DP16511 Expansionary Austerity: Reallocating Credit Amid Fiscal Consolidation
We show expansionary fiscal austerity via reallocation of credit supply, but with a raise in poverty.
For identification, we exploit the introduction of a Mexican law limiting the debt of subnational
governments along with matched credit register, firm, bank, and state datasets. After the law,
states with higher ex ante public debt grow substantially faster, despite larger fiscal consolidation
(higher taxes and lower public expenditure). Banks operating in more indebted states reallocate
credit supply away from local governments into private firms, with stronger effects for banks with
higher exposure to local public debt, consistent with lowering crowding out. Effects only happen
after the law, not before, and there are strong firm-level real effects associated. The reduction of
crowding out is stronger for financially constrained firms and for firms operating in states with
higher ex ante public spending on social services over infrastructure projects. In states more
affected by the law, despite better economic effects, extreme poverty increases--especially in
states with higher ex ante public spending on social services over infrastructure--consistent with
a strong reduction for social services during the fiscal consolidation.