Macro Fiscal Policy in Economic Unions: States as Agents

49 Pages Posted: 22 Oct 2013

See all articles by Gerald A. Carlino

Gerald A. Carlino

Federal Reserve Bank of Philadelphia

Robert P. Inman

University of Pennsylvania - Finance Department; National Bureau of Economic Research (NBER)

Multiple version iconThere are 3 versions of this paper

Date Written: October 2013

Abstract

The American Recovery and Reinvestment Act (ARRA) was the US government’s fiscal response to the Great Recession. An important component of ARRA’s $796 billion proposed budget was $318 billion in fiscal assistance to state and local governments. We examine the historical experience of federal government transfers to state and local governments and their impact on aggregate GDP growth, recognizing that lower-tier governments are their own fiscal agents. The SVAR analysis explicitly incorporates federal intergovernmental transfers, disaggregated into project (e.g., infrastructure) aid and welfare aid, as separate fiscal policies in addition to federal government purchases and federal net taxes on household and firms. A narrative analysis provides an alternative identification strategy. To better understand the estimated aggregate effects of aid on the economy, we also estimate a behavioral model of state responses to such assistance. The analysis reaches three conclusions. First, aggregate federal transfers to state and local governments are less stimulative than are transfers to households and firms. It is important to evaluate the two policies separately. Second, within intergovernmental transfers, matching (price) transfers for welfare spending are more effective for stimulating GDP growth than are unconstrained (income) transfers for project spending. Matching aid is fully spent on welfare services or middle-class tax relief; half of project aid is saved and only slowly spent in future years. Third, simulations using the SVAR specification suggest ARRA assistance would have been 30 percent more effective in stimulating GDP growth had the share spent on government purchases and project aid been fully allocated to private sector tax relief and to matching aid to states for lower-income support.

Keywords: American Recovery and Reinvestment Act of 2009, Fiscal policy of United States

Suggested Citation

Carlino, Gerald A. and Inman, Robert P., Macro Fiscal Policy in Economic Unions: States as Agents (October 2013). FRB of Philadelphia Working Paper No. 13-40. Available at SSRN: https://ssrn.com/abstract=2343121 or http://dx.doi.org/10.2139/ssrn.2343121

Gerald A. Carlino (Contact Author)

Federal Reserve Bank of Philadelphia ( email )

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Philadelphia, PA 19106-1574
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Robert P. Inman

University of Pennsylvania - Finance Department ( email )

The Wharton School
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Philadelphia, PA 19104
United States
215-898-8299 (Phone)
215-898-8200 (Fax)

National Bureau of Economic Research (NBER)

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United States

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