Fiscal Policy Cyclicality and Growth within the US States

Abstract

We exploit differences in the stringency of balanced budget rules across US states to estimate the effect of fiscal policy cyclicality on state GDP growth. While most states have passed laws restricting deficits, the nature and strictness of these laws vary greatly. States with more stringent balanced budget restrictions run more procyclical fiscal policy. We use the diversity in these laws as an instrument for the cyclicality of state government spending. We find modest evidence that more counter-cyclical public expenditure increases a state's average growth rate per capita. Further, our point estimates suggest that a state could increase its annual growth rate by 0.4% by relaxing the "ex-post" balanced budget restriction. This estimated effect is statistically significant at the 10% level in our basic specification, but loses its significance when we control for the initial debt to GDP ratio.

Do balanced budget practices of U.S. states make sense? Alternatives from the Eurozone

“…The strictness of balanced budget requirements exacerbates the procyclical behavior of state governments. States with stricter balance requirements are more likely to cut spending and raise taxes in response to unexpected deficits (Clemens and Miran, 2012; Svec and Kondo, 2012; Costello et al ., 2017), and states attempting to balance their budgets over a less-restrictive biennium rather than annually experience lower expenditure volatility (Kim and Wang, 2015).…”

“…Spending increases at the subnational levels in the United States, in contrast, have been found to be associated with economic growth, with larger effects during recessionary periods (Atems, 2019) and lasting effects beyond the year in which the money is spent (Srithongrung and Kriz, 2014). Moreover, Svec and Kondo (2012) found that countercyclical deficit spending at the state level leads to larger growth rates, but states with stricter balanced budget requirements engage in more procyclical polices. Bi et al .…”

“…The scholarly research we outlined above provides strong evidence that the balanced budget norm followed by U.S. states leads to suboptimal outcomes. Efforts to balance budgets during economic downturns inhibit countercyclical spending (Svec and Kondo, 2012; Bi et al ., 2023) and work against actions by the federal government to stimulate the economy (Hou, 2006; Fardoust and Ravishankar, 2013). The balanced budget norm also increases spending volatility (Hou, 2006), which reduces overall societal welfare because it lowers service levels, harms citizens and reduces equality (Clemens and Miran, 2012).…”

Fiscal Policy, Consumption Risk, and Stock Returns: Evidence from U.S. States

“…The inclusion of additional lags does not change our results. Svec and Kondo (2012) estimate a regression specification that is similar to equation 2, but their study does not investigate the impact of fiscal policy on consumption or stock returns.…”