Stealth Fiscal Stimulus Is Complicating the Fed’s Job
State and local governments are flush with cash, which may enable the economy to avoid a recession. The trade-off may be elevated inflation.
Federal Reserve Chair Jerome Powell’s job just got tougher.
Photographer: Julia Nikhinson/Getty Images
Lost in the debate over whether the US economy is headed for a recession is the extraordinarily robust condition of state and local government finances. Flush with funds, municipalities are providing a sort of stealth fiscal stimulus that promises to keep the economy from going into a downturn, but also makes the Federal Reserve’s battle to tame inflation even harder.
Historically, when economic growth slowed and tax collections fell short of trend, state and local governments were compelled to cut spending. Yet, by cutting spending they weakened the overall economy even more. But over the years state governments established rainy day funds to mitigate this effect. The idea was that states would save money when the economy was good and then use those savings to offset lower revenues when times were bad. Leading up to both the 2001 and 2008 recessions, the median state had the equivalent of 17 days of operating costs in their rainy day funds.