COVID-19 Crisis, Bankruptcy Risk, and Transition Dynamics

The COVID-19 pandemic has pushed many firms to the edge of bankruptcy and revived concerns of a prolonged/deep recession. The government has introduced various policies to mitigate its economic impact. We build a continuous time heterogeneous agent model to study (i) corporate bankruptcy risks, and (ii) the transition dynamics of the economy. This general framework is applied for understanding the implications of the COVID-19 economic crisis. The higher the bankruptcy rate, the faster the transition towards the new long run steady state. Transition speed decreases as the mass of firms in the upper tail of the net worth distribution increases. While broad fiscal policies are relatively more effective in reducing bankruptcy risks, monetary policies of providing market liquidity are more effective in generating faster transition dynamics