Fiscal Policy and Credit Supply: The Procurement Channel

Abstract

We show that bank credit exposure to firms with public procurement contracts can amplify fiscal multipliers during 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 firms with procurement contracts, which led to a reduction in credit supply to other firms. The credit supply shock in turn caused firm output to decline. Abstracting from general equilibrium effects, our estimates can account for a quarter of the output loss during the crisis, and imply a credit-driven fiscal multiplier of 0.4.

Keywords: Credit supply, Financial crises, Fiscal policy, Public procurement, Fiscal multipliers, Bank-sovereign loop

JEL Classification: G10, G20, G31, H57