Journal of Applied Finance & Banking

Credit Expansion and Misallocation

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  • Abstract 

    In response to the global financial crisis in 2008, the Chinese government launched a 4-trillion-yuan economic stimulus plan, which represented a typical episode of government intervention in the economy. This paper analyzed the impact of the stimulus plan, which mainly took the form of bank credit lines, on resource allocation and aggregate productivity. Using manufacturing data from 2001 to 2013, we showed empirically that it pulled up the total demand in the short term, but by extending excessive credit to weak firms, it created resource misallocation and over-capacity in the long term. This effect was observed after a lag of 3 years and was especially pronounced in resource-based industries. The results carried strong implications for emerging economies that undertook similar stimulus plans and whose financial markets have been plagued by severe frictions.

    JEL classification numbers: G01, G21, G28

    Keywords: Bank credit, Corporate governance, Financial crisis