Support for small businesses amid COVID?19

How should the government support small and medium-sized enterprises amid a pandemic crisis while balancing trade-off between short-run stabilization long-run allocative efficiency? We develop two-sector equilibrium model featuring businesses with private information on their likely future success screening contract. Businesses in sector adversely affected by can apply for loans to stay afloat. A pro-allocation sets harsh default sanction deter entrepreneurs poorer projects, thereby improving productivity at cost of persistent unemployment, whereas pro-stabilization lenient sanction. Interest rate effective lower bound leads involuntary unemployment other open shifts optimal stance. The rise firm markups exerts opposite effect. high creative destruction wedge polarizes government's hawkish dovish stances, is more lenient, exacerbating resource misallocation. illuminates how credit guarantees might be structured crises.