Association for Public Policy Analysis & Management

The Great Recession that happened at the end of 2007 brought state governments into a serious fiscal crisis, making the total revenues of state governments decline by almost a half from fiscal year 2007 to 2009. Facing the dramatic decline of revenues, state governments are supposed to cut down a large proportion of their expenditures (this research focuses on the current operation expenditures) in order to meet the balanced budget requirement. This will make the expenditures of state governments deviate from the previous trend and increase the volatility of state government’s expenditures. However, according to the collected data, the overall current operation expenditures of state governments do not decline, and there does not exist an obvious volatility during the great recession period. What are the reasons leading to this phenomenon?

This research intends to explore the reasons, and it supposes that the Rainy Day Funds of state governments help themselves alleviate the fiscal crisis and smooth the expenditures to a certain degree. Of course, other factors, such as the increasing federal transfers through the American Recovery and Reinvestment Act of 2009 (ARRA), cannot be ignored, and these variables are included in the data analysis.

Previous researches on Rain Day Funds mostly concentrate on its effect on state government savings and fiscal stress and stability. Or they focus on the development, structures, and size of the RDFs. Some researchers have focused on the effect of RDFs on smoothing government spending, however, few of them have probed into the effect of RDFs in the Great Recession period. This research intends to make a contribution from this perspective.

The fundamental work of this research has been finished. The main part of data are collected from the Fiscal Survey of States by NASBO, the Urban Institute, and the United State Bureau of Census. The time series mixed-effects method is adopted in the regression analysis, and some robust checks have been conducted. The preliminary results show that the size of Rainy Day Funds balance do negatively relate with the volatility of state government expenditures, and the deposit and withdrawal rules attached to the Rainy Day Funds play an important role in determining the effect of Rainy Day Funds. This research has some important policy implications: 1) RDFs with a strict deposit rule make the volatility decrease. In order to keep expenditure stable, state policy makers that adopt RDFs should assign a strict deposit rule; 2) States that intend to stabilize their current operation expenditure need to keep RDFs large in a good economic period to provide them more financial resources in fiscal recessions.