Some evidence about state government spending multipliers.

Three abstracts. The findings should give the pain caucus some pause.

Daniel Shoag:

The effect of government spending on income and employment is a central unresolved question in macroeconomics.

This paper employs a novel identification strategy to isolate exogenous and unexpected variation in state government spending. State governments manage large defined-benefit pension plans for which they bear the investment risk. Using a newly-collected dataset on the returns and portfolios of these plans, I show that the idiosyncratic component of their returns is a strong predictor of subsequent
state government spending. Instrumenting with this ‘windfall’ component of returns, I find that state government spending has a large positive effect on income and employment. Baseline estimates indicate that each dollar of spending raises in-state income by 2.12, and that 35,000 of spending generates one
additional job. These effects are not due to in-state investment bias, are concentrated in the non-traded sector, and are larger during times of labor force ‘slack.’ Finally, I consider how these results compare with the predictions of a standard macroeconomic model and outline which features in the model are
consistent with the empirical findings.

Nakamura and Steinsson:

We use rich historical data on military procurement spending across U.S. regions to estimate the e ffects of government spending in a monetary union. Aggregate military build-ups and draw-downs have diff erential e ffects across regions. We use this variation to estimate an open economy government spending multiplier of approximately 1.5. Standard closed economy estimates of the government spending multiplier are highly sensitive to how strongly monetary policy \leans against the wind." In contrast, our estimates "diff erence out" these eff ects because diff erent regions in a monetary union share a common monetary policy. This allows us
to better distinguish between alternative business cycle models. We show that our estimates are consistent with a New Keynesian model with GHH preferences. They are consistent with a small closed-economy multiplier when monetary policy is highly responsive (as in the Volcker- Greenspan era) and a substantially larger closed-economy multiplier when interest rates are less responsive (as at the zero lower bound).

Clemens and Miran:

Balanced budget requirements lead to substantial pro-cyclicality in state government spending outside of safety-net programs. At the beginnings of recessions, states tend to experience unexpected deficits. While all states ultimately pay these deficits down, differences in the stringency of their balanced budget requirements dictate the pace at which they adjust. States with strict rules enact large rescissions to their budgets during the years in which adverse shocks occur; states with weak rules make up the difference during the following years. We use this variation to identify the impact of mid-year budget cuts on state income and employment. Our baseline estimates imply i) a state-spending multiplier of 1.7 and ii) that avoiding $25,000 in mid-year cuts preserves one job. These cuts are associated with shifts in the timing of government expenditures rather than differences in total spending over the course of the business cycle. Consequently, our results are informative about the potential gains from smoothing the path of state government spending. They imply that states could reduce the amplitude of business-cycle fluctuations by 15% if they completely smoothed their capital spending and service provision outside of safety-net programs.