Economy-wide consequences of credit subsidies to targeted firms

Credit constraints are widely recognized as impediments to the economic development of nations. Governments often seek to boost credit markets with direct lending or subsidies. These policies can alleviate credit constraints for targeted firms, but general equilibrium effects indirectly impact other economic agents. To analyze the impacts of such interventions on heterogeneous agents and macroeconomic variables in a real economy, we propose a dynamic general equilibrium model with heterogeneity, occupational choice, and credit constraints, where subsidized credit, market-driven credit, and self-financing coexist. We calibrate the model to fit credit and firm data from Brazil, where recently more than 40% of loans to firms originated from government policies with subsidies. The model indicates that subsidy policies have substantial impacts on non-targeted agents, distorting capital allocation and significantly reducing credit access for other firms. In our benchmark calibration, these distortions lead to lower productivity and wages, and higher inequality. We also examine the impacts of variations in subsidy policies, such as changes in the duration of eligibility and different correlations between eligibility and individual characteristics. In all exercises performed, subsidies increase inequality and diminish the fraction of firms using credit. However, if subsidy programs are properly targeted and short-lived, they are able to generate improvements on some economic variables, such as output and productivity.