whether the consequences of austerity episodes depend on the type of fiscal consolidation and show that “expansionary austerity” can arise on increased business confidence and private investment. Corbi, Papaioannou and Surico (2019), studying Brazilian federal transfers show that fiscal spending has a positive multiplier that depends negatively on the income of recipient localities (i.e. poorer municipalities have a significantly larger multiplier).<sup>11</sup> We contribute to this literature by providing granular evidence that the reduction in the supply of bank credit towards local governments can increase credit supply to local private firms, with positive firm-level real effects. Such positive effects are also present at the state-level GDP and employment. However, and consistent with a significant reduction in social public spending, we also find increases in extreme poverty, which are stronger in states where public spending in social programs is relatively higher than on infrastructure.<sup>12</sup> Empirically, while there is evidence of a negative correlation between public debt and growth (see Reinhart and Rogoff (2010) among others), establishing causality is harder. Huang, Pagano and Panizza (2020) use firm-level data to show that local public debt in China crowded out the investment of private firms by tightening their funding, especially of more financially constrained borrowers.<sup>13</sup> Similarly, Hoffmann, Stewen and Stiefel (2021), using a German panel of firms, find that when spreads on local government debt are low, local public banks use their market power to charge higher rates to their customers, reducing investment; further, fiscal consolidation worsened this effect by putting pressure on the budgets of municipal governments which increasingly borrowed from local public banks. Different from these papers, we use an exogenous negative shock to local public debt, along with detailed loan-level data, to show a decrease in public spending and increase in taxes (fiscal consolidation) but with an overall positive effect on local bank lending to private firms, particularly to the more capital-intensive secondary sector, and especially when pre-law public spending was directed more towards social services

> 11 Likewise, Braga, Guillen, and Thompson (2017) find that negative shocks to Brazilian federal transfers have a particularly negative impact on low-skill employment.

> 12 Becker and Ivashina (2018) study the impact of financial repression and find that the lending of banks to their respective governments increased during the European sovereign debt crisis, leading to a reduction in corporate credit. 13 Similarly, Broner, Erce, Martin, and Ventura (2014) along with Gennaioli, Martin and Rossi (2014) show that under credit rationing and financial frictions, government debt is especially damaging for credit constrained firms. Greenwood, Hanson, and Stein (2010), Graham, Leary, and Roberts (2015), and Demirci, Huang, and Sialm (2019) describe the relationship between the structure and level of government debt and firms’ leverage, focusing on their capital structure. Finally, Chakraborty, Goldstein, and MacKinley (2018) show that banks operating in strong housing markets increase mortgage lending at the expense of commercial lending, suggesting that monetary policy accommodation has some negative spillovers to the real economy.

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