the damage to businesses, governments around the world have implemented a variety of financial programs to help firms. These programs have been criticized as interfering with markets, providing bailouts, and creating adverse incentives. In this article, I review both the rationale for government-provided assistance and the costs of providing that assistance from the perspective of how that aid effects the likely level and volatility of economic growth. The conclusion of this article is as a part of their decision making, policymakers should weigh both the intended and unintended consequences of such aid on the economy when deciding whether, what type of, and how much assistance should be provided.

Key findings:

  1. One rationale for providing businesses with support is that worker layoffs have been shown to result in substantial reductions in affected workers' income. Another rationale for providing support is that the bankruptcy process is costly and likely to operate less efficiently during a crisis.
  2. Government support of businesses is unavoidably a subsidy to the firm's owners and creditors and is associated with a variety of costs including moral hazard, continued operation of failing firms (often referred to as zombies), and debt overhang. Good program features can reduce, but not eliminate, these costs.

Center Affiliation: Center for Financial Innovation and Stability

JEL classification: G31, G32, G38, H25, J63

Key words: corporate financial policy, layoffs, government bailouts, COVID-19

https://doi.org/10.29338/ph2020-10Off-site link

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