Credit Guarantee and Fiscal Costs

Abstract: This paper studies the effectiveness of government‐backed credit guarantees to the infrastructure sector. We propose a two‐sector model with financial intermediary frictions so that infrastructure producers rely on bank loans to finance production. Governments can intervene in the credit market by providing a partial guarantee. We find that a credit guarantee increases infrastructure production, leading to a high fiscal multiplier in the longer run. In the near term, however, higher infrastructure‐sector wages crowd out private‐sector labor supply. Importantly, the higher leverage associated with credit expansion raises nonperforming loans, and this channel is particularly pronounced if the government‐backed credit guarantees linger.