Wednesday, July 01, 2009

Fed Letter: Should U.S. Bailout States?

by Calculated Risk on 7/01/2009 06:30:00 PM

Here is a review of a few previous state bailouts during recessions by Richard H. Mattoon, senior economist at the Chicago Fed: Should the federal government bail out the states? Lessons from past recessions. A few excerpts:

The rationale for [a bailout] is that states (which are generally prohibited from running deficits) need the money to maintain key programs, such as Medicaid, unemployment insurance, and work force training, for which demand rises during a recession. Also, this aid might help states avoid enacting spending cuts or tax increases that could deepen or prolong the economic downturn.
Three factors are particularly important in evaluating the effectiveness of such federal aid to states—timing, triggers, and targeting.
The biggest problem was found to be timing - here is a review of a previous bailout (the 1973-1975 Antirecession Fiscal Assistance (ARFA)):
Extensive evaluations were conducted by the U.S. Department of the Treasury, the Congressional Budget Office (CBO), and the U.S. General Accounting Office (GAO) to assess the federal government’s aid package in response to the 1973–75 recession. In general, the reports were critical of the effectiveness of the aid programs. Specifically, the Treasury’s report found that the aid to the states arrived after the recession had already bottomed out and did little to forestall states from taking budgetary actions that likely exacerbated the recession. In addition, a significant portion of the aid was received during the subsequent economic recovery and may have contributed to post-recession inflationary pressures. Finally, it appears that some states failed to spend the money and instead put the aid toward rebuilding state budget balances during the recovery.
emphasis added
First, many states are now cutting spending and / or raising taxes - what Krugman calls the Fifty Herbert Hoovers.

Second, aid to the states is already late and the public layoffs are already happening (and tax increases for 25 states). But the "good news" is the recovery will probably be very sluggish - so it is unlikely that the aid will not be used (or lead to inflationary pressures).

Of course states like California need more than a little aid ...