The Economic Effects of Public Financing: Evidence from Municipal Bond Ratings Recalibration

Abstract

We show that municipalities’ financial constraints can have important effects on local economies through a ratings channel. We identify these effects by exploiting exogenous variation in U.S. municipal bond ratings caused by Moody’s recalibration of its ratings scale in 2010. We find that local governments increase expenditures because their debt capacity expands following a rating upgrade. These expenditures have an estimated local income multiplier of 2.4 and a cost per job of $21,000 per year. Our findings suggest that debt-financed increases in local government spending can improve economic conditions during recessions.