Posted by: mulrickillion | December 7, 2011

Using Credit Subsidies to Counteract a Credit Bust: Evidence from Serbia

By Jiri Podpiera

International Monetary Fund (IMF), Working Paper No. 11/285, December 2011 —

Summary: Emerging markets are particularly vulnerable to boom-bust credit cycles, due to excessive capital flows, shallow equity markets, and companies’ high leverage and open FX positions. While the policy debate on how to respond to boom-bust credit cycles remains unsettled, it has been conjectured that credit subsidies may provide a particularly effective policy tool to counter a credit bust. This paper reports on a rare policy experiment where credit subsidies were used to buffer the impact of the global financial crisis on Serbia in 2009. Model simulations suggest that credit subsidies in Serbia helped to mitigate the slump in output.

[An excerpt from the Working Paper reads]:

The right policy response to boom-bust credit cycles in emerging markets remains controversial. In a review of how emerging markets coped with the recent global financial crisis, IMF (2010) found that countries that managed to keep external pre-crisis vulnerabilities relatively low tended to recover faster from the crisis. In particular, prudential and capital control policies are the conventional tools to counter boom-bust cycles, but their design, effectiveness, and effects remain subjects of debate (see for instance, Ostry et al., 2010, and Stiglitz, 2003). Once a bust takes place, Calvo (2010) has argued that there is a strong case to attenuate credit conditions, particularly for small- and medium-sized enterprises, and he conjectured that credit subsidies could provide a potentially effective tool.

This paper provides evidence on the effectiveness of countercyclical credit subsidies, drawing on a rare policy experiment in Serbia. Credit subsidies have been standard policy fare for addressing market imperfections in advanced countries, notwithstanding questions about adverse allocation and other effects (see Buttari, 1995; Rapisarda and Patacchini, 2003). On aggregate level, excessive optimism followed by sudden corrections, which produce boombust cycles, can be also viewed as consequence of market imperfections. Therefore credit subsidies could be a potentially effective tool to address these imperfections during a bust, see Calvo (2010). However, there seems to be no direct evidence available on the effectiveness of such credit subsidies. Largely due to unusual local circumstances, the Serbian government had at the beginning of 2009 the scope to launch a package of credit subsidies to counteract the spillovers from the global financial crisis. Serbia’s experience with these credit subsidies is explored in this paper, and can offer some preliminary evidence on Calvo’s policy conjecture. . . .

>>Read the full Working Paper here (wp11285.pdf).

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