The paper analyses optimal public support to firms during the Covid-19 crisis, considering its impact on economic activity and the government's maximum expenditure capability. The proposed theoretical framework accounts for the impact of an increase in firms' leverage on their riskiness and on the banking sector.
Optimal government intervention consists of the combination of transfers to firms and guarantees on new bank debt. Banks must reimburse the government fairly for the provision of such guarantees in the future, once the recovery of economic activity is sustained. This reduces the expected cost of the intervention for the government but has no adverse impact on banks during the crisis.
