Association for Public Policy Analysis & Management

 Do state level countercyclical fiscal policy tools effectively stabilize the regional economies during recession years?  This paper digs into the working mechanisms of sub-national government’s stabilization function in the public finance theory, by testing the efficacy of a particular countercyclical fiscal policy tool at the state level. The Great Recession with its sluggish subsequent recovery put both (federal) monetary policy and (federal and state) fiscal policy to a real test of their efficacy and reliability. Had these policies been designed well and implemented, the outcome of the Federal 2008-09 stimulus packages should have obtained designed goals. One puzzle was, the policy outcome barely meet the expectations. Economic stabilization has long been considered as a key function of central governments but whether the state governments also play a role in stabilizing their regional economies is less understood.

This paper attempts to analyze whether states with a particular countercyclical fiscal policy tool have been able to stabilize their economies during recession years. Budget stabilization fund (BSF), often referred to as the rainy day fund, is a state-level reserve fund that is accumulated during non-recession years to use during economic downturns. While by definition, BSF are expected to serve the purpose of budget stabilization, a number of states have explicitly mentioned in their legislation that BSF is for stabilizing the economy. In this research we focus on Maine and Michigan where their BSF are designated for use in retaining or stabilizing jobs in their region, respectively. This paper focuses on employment as a key measure of economic stability because it is on one hand an important part of overall economic stability and on the other hand, it is a long-held policy goal by lawmakers in some states.

Here we indirectly test whether states that have BSF designed to stabilize the economy and employment, are able to retain their workforce in the public sector. We exploit the differences in state laws as an opportunity for natural experiment. We conduct tests by examining the effects of maintaining a sizeable reserve in the BSF on two outcomes in these two treated states, over two periods of recession(the first wave in early 1980s and the second in early 1990s). We conduct two sets of analyses for each Maine and Michigan to compare pre and post recession outcomes between one treatment state and a synthetic state that had no BSF balance until the end of recession period. First, we examine the impact of BSF on state unemployment rate, by using the Bureau of Labor Statistics data.  Then we examine the impact on job retainment in the public and non-profit sector at the micro level, by using CPS March supplement data. Through empirically testing the effects of a particular type of  state level countercyclical fiscal tool, we hope to contribute to a better understanding of the role of subnational governments in stabilizing their regional economies.