there are costs to keeping firms and their key relationships active: some firms might not be viable after the crisis, and preventing their closure early on during the crisis can lead to inefficiencies. Hence, there are trade-offs involved in designing policies to help keep firms alive and maintain their relationships.

Research has argued that a transitory shock that destroys a significant mass of relationships can lead to long-term scarring economic effects and a slow economic recovery. Predictions from a search-theoretic model for labor market dynamics show that the speed of the post-pandemic recovery would crucially depend on the extent to which relationships between firms and employees are maintained, suspended, or terminated (Gregory et al., 2020). An L-shaped recession would ensue if many workers go into unemployment without maintaining ties to their previous employer and if those workers cannot quickly find new, stable jobs. Moreover, financial constraints and bargaining frictions distort labor hoarding decisions when firms are hit by a temporary shock, leading to inefficiently low overall employment levels (Giupponi and Landais, 2020). Empirical evidence from the GFC suggests that keeping workers’ attachment to their previous employers, thus preserving the aggregate stock of firm-specific human capital, could avoid persistent mismatches and preclude the temporary shock from becoming a prolonged stagnation (Fujita et al., 2020).

Breaking firms’ relationships can trigger magnification effects within firms, which can justify a role for government intervention. One channel is an unemployment and asset price deflation “doom loop” working through credit market imperfections and a productivity-related channel (Cespedes et al., 2020).<sup>3</sup> Specifically, weak aggregate demand triggered by the pandemic could lead to a destruction in workers-firms matches. If these broken relationships are numerous (e.g., layoffs beyond certain thresholds), they could lower firms’ expected productivity. This, in turn, could lower the collateral value of the firms, tightening financial constraints and limiting their borrowing capacity, which could further lower firms’ productivity.

A number of recent theoretical studies emphasize that business closures since the onset of the COVID-19 pandemic could trigger significant economy-wide amplification effects, which further justify policy interventions. One line of argument posits that the supply shocks originated by lockdowns and other containment measures could get amplified through demand factors.<sup>4</sup> A firm exit multiplier can trigger such amplification mechanism (Guerrieri et al., 2020). Specifically, business closures in the sectors most affected by the pandemic (such as those highly dependent on social interactions) could lead to reduced demand for businesses in less-affected sectors. In turn, some of those other businesses might become unable or unwilling to remain open. These additional closures could generate a new endogenous supply shock that amplifies the initial exogenous shock, creating a multiplier effect that may be sufficiently strong to shut down most of the economy. The large supply shock could also endogenously reduce agents’ risk tolerance, lowering asset prices and reducing agents’ wealth, which, in turn, could induce a disproportionately large contraction in aggregate demand that exceeds the decline in supply (Caballero and Simsek, 2020).

> 3See Fornaro and Wolf (2020) for a broader explanation of this vicious cycle.

> 4Some studies examine the extent to which a decline in demand in some sectors can propagate to others (Bigio et al., 2020; Faria-e-Castro, 2020).

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