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 most exposed to the spending shock results in lower non-performing loans at banks. In turn, banks increase lending to small businesses in not-directlyshocked counties where they operate branches. This effect is driven by constrained banks. The additional lending capacity created in the constrained intermediary sector amplifies the effects of a stimulus. The economic activity enabled by this ‘credit multiplier’ is important to consider when assessing the overall impact of a stimulus.

Keywords: Government spending, Fiscal multipliers, Bank lending, Small firms, Spillover effects