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Credit and Liquidity Policies during Large Crises

Author

Listed:
  • Mahdi Ebsim
  • Miguel Faria-e-Castro
  • Julian Kozlowski

Abstract

We study the evolution of firm financials during two large crises: the Great Financial Crisis (GFC) and the COVID-19 pandemic. While the two crises featured similar increases in corporate spreads, corporate debt and liquid asset holdings moved in opposite directions. The micro-data reveal that firm leverage was a more important predictor of firm-level credit spreads and investment during the GFC, but that firm funding liquidity was more important during the pandemic. We augment a dynamic model of firm capital structure with an explicit motive to hold liquid assets, and calibrate it to match the joint distribution of firm leverage, liquidity and credit spreads. The model shows that the GFC resembled a combination of TFP and credit market shocks, while the pandemic also featured aggregate liquidity shocks. We study the effectiveness of credit and liquidity policies in response to these shocks. Credit policies, such as corporate credit facilities or credit guarantees, are effective in terms of reducing the fall in investment, while liquidity policies, such as direct loans or transfers to firms, are particularly effective at preventing bankruptcies.

Suggested Citation

  • Mahdi Ebsim & Miguel Faria-e-Castro & Julian Kozlowski, 2020. "Credit and Liquidity Policies during Large Crises," Working Papers 2020-035, Federal Reserve Bank of St. Louis, revised 10 Sep 2021.
  • Handle: RePEc:fip:fedlwp:88871
    DOI: 10.20955/wp.2020.035
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    References listed on IDEAS

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    Cited by:

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    2. Imdade Chitou & Gilles Dufrénot & Julien Esposito, 2021. "Linking Covid-19 epidemic and emerging market OAS: Evidence using dynamic copulas and Pareto distributions," AMSE Working Papers 2138, Aix-Marseille School of Economics, France.
    3. Massimiliano Affinito & Raffaele Santioni, 2021. "When the panic broke out: COVID-19 and investment funds' portfolio rebalancing around the world," Temi di discussione (Economic working papers) 1342, Bank of Italy, Economic Research and International Relations Area.
    4. Imdade Chitou & Gilles Dufrénot & Julien Esposito, 2021. "Linking Covid-19 epidemic and emerging market OAS: Evidence using dynamic copulas and Pareto distributions," Working Papers halshs-03297198, HAL.

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    More about this item

    Keywords

    Credit Spreads; Liquidity; Great Recession; COVID-19;
    All these keywords.

    JEL classification:

    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
    • G01 - Financial Economics - - General - - - Financial Crises

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