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 persistent reduction in credit supply to other firms. We estimate a bank-level elasticity of credit supply with respect to procurement demand of 2.5. In a general equilibrium model, our findings point to large effects of fiscal policy on credit supply and output in a crisis.

Keywords: JEL classification: G01, G20, G31, H57 Credit supply, Financial crises, Fiscal policy, Credit channel, Public procurement, Fiscal multipliers, Bank-sovereign loop

JEL Classification: G10, G20, G31, H57