Tyler Cowen writes

Paul Krugman asked a good question yesterday: “…if states and localities can borrow freely, how do you explain the drastic fall in their spending I have been documenting?”

This is maybe too literal an answer to address his macroeconomic concerns, but I view state and local government spending as falling because voters wanted it to, either directly or indirectly.  Inflation-adjusted net worth per capita is still below the level of the late 1990s, and not returning any time quickly (an important point), and so voters/spenders wanted to cut back somewhere.  Local government is the target they chose, and not just in the Red states.  My point is not that the median voter is all-wise, but rather the Austerians are the guy next door.  Voters apparently don’t see marginal local government activity as having the same value as cash in their pockets.  There still may be a role for a federal fiscal bridge to ease the transition, but in democratic systems some expenditure declines are in the cards, just as the rollicking revenues of earlier years led to big boosts in state and local spending.  We are not as wealthy as we thought we were, and greater federal borrowing can blunt this reality only to some extent.  The notion of a voter ideal point ought to somewhere enter the analysis.

I’ll say a bit since I actually advised State and Local Governments on this issue and in some cases helped write the budgets.

I would find it highly shocking that median voter preferences played any serious role in the period from late 2008 through 2009. The primary concern for most state and locals was survival.

Unlike the Federal Government which has lender of last resort, local governments in particular can and have gone bust. The scale of the recession was an extinction level event.

You might remember that Wall Street analysts were predicting massive municipal defaults and that we were locked out of many of the bond markets. You may also have noticed that there were in fact very few defaults.

The primary goal, certainly for the State and Local governments that we worked for and as far as we can tell most other folks we talked to was to hold on as long as we could.  This meant a general mantra of: cut what is easy now, or cut what is hard later.

So very few politicians were talking about increasing expenditures and I don’t know of any economists, budget directors or finance officers who were pushing this.

To be quite honest I am not immediately sure how much money would have had to come down for the Federal government for us to push an increase in expenditures. Large multiples of what did come, that’s for sure.

Almost everyone I talked to – and how could you do anything else – had a “When ARRA ends” model and none of them looked good.

This is why you actually say many of the painful cuts come after ARRA was over. For example, cutting K12 employment is for local governments very difficult.

And as you can see the line was held on that until 2010

FRED Graph

So in some sense both Paul and John are right.

My general take on John Taylor’s paper is that it is an interesting piece of academic work but is not terribly relevant from a policy perspective.

It is no doubt the case that both families and state and local governments expenditures rose very little in response to stimulus. We were facing a credit crisis. The whole point is that folks were afraid that they were going to run out of money.

If you then send people a bunch of money are they going to run out and spend it on goods and services? Not likely.

At least in the case of State and Local governments ARRA allowed us to smooth out the cuts, at least at first. In to 2010 it became impossible to do even that and so you ended up with the decline.

The worst part about this whole thing is that some people seem to be drawing the lesson that it should have been more difficult for state and local governments to save.

Why, oh why would you do that to us?

It would simply mean that the hard cuts would have had to be harder and that the decline you are seeing now would be even worse.