As Congress debates the latest fiscal stimulus bill, commentators have been debating the effectiveness of the previous one. Much of this debate has focused on funds flowing through state capitals, cities, and towns. Depending on whom you ask, these funds have been a critical lifeline or a colossal waste of money. Both views are probably overblown. Last year’s stimulus worked pretty much like previous efforts to boost the economy through state and local governments.
Last week, Harvard’s Ed Glaeser argued that the American Recovery and Reinvestment Act was poorly targeted, going to states that did not exhibit high pre-recession unemployment. White House economic advisor Jared Bernstein countered that Glaeser had ignored large chunks of federal money, namely unemployment benefits for individuals and Medicaid aid for states (precisely the funds that were targeted to economic conditions). Meanwhile, Joshua Aizenman and Gurnain Kaur Pasricha showed in a National Bureau of Economic Research paper that, using either measure, ARRA’s “net fiscal impact” was zero.
What gives? Did Paul Krugman’s prognostications about Fifty Little Hoovers come true? Not so fast. The NBER study asked not whether ARRA boosted the economy but merely whether it stimulated government spending. (Tax cuts are completely out of the story.)
There is no doubt federal outlays grew – to the tune of about $160 billion through last December according to the CBO. But, the NBER authors say, belt tightening by state and local governments almost completely offset this increase.
As the NBER authors note, “the counterfactual of the performance of the US economy in the absence of the fiscal stimulus is hard to ascertain.” In other words, no one knows what would have happened to government spending without the stimulus. They assume it would have chugged along at typical post-World War II levels, while others think we were headed for The Great Depression 2.0. In any event, it’s certainly not hard to find a governor who says that, but for those extra federal funds, their budget situation would be a lot worse.
So was ARRA a flop? No more so than usual. States and localities generally save federal dollars for a rainy day if they can get away with it, much like individuals save tax cuts. This tendency also frustrated Washington architects of General Revenue Sharing during the 1970s and 1980s.
In any case, expecting states and localities to bail out the national economy, aid the needy, and (literally) pave the way for a new economic future may be a bit much. Next time the federal government fights a recession by sending money to state and local governments (as it probably should), we should avoid weighing this effort down with excessive expectations.
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