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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.
