Fiscal Policy and Credit Supply: The Procurement Channel

Abstract

We measure how cuts to public procurement propagate through the banking system in a financial crisis. During the European sovereign debt crisis, the Portuguese government cut procurement spending by 4.3% of GDP.We find that this cut saddled banks with non-performing loans from government contractors, which led to a reduction in credit supply to other firms. The credit supply shock, in turn, caused firm output to decline. In a general equilibrium model, our firm-level estimates imply an aggregate elasticity of credit supply with respect to aggregate demand of 1.6 and a credit-driven fiscal multiplier of 0.6.