Working Paper Revision

Corporate Borrowing, Investment, and Credit Policies during Large Crises

Abstract: We compare the evolution of corporate credit spreads during two large crises: the Great Financial Crisis (GFC) and the COVID-19 pandemic. These crises initially featured spread increases of similar magnitudes, but the pandemic was much more short-lived. The microdata reveal that firm leverage was a more important predictor of credit spreads during the GFC, but that firm liquidity was more important during the pandemic. In a model of the firm capital structure that is calibrated to match the joint distribution of leverage, liquidity, and credit spreads, we show that the GFC resembled a combination of real TFP and credit market shocks, while the pandemic was more akin to a short-lived cash flow shock. We study the effectiveness of credit market interventions in response to these shocks: policies such as QE or credit guarantees are ineffective against real shocks, but can greatly mitigate the effects of financial and cash flow shocks. Transfers and grants (similar to the PPP) are effective if the policymaker’s objective is to prevent corporate bankruptcies.

Keywords: Credit Spreads; Great Recession; COVID-19;

JEL Classification: E44; G12; G32;

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Bibliographic Information

Provider: Federal Reserve Bank of St. Louis

Part of Series: Working Papers

Publication Date: 2021-02-05

Number: 2020-035

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