Uncertainty, government bailouts and the macro economy

The COVID-19 pandemic and ongoing geopolitical risks have led to a massive spike in uncertainty. In this paper, we examine the impacts of economic uncertainties on macroeconomic variables and the optimal policy reactions to the rising uncertainty in a two-sector Dynamic Stochastic General Equilibrium (DSGE) model with Chinese characteristics. With the assumption that the government provides bailouts for bank loans to state-owned enterprises (SOEs) and financial market friction problem is more severe for private-owned enterprises (POEs), the uncertainty shock induces an inefficient capital reallocation from POEs to SOEs. Our results demonstrate that reducing bailouts to SOEs and granting more bailouts to POEs is a welfare improvement when uncertainty increases.