Amplifying the Fiscal Multiplier : The Role of Banks

We study the role of banks in amplifying a fiscal stimulus. Exploiting increases in US defense spending following the 9/11 attacks, we show that increased economic activity in counties exposed to the spending shock lowered non-performing loans at banks. In turn, banks increased lending to small businesses in not-directly-exposed counties where they operated branches. This effect was mainly driven by constrained banks. The additional lending capacity created in the constrained intermediary sector amplifies the effects of a fiscal stimulus. The economic activity enabled by this ‘credit multiplier’ is important to consider when assessing the overall impact of a fiscal stimulus