Abstract
'Zombie lending' occurs when a lender supports an otherwise insolvent borrower. Recent studies document that zombie lending to European firms has been widespread following the onset of the European sovereign debt crisis. This paper develops a quantitative model to study the impact of these lending practices on the dynamics and financial decisions of firms. In the model, firm liquidations and zombie lending arise endogenously. The model provides a good match to key euro-area firm statistics over the period 2011 to 2014. A key finding is that zombie lending has a substantial impact on borrowing costs, helping more low-productivity firms to survive. This, in turn, causes a drag on aggregate output, investment and productivity. These results suggest that zombie lending practices contributed to the lower output experienced by the euro area following the onset of the sovereign debt crisis.
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