Working Paper Revision

Credit and Liquidity Policies during Large Crises

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.

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

JEL Classification: E6; G01;

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Bibliographic Information

Provider: Federal Reserve Bank of St. Louis

Part of Series: Working Papers

Publication Date: 2021-09-10

Number: 2020-035

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