Federal Fiscal Policy Research Articles

Partisanship and Fiscal Policy in Economic Unions: Evidence from US States

Partisanship of state governors affects the efficacy of US federal fiscal policy. Using close election data, we find partisan differences in the marginal propensity to spend federal intergovernmental transfers: Republican governors spend less than Democratic governors. Correspondingly, Republican-led states have lower debt, (delayed) lower taxes, and initially lower economic activity. A New Keynesian model of partisan states in a monetary union implies sizable aggregate effects: The intergovernmental transfer impact multiplier rises by 0.58 if Republican governors spend like Democratic governors, but due to delayed tax cuts, the long-run multiplier is higher with more Republican governors, generating an intertemporal policy trade-off. (JEL D72, E12, E62, H71, H72, H74, H77)

Heterogeneous Capitalization of Local Public Goods Induced by Federal Fiscal Policy

Heterogeneous Capitalization of Local Public Goods Induced by Federal Fiscal Policy

State government saving over the business cycle

State governments in the United States use savings funds to smooth public finances over the business cycle, and these funds respond to federal policy. State savings are positive and precautionary, insuring against adverse shocks. Federal transfers to states react to national business cycles, leaving states exposed to idiosyncratic risk. State governments faced with idiosyncratic and volatile business cycles save more than less risky states. Results suggest that federal fiscal policy is an influential determinant of state fiscal policy, but does not represent a fiscal union of perfect risk sharing.

Fiscal Federalism and K–12 Education Funding: Policy Lessons from Two Educational Crises

We synthesize and critique federal fiscal policy during the Great Recession and COVID-19 pandemic. First, the amount of aid during both crises was inadequate to meet policy goals. Second, the mechanisms used to distribute funds were disconnected from policy goals and provided different levels of aid to districts with equivalent levels of economic disadvantage. Third, data tools are missing, making it difficult to understand whether funds were used to meet policy goals. Details for these results are provided along with policy recommendations.

The Unprecedented Federal Fiscal Policy Response to the COVID-19 Pandemic and Its Impact on State Budgets

In response to the COVID-19 pandemic, within a year’s time span, the federal government enacted unprecedented fiscal response bills totaling over $5 trillion. This response amount equates to about 25% of U.S. GDP in 2020. These massive allocations funded direct pandemic public health responses, along with vast fiscal support for households, firms, and state and local governments. This enormous response supported state and local government budgets both indirectly and directly, resulting in a marked budgetary shift from anticipated shortfalls to significant revenue growth and inflationary budget pressures.

Partisanship and Fiscal Policy in Economic Unions: Evidence from U.S. States

Partisanship of state level politicians affect the impact of federal fiscal policy in the U.S. Using data from close gubernatorial elections, we find partisan differences in the marginal propensity to spend federal transfers since the early 1980's: Republican governors spend less. A New Keynesian model of partisan states in a monetary union implies sizable aggregate income effects from these partisan differences. First, the transfer multiplier would rise by 0.60 if Republican governors were to spend as much from federal aid as do Democratic governors. Second, the observed changes in the share of Republican governors imply variation in the fiscal multiplier of 0.40. Local projection regressions support this prediction.

State-level implications of federal tax policies

The United States federal fiscal policy has differential impact across states. We construct a new quarterly state-level dataset that we use to analyze the impact of unexpected changes in federal personal and corporate income taxes. We find substantial heterogeneity across states, with more than half having no significant response to the tax cuts. In addition, less capital intensive states have larger responses to corporate tax cuts. Although puzzling in standard models, a model with corporate and non-corporate sectors is consistent with this evidence. Overall, our results suggest the importance of variation and reallocation across states in evaluating federal policy.

Policy Forum: Structural Deficits and Long-Term Fiscal Consequences for the Federal Government—Some Observations and Advice

This article examines the changing nature and size of public deficits in Canada. In this context, the authors draw a distinction between short-term "cyclical deficits" and long-term "structural deficits." They argue that beyond the issue of fiscal sustainability, judgments concerning the appropriateness of federal deficits should take into consideration the overall level of public and private debt in the economy. The authors then set out several proposals to improve fiscal risk analysis and deficit management at the federal level. They conclude that while the merits of a given deficit might be judged by whether the excess spending is used to fund current consumption or to invest in future economic growth, sustained structural deficits with no plan to return to balance before 2040, as projected under current federal fiscal policy, are inappropriate.

The impact of federal income tax rate cuts on the municipal bond market in the U.S.: A brief exploratory empirical note

Using annualized data for the 1974–2015 period, this study adopts a loanable funds approach to investigate empirically the impact of U.S. federal government fiscal policy of income tax rate cuts on the ex ante real interest rate yield on high grade municipal bonds. Empirical appears to show that the ex ante real interest rate yield on high grade tax free municipal bonds is a decreasing function of the maximum marginal federal personal income tax. Based upon this very preliminary, exploratory study, it follows that reducing federal income tax rates may act to raise the cost of borrowing to cities, counties, and states across the U.S.

Interaction of Government Tiers and Central Banks in a Federation: An Empirical Test

AbstractFiscal rules are necessary to protect monetary policy from the consequences of unsustainable or active fiscal policy for inflation. Monetary unions, such as the Economic and Monetary Union (EMU), require even stronger fiscal rules to avoid free riding by regional fiscal authorities on the common monetary policy. By contrast, in a fiscal federation, the federal government internalises the effect of active regional policies on the overall price level. Federal fiscal policy contributes to price stability either by enforcing fiscal rules or by adjusting its own stance. Following Canzoneri, Cumby and Diba (2001), we test whether federal and regional governments in Germany behave in an active or passive way. We find evidence of a spillover effect of unsustainable policies on other regions. The German federal government offsets the effect on the price level by running passive policies. The Bundesbank's prime objective of price stability is therefore endorsed by fiscal policy. The results have implications for the regulation of fiscal policies in the EMU.

Effects of the Great Recession on state output in Mexico

This paper investigates the effects of a battery of variables on total and sector output drops in the Mexican states during the Great Recession by estimating spatial and cross-section regression models. Our main results can be summarized as follows. First, there is evidence of spatial autocorrelation only in the case of total production and it seems to be negative, which does not support the hypothesis of interstate transmission of the recession. Second, total and sector production falls can be explained by the specialization in the production of tradable (mainly durable) goods. Third, exposure to external shocks plays an important role in the cases of industrial and services production, but not in total output. Fourth, there seems to be that federal fiscal policy has actually been pro-cyclical while state fiscal policies have contributed to mitigate the recession.

Labor Mobility and Fiscal Policy in a Currency Union

Labor mobility is commonly taken as a property of an optimal currency area (OCA). But how does that property affect the outcome of fiscal policies? In our model, we show that perfect (costless) labor mobility is not necessarily welfare-improving, since it prevents the national fiscal authorities from pursuing independent policies, opening the way to a coordination problem. With symmetric shocks, the federal fiscal policy can improve welfare by playing a coordinating role. With asymmetric shocks, the federal policy allows both countries to reach a higher productive efficiency, provided the federal government is endowed with a federal budget.

Budget Cycles, R&D Investment and Crowding Out: Government Dependent Firms and Their Peers

Federal budget shocks lead government-dependent firms to expand R&D investment whereas industry-peer firms contract. The net result is a reduction in industry-level R&D investment. We offer a novel interpretation for the crowding out of peer-firm investment, namely, that peer-firm managers respond to falling relative performance by cutting R&D to manage current earnings upward. Since R&D investment affects value, we show that these differential responses manifest is differential firm value: higher federal spending is associated with higher value for government-dependent firms but lower value for industry-peer firms. Our results highlight how managerial incentives can influence the effectiveness of federal fiscal policy.

Labor Mobility and Fiscal Policy in a Currency Union

Labor mobility is commonly taken as a property of an optimal currency area. But how does that property a¤ect the outcome of fiscal policies? We address this issue with a two country ?two period model, where both asymmetric and symmetric productivity shocks may hit the countries. We show that perfect (costless) labour mobility is not necessarily welfare improving, since it prevents the national fiscal authorities from pursuing indepen- dent policies, opening the way to a coordination problem between them, which is particularly relevant when the two countries di¤er for their intertemporal preferences. With symmetric shocks, the federal fiscal policy can improve welfare over national policies by playing a coordinating role. With asymmet- ric shocks, the federal fiscal policy allows both countries to reach a higher productive efficiency; to do that, the federal government must be endowed with a federal budget, playing a stronger role than plain coordination between countries.

Monetary Policy, Fiscal Policy, and the Housing Bubble

The paper employs monthly data to test alternative hypotheses for the causes of the large increase and subsequent decline in U.S. housing prices during the 2000-2010 decade. The empirical evidence using VAR modeling is consistent with the hypothesis that Federal Reserve interest rate policy was a cause of the movements in housing prices. In addition, federal fiscal policy and interest rates on adjustable-rate mortgages are found to be associated with housing prices. On the other hand, the interest rate on standard 30-year mortgages and a measure of net capital flows from abroad were not related to housing prices. Foreclosure rates were also important. The study finds that foreclosures and housing prices interacted: more foreclosures produced lower housing prices and lower housing prices generated more foreclosures.

Reopening the Case for a Balanced Budget Amendment

Congress has expressed interest, one way or the other, in a balanced-budget requirement for the past six decades. Yet despite numerous attempts, the legislative body has never passed a constitutional balanced-budget amendment. Most of the analysis of why we don’t yet have a constitutional amendment has been focused on the legal and political aspects of the issue. Less time and effort has been spent on economic analysis. This paper discusses how a balanced-budget requirement would change federal fiscal policy and thereby to some degree the federal government's role in the economy. The paper proposes an evaluation method for the impact that balanced-budget requirements have on the economy.

Attempting an Affirmative Approach to American Broadcasting

The Public Telecommunications Facilities Program (PTFP) was the largest source of capital funding for U.S. public broadcasters for nearly fifty years. Between 1963 and 2010, the PTFP distributed more than $800 million to support the construction of public broadcasting facilities. Though the PTFP itself was generally noncontroversial, the fortunes of the program were complicated by the partisan politics of public broadcasting and federal fiscal policy. This study provides evidence of the ambiguous and contingent nature of the American approach to public broadcasting, and demonstrates some of the problems associated with affirmative efforts by government to advance public communication.

Financial Instrument Generation in the U.S. Financial System

A four sector model of the U.S. financial system is used to analyze the June 7, 2012 flow of funds accounts (FOFA) obtained from the Federal Reserve via its data download facility. The four sectors are identified as Fed, Treasury, Banks, and Nonbanks. The four sector model provides a foundation to study how the macroeconomy generates and destroys financial instruments via credit interactions involving an aggregate Bank, an aggregate Nonbank, a federal monetary authority (Fed), and the fiscal agent of the federal government (Treasury). Financial instruments are generated and destroyed by credit deals made between banks and nonbanks, by credit deals made among nonbanks, and by credit operations necessary to implement federal monetary and fiscal policy. Net generation of financial instruments sustains aggregate demand. Net destruction of financial instruments accompanies balance sheet recessions and depressions. Banks and Nonbanks demand liabilities of Fed and Treasury (Sovereign agents) as financial security systems and thus federal government does not face a budget constraint. Congress can use deficit spending to increase levels of employment and economic output by providing markets with secure savings instruments. But Congress must avoid causing financial injustice and instability.

Okun’s law, asymmetries and regional spillovers: evidence from Virginia metropolitan statistical areas and the District of Columbia

The purpose of this paper was to examine the strength of the relationship between unemployment and GDP, to determine the extent to which this relationship has been stable in Virginia metropolitan statistical areas (MSA) during the Great Recession and to examine the importance of regional spillovers in Okun’s law. Our results suggest that regional spillovers are very important in local labor markets and in defining the relationship observed at the national level. The MSA level data further supports asymmetries in Okun’s law. The weaker direct relationship between GDP and unemployment at the local level suggests that while federal fiscal and monetary policies to stimulate aggregate demand during periods of economic recovery may be effective, over time, in reducing the unemployment rate, local economic development policies are not effective in achieving the substantial short-term reduction in unemployment needed during recovery. The strong business cycle effects observed in the state MSA, relative to the U.S., suggests that countercyclical policies are fundamentally important and should be targeted more generally to exploit regional spillovers.

Monetary union: a theoretical perspective

The work provides a theoretical analysis of monetary policy and unification in light of today’s debate among academic economists on EMU. A brief survey of the main issues concerning monetary policy is presented. The author then puts the subject in a broader perspective, showing that central questions concerning the optimality of currency areas are strictly related to the theory of monetary policy and, particularly, to the effectiveness of domestic monetary actions. Since participation in a monetary union implies loss of monetary sovereignty, the issue at hand is evaluating the effects of this loss on social welfare. Hence, the author argues that federal fiscal policy can play a crucial role in the adjustment mechanism.