Optimal Allocation of Relief Funds: The Case of the Paycheck Protection Program 
To preserve jobs at small and medium-sized businesses adversely affected by the COVID-19 crisis, the US government created the Paycheck Protection Program (PPP). In 2020 and 2021, the program disbursed nearly $800 billion in loans and grants. The government empowered banks to approve or reject the loan applications to facilitate timely delivery of the funds. This authority enabled banks to target loans to their preferred borrowers, particularly at the beginning of the program, when the demand for funds overwhelmingly exceeded the supply. This paper assesses the optimal target of PPP loans, examines the distortions caused by allocating these loans through the banking system, and discusses alternative policies that could have been implemented to minimize the misallocation. To conduct this assessment, the authors develop a theoretical framework of the PPP involving firms, banks, and the government. In the model, it is optimal for the government to allocate PPP loans to firms that are likely to be intermediately affected by the pandemic, because regardless of the allocation of PPP loans, firms expected to be severely affected by the pandemic will likely shut down, and firms not significantly affected are likely to survive. Also, in the model, banks have an incentive to distort the allocation toward firms that are more likely to survive without a PPP loan.
Key Findings
- The PPP was initially significantly less effective than it could have been under the optimal allocation, but this difference in effectiveness shrank as more loans were made. These results are a reflection of the excessive demand for PPP loans early in the program, when banks played a significant role in the allocation of the loans.
- Using a counterfactual setup in which the government allocates PPP loans and cannot optimally target firms, the authors find that if the PPP program had been funded with only the $349 billion initially appropriated in the Coronavirus Aid, Rescue, and Economic Security Act (CARES) Act, it would have been better for the government to randomly assign loans across firms than to allocate loans through banks.
- In that same counterfactual scenario, the PPP would have been significantly more effective if the government allocated loans to the smallest firms earlier in the program.
- Increasing the size of the program to reduce the misallocation of loans would have been optimal only if the marginal cost of funds were low.
Implications
The paper provides a theoretical framework for emergency lending programs that are now part of the crisis-response toolkit. The model offers guidance on which firms should be targeted by the government, indicates under which conditions the program should be intermediated by the banking system versus implemented directly by the government, and studies the optimal program size.
Abstract
The Paycheck Protection Program (PPP) was a large and unprecedented small-business support program that allocated $800 billion in loans and grants to small businesses following the onset of the COVID-19 crisis. This paper explores the optimal allocation of funds across firms and the distortions caused by allocating these funds through banks. We show that it can be optimal to allocate funds to the least or most affected firms de- pending on the underlying distribution of the shock that firms face, the firms’ financial position, and the total budget available for the program. In the model, as in the data, banks distort the allocation toward firms with more pre-pandemic debt and those less affected by the COVID-19 crisis. We characterize how this misallocation depends on the degree of asymmetric information between banks and the government. In an empirical application of our model, we estimate the PPP’s effectiveness and compare it with alternative policies. A policy targeted at the smallest firms could have increased the program’s effectiveness significantly.