Epidemic shocks, structural monetary policy and SME financing in China

Abstract

This paper extends the SIR-DSGE framework developed in Eichenbaum et al. (2021, 2022) to study the impacts of structural monetary policy—targeted central bank instruments designed to channel credit to specific sectors or markets, in response to epidemic shocks on SME financing. The model distinguishes between large enterprises (LEs) and SMEs by their labor intensity in production and working capital constraints, and incorporates four commonly used structural policy tools in China. Structural monetary policy tools take effects by incentivizing banks to offer financing support to SMEs. Results show that SMEs are more severely hit by the epidemic for their high labor-intensity in production and tighter working capital constraints, and structural monetary policy can mitigate the severity of an epidemic shock on the macroeconomy and SMEs, by lowering financing costs and increasing financing availability for SMEs. Whether for the economy as a whole or SMEs, structural monetary policy tools yields better stabilization effects than conventional monetary policy. Further analysis shows that the combination of structural and conventional monetary policy improves social welfare than with conventional monetary policy alone, and price-based structural monetary policy instruments are more desirable than quantity-based.