Working Paper

Expansionary Austerity: Reallocating Credit Amid Fiscal Consolidation

Abstract: We study the impact of public debt limits on economic growth exploiting the introduction of a Mexican law capping the debt of subnational governments. Despite larger fiscal consolidation, states with higher ex-ante public debt grew substantially faster after the law, albeit at the expense of increased extreme poverty. Credit registry data suggests that the mechanism behind this result is a reduction in crowding out. After the law, banks operating in more indebted states reallocate credit away from local governments and into private firms. The unwinding of crowding out is stronger for riskier firms, firms borrowing from banks more exposed to local public debt, and for firms operating in states with lower public spending on infrastructure projects.

Keywords: Crowding out; Government lending; Subnational debt; Banks; Emerging markets;

JEL Classification: D72; G21; L33; P16;

https://doi.org/10.17016/IFDP.2021.1323

Bibliographic Information

Provider: Board of Governors of the Federal Reserve System (U.S.)

Part of Series: International Finance Discussion Papers

Publication Date: 2021-08-04

Number: 1323