The effect of credit guarantee on macroeconomic stability

Developed countries, for now, tend to depend on fiscal policy to revitalize their business cycles, while low-level interest rate policy has failed to achieve intended outcomes. Fiscal policies in nature cannot be a sustainable policy measure that could be used in the long-run, in that it impedes fiscal soundness. Meanwhile, public credit guarantee can be a useful tool to use without worrying about government deficit because it is based on the leverage ratio; that is, the ratio of total outstanding guarantee commitments to the size of the guarantee fund. In addition, credit guarantee is allopathic prescription about pre-selected firms according to their prospect. Using Korean quarterly time series data from 1/4 of 2003 to 2/4 of 2017, we investigated economic additionality and the effect of easing business fluctuation using a Keynesian structural simultaneous macroeconometric model. Our findings show that public credit guarantee increases economic growth via increase in investments and employment by enterprises. Supply of credit guarantee created value-added: when considering the average leverage ratio of 9.04, between 2012 and 2016, the long-run GDP multiplier is 1.45 which is much bigger than government expenditure multipliers associated with previous literatures. Also, we showed that when the GDP gap decreases each quarter by 1% relative to the actual GDP gap, credit guarantee supply increases. Due to this sustained increase in credit guarantee supply, money supply and firm investment stay high, resulting in increase of the real GDP, thus implying the stabilization of the economy. We conclude that the public credit guarantee system is a useful tool to achieve a development of the national economy from the recession.