Effectiveness of Credit Guarantees in the Japanese Loan Market (経済研究所創立20周年記念号)

From 1998-2001, the Japanese government, in an effort to stimulate the flow of funds to the small business sector, implemented a massive credit guarantee program that was unprecedented in both scale and scope. Because the program was accessible by nearly every small firm we are able to clearly identify the policy effect. The program, therefore, presents a unique opportunity to determine if government intervention in credit markets can improve the efficiency of credit allocation among bank-dependent small businesses. Utilizing a new panel data set of Japanese small businesses we empirically test the theoretical predictions of Mankiw\u27s (1986) adverse selection model. We investigate whether government credit programs do more to stimulate small business investment, or serve to worsen the adverse selection problems prevalent in credit markets. We find evidence consistent with the former hypothesis. Specifically, program participants (1) significantly increase their leverage, especially their use of long-term loans, and (2), with the exception of high-risk firms, become more efficient