Credit Guidance in Economic Cycles: A Network Game Perspective
Title: Credit Guidance in Economic Cycles: A Network Game Perspective
Authors: ZHAO Mofei, XU Xiang
Published in: Economic Research, 2021, 56 (08): 74-90
Credit guidance is a common policy practice for the governments of each country. Governments adopted credit guidance to sustain economic growth after the global financial crisis in 2008, and after the COVID-19 pandemic outbreak in 2020. When the economy is in a cyclical upswing，governments may also guide credit flows to develop certain industries and to secure macroeconomic safety. When credit guidance is adopted, governments may choose different firms in different sectors. When the economic cycle changes phases, the governments' credit guidance targets also change accordingly.
This paper discusses the impact of credit guidance in different stages of economic cycles. Why is credit guidance barely seen when the economy is booming, and why is it frequently adopted when the economy is starting to go down? Why is credit guidance hardly seen when the economy is in recessions or even collapse? When credit guidance is adopted, why is most credit provided to traditional firms or even sectors with low production efficiencies, rather than emerging sectors like financial derivatives and the internet economy? We build a theoretical model and analyze real policy cases to answer these questions．
The network game model in this paper consists of one government, one state-owned bank, and a number of heterogeneous firms. These heterogeneous firms form a credit network through unfulfilled product orders. They have different production efficiencies, and the economy has different degrees of properties. These two factors affect firms' ability to produce goods and deliver orders. If an order cannot be delivered as required, the productivity of firms in the downstream will be reduced, and the credit risk will spread through the network. In this model, the state-owned bank can make its own credit plan to distribute a fixed amount of credit resources，and the government can either approve the bank's plan or issue administrative orders to assign a different credit plan. The bank's goal is to maximize its own profits for each credit plan, while the government's goal is to maximize gross output.
After building the basic model, we then discuss the equilibrium strategy for the bank and the government. When the economy is booming, no matter what network structure it is, both the government and the bank will prefer lending to high-efficiency firms, and there is no need for credit guidance. When the economy is slowing but productivity is not seriously damaged, the credit choices of the government and the bank depend on the network structure, and divergence may appear: the bank prefers lending to high-efficiency firms, while the government prefers lending to low-efficiency firms with intense network connections. Lending to these firms could lead to a direct decrease in their productivity, but it reduces credit risk contagion through their networks, and increases gross output as a result．When the economy is in severe recessions, the bank will again prefer lending to high-efficiency firms, and the government will not intervene in the credit supply. In this circumstance, lending to low-efficiency firms with intense network connections can still reduce credit risk contagion, but this positive effect cannot cover the efficiency loss from lending to firms with low production efficiencies．
Besides preventing credit risk from spreading through producer networks, governments also have other motivations for credit guidance. In this paper, we expand the basic model to describe the motivation sources of the government's credit guidance under other conditions, and focus on the financial support for high-tech firms and ensuring macroeconomic safety through credit support. These two exercises help to confirm the universality of our network game model, and lay a solid foundation for future research．
The contributions of this paper are twofold. Theoretically，we build a new expandable framework for analyzing and evaluating government credit guidance from a network game perspective. By introducing various macro variables and inter-industry economic variables, this framework can be used to analyze the optimal choice of credit supply in different stages of the economic cycle and under different network structures, especially whether the government needs to guide the bank's credit supply. Practically，we confirm the necessity and efficiency for governments' credit guidance in different phases of economic cycles, and analyze related policy cases.
We have four pieces of policy advice. First, governments should fully consider the impact of producer networks when making and implementing credit guidance plans. Second，governments should choose their credit targets based on network intensity and supply chain length. Third，governments should watch closely for endogenous changes in sectoral network structures. Fourth, credit guidance in the cyclical upswing should focus on increasing long-term economic growth potential and keeping lifeblood firms alive．
Keywords: Credit Guidance; Network Game; Risk Contagion; Government-market Relations
JEL Classification: D21, E61, G28