Why Federal Economic Stimulus Matters for State and Local Governments

By: Christopher Ryan Crisanti

Fiscal stimulus is not meant to simply be a generous act by the federal government to provide financial help to struggling Americans. Rather, the public policy serves a major economic purpose to stimulate economic activity by increasing aggregate demand for goods and services.

In normal economic times, the Federal Reserve relies on increasing or decreasing interest rates to help steer the economy. When interest rates are low, the cost of borrowing is cheaper which will lead to greater consumer demand to spend. Consequently, when rates are high demand is slowed yet those who are the lenders are able to yield greater return on their investment.

However, when the economy is depressed and interest rates are already near zero, the federal government must pursue a new approach to get the economy back on track. This approach involves expanding fiscal policy, or having the federal government to spend a lot of money in order to stimulate the economy and increase aggregate.

The massive spending by the federal government yields economic multiplier effects, which ultimately leads to more spending by consumers, jobs, and growth. This is because economies are built on the macroeconomic effects of consumer spending on goods and services. When I go to Dunkin’ Donuts and spend money on a coffee, that is part of a person’s income. But how much I spend is relative to my ability to, as well as my savings.

By increasing an individual’s marginal propensity to consume (MPC) more than their marginal propensity to save (MPS), the spending is put back into the economy and increases aggregate demand. During economic downturns, households, businesses, and lenders have a greater MPS than MPC because they hold back on their savings and investments due to economic uncertainty. The efforts of fiscal stimulus by the federal government attempts to temporarily flip this so that consumer confidence increases in a time of broad-based economic weakness.

State government and municipalities are no different in that they need money to provide services, finance projects, and service their debt obligations. When there is an economic downturn, state and municipal coffers are depleted and their ability to operate effectively and efficiently is compromised. As I have wrote in a prior column with The Des Plaines Valley News, local governments have experienced a major decline in sales tax revenue due to a lack of aggregate demand from the COVID pandemic.

Moreover, it’s people who make up government. They, like every other working person, rely on a paycheck from employment to meet their financial needs. When state and municipal budgets feel the effect of a national recession, the dire economic consequence trickles down to those public employees; everyone from police officers to firemen, social workers to school teachers.

As more of these public employees are laid off, it only adds to problem of an already depressed economy: government can’t operate effectively, taxpayers can’t get the services they need, and (probably most importantly) the public employees who were laid off will cut back on their own spending.

Unlike the federal government, states and municipalities do not have a fiat currency or monetary sovereignty. The state of Illinois cannot print it’s own money or move interest rates to steer the economy or combat inflation. The federal government is the only sole issuer of all U.S. currency. State and local governments, just as individuals, businesses, and lenders are simply users of the currency.

The state can technically expand fiscal policy through borrowing. However, it is very limited in it’s capacity to due so because it is burdened by budgetary constraints and the reality that it is just a user of U.S. currency. The federal government does not share the same constraints as other entities because of its ability to use both fiscal and monetary policy to its advantage. Only the federal government could, and should, pull off the much-needed economic relief of this capacity. Any concerns of federal debt and deficits are debunked through an evaluation of history, structure of the country’s monetary sovereignty, and analysis of the its debt to GDP ratio. But that is a topic for another column.

By allocating fiscal stimulus to state and local governments, something that the first economic relief payments in early 2020 failed to do, state and localities will have more resources available as they coup with tough decisions to make budget cuts and scale back government operations. Additionally, the relief will provide the state and local governments the cushion it needs to help keep workers employed, enhance aggregate demand in the economy, and efficiently deliver to the public services it expects and deserves.

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