Abstract

This paper studies the effectiveness of government-backed credit guarantees to the infrastructure sector. We propose a two-sector model with financial intermediary frictions so that infrastructure producers rely on bank loans to finance production. Governments can intervene in the credit market by providing a partial guarantee. We find that a credit guarantee increases infrastructure production, leading to a high fiscal multiplier in the longer run. In the near term, however, higher infrastructure-sector wages crowd out private-sector labor supply. Importantly, the higher leverage associated with credit expansion raises nonperforming loans, and this channel is particularly pronounced if the government-backed credit guarantees linger.