Insights Blog

Will the Fed Rescue State And City Budgets If Congress Won’t?

June 18, 2020

With Washington in partisan deadlock and revenue shortfalls in city and state budgets across the country, where can local governments turn to avoid economic collapse? Some are hoping the Federal Reserve could be the answer, writes SCEPA Fellow Rick McGahey in a new Forbes blog.

 

In the wake of COVID-19, reports from the front lines of American cities are grim. The US Conference of Mayors “fiscal pain tracker” reports hiring freezes, employee furloughs and layoffs, reduced or stopped capital spending, and some tax increases as state revenues fall. The news ranges from bad (4% revenue decline in Arkansas) to worse (35% revenue decline in New Mexico).

In a dire situation like this one, the Fed could help plug budget gaps, and a new $500 billion Municipal Liquidity Facility (MLF), established earlier this year, was a historic step in that direction. The MLF will allow the central bank to purchase state and local debt directly, a role they previously avoided for fears of being involved with local politics, explains McGahey.

Unfortunately, the MLF has thus far been limited. High interest rates, like the estimated 3.83% rate the Fed will charge Illinois, is leading cities and states to avoid MLF in favor of the regular market. Instead of offering a viable solution to local governments, the Fed has just created a “lender of last resort” program. Meanwhile, the Fed has already used its authority to help corporations and “vulture funds” without the same penalties.

Critics like David Dayen have called on the Fed to make changes to the MLF’s structure to make it more practical and attractive, while others have called for the Fed to use its authority in other ways to ease the burden on local governments. But so far, the Fed has been unresponsive to these calls. Despite the potentially valuable role the Fed could play in helping states and cities to get through the economic downturn, fighting for direct federal aid remains the only viable option.

About SCEPA

SCEPA works to focus the public economics debate on the role government can and should play in the real productive economy - that of business, management, and labor - to raise living standards, create economic security, and attain full employment.