Tap Fed Lending Facilities to Support Local Economy

By Carl Bonham, Byron Gangnes, Sumner LaCroix, and James Mak

The State and counties are facing unprecedented budget shortfalls in this fiscal year and the next.  While a combination of carry-over funds and monies from various special funds could tide the State over in the very short run, tax revenue declines that could easily top 15-20% will almost certainly require reductions in some public programs, given balanced budget rules. The State is also considering large cuts to public worker salaries.  Meanwhile, proposals are flooding in on how to help families and businesses by reducing their tax burdens. What’s badly needed right now is a holistic look at the entire fiscal situation and the full range of options that the State and county governments may be able to take advantage of to get through this unprecedented shut-down.  

For Hawaii, the best possible solution to our sharp near-term decline in revenues is for the Federal Government to borrow in the bond markets to make large direct grants to states. Such grants are in the best interest of the entire country, if we are to avoid having draconian spending cuts at the state and local level neutralize the positive effects of the federal CARES act and future federal stimulus. Unlike state and local governments, the Federal Government has vast borrowing capacity without balanced-budget restrictions, making it the ideal agent to address what is at base a transitory medical and economic challenge.   

What solutions are potentially available to Hawaii if the Federal Government fails to act? One possible option to avoid large near-term cuts to state and county spending is to take advantage of the Federal Reserve’s Municipal Lending Facility. The purpose of this facility is to allow states and municipalities to borrow despite the dysfunction in funding markets.

The Municipal Lending Facility allows for use of short-term borrowing—up to 24 months—to bridge funding gaps. The maximum amount that could be borrowed under this program is a little over $3b for the State and up to $4b if county borrowing is included as well (20% of 2017 general fund revenue).   Proceeds from borrowing may be used to deal with the impact of income tax deferrals, loss of tax revenue, increased expenses resulting from the COVID-19 pandemic, or to make principal and interest payments on existing state and county obligations.   

How will the State repay such borrowing? A temporary future increase in the General Excise & Use tax is an obvious candidate for revenues to service refinanced bonds. But such a tax increase will need to be paired with relief for the lowest-income households for whom excise taxes are particularly burdensome. Because of this, it is important to consider other forms of tax increases and to allow for rates to gradually decline as the borrowing is repaid. There is a strong rationale for the Federal Government to step in, as well, to alleviate the repayment burden. Because state and local borrowing will support CARES Act objectives of restoring employment, the Federal Government should provide additional assistance by waiving repayment of state and local government borrowing from the Fed’s new municipal lending  facility under conditions similar to those applied to small businesses accessing Paycheck Protection Program loans

We have not addressed here any constitutional issues that may arise for example due to balanced budget requirements, or if State borrowing were to exceed the debt ceiling.  We will leave these legal issues to others.  We do note in passing that governments regularly borrow short-term to fill funding gaps.  Local governments rely heavily on the property tax to fund their operations. Property taxes are usually paid once or twice per year, so there is always a mismatch between spending and revenue that is resolved by short-term borrowing.

Notwithstanding practical challenges or fear of future debt, we think it is essential for policymakers to consider the potential use of the Municipal Lending Facility or any other reasonable means of maintaining state and local spending and employment levels during the current crisis.  We cannot overstate the tremendous adverse impact that a sharp contraction in government spending will have on the Hawaii economy, and the corresponding positive effects that sustaining public spending will confer. The experience of the Great Recession is particularly informative. That crisis spawned a large economic literature arguing that more federal and state spending would have significantly accelerated recovery, and that budget-driven reductions in state spending instead prolonged the economic pain. And the severity of this crisis, at least in the short run, far outstrips the Great Recession impacts. 

How big are these effects? Very preliminary analysis by UHERO suggests that a cut of 20% to State salaries would lead to a drop in GDP of $3.3 billion over the 2020-2022 period. This reflects a spending “multiplier” of 1.5—that is the likelihood that every $1 reduction in State salary outlays results in a $1.50 reduction in overall economic activity here. In fact, the academic literature that has studied the regional effects of the 2009 ARRA stimulus and other government spending programs has found that multipliers can be even larger in periods of extreme slack, such as the downturn we are now entering.  The results from our models may very well understate the benefit of borrowing now to keep state and county spending in place.

Beyond the direct impacts on GDP and income,  spending cuts risk prolonging what has already turned into the deepest downturn the state has ever experienced. The long-term consequences of a prolonged, high rate of unemployment is a deterioration in health outcomes and a decline in worker productivity and wages that could potentially last for many years. While the pandemic has not destroyed Hawaii’s hotels, restaurants, airports and beaches, the risk of long-term damage to Hawaii’s work force is large and will be made worse the deeper and more prolonged the downturn.


Photo by Peter Fuleky.

14 thoughts on “Tap Fed Lending Facilities to Support Local Economy”

  1. The article doesn’t seem to address the necessity for state and county leadership to be extremely thoughtful about which parts of the economy they shut down, and which parts they leave open, and soon re-open quickly. I have seen an indiscriminate approach to simply shutting everything down and imposing draconian restrictions. The impact and actions related to COVID19 must be managed carefully and thoughtfully to maximize economic continuity, and the resulting tax revenues, while also protecting citizens. A balance is possible and some states are getting it right, but the Hawaii approach seems asymmetric. Taxing everyone more to make up for policy mistakes will simply add insult to severe injury and punish businesses even more.

  2. Tough problem many states, residents, businesses and local governments will need to get through. I always hope that our government officials will make better decisions on procurement and contracts as it seems to me, we waste many, many dollars unnecessarily.

    1. Greg,

      You are correct, waste is unfortunately a problem with all government procurement and can be made worse during surges in spending dealing with disasters from hurricanes to pandemics. One provision of the CAREs act requires that funding be expended by the end of this calendar year. But even during normal times, use it or loose it provisions lead to a surge in spending that is often wasteful. https://www.nber.org/digest/mar14/w19481.html.

  3. Excellent points that generate probing questions. While I agree with the overall argument that state should tap the Muni Lending Facility, I can’t help getting into the details to ask/bring up some things:
    – The recommendation and analysis adhere to standard Keynesian macro, but you make it sound as though this is unquestionably the right course of action. Seems to me that fiscal multipliers are frequently debated even in slack scenarios and even among Keynesians, so why no mention that this may be under 1.0x? Or maybe recommend how best to spend to increase the probability of a positive multiplier?
    – Similarly, why focus exclusively on maintaining services? Just looking at maintaining employment maybe? There have been studies showing greater multipliers from tax credits/payments coupled with reduced state spending, so wouldn’t this be a worthwhile option to mention also?
    – Shouldn’t state inefficiencies be addressed also? I get that legal/political constraints are often left out of economic analysis, but I really don’t think you can assume those away in a public policy recommendation like this. The article seems to take it as given that state spending won’t be subject to standard public choice challenges but this seems a bit unrealistic, particularly for HI, no?

    Hope these questions don’t come across as criticism, they’re just the thoughts I had while reading and I figured challenging questions would generate a more interesting discussion than pointing out all of the areas of agreement. Mahalos in advance!

    1. Laron,

      There are clearly many issues, and the post really only touches on some of them. As for the multiplier debate, we included a link to a pretty long list of research on this subject. https://voxeu.org/taxonomy/term/1907. The debate is by no means over, but it strikes me that there is near consensus on multipliers being much larger than normally thought during periods of extreme unemployment as we are facing. And, IF the cost of borrowing both short term and long-term remain low, there are clearly many forms of state and federal spending that have enormous social rates of return.


  4. Sorry off topic but…

    I know NONE of you will remember me, but ALL of you were my professors back in the day! (BA Economics 1990). Just wanted to say nice job in letting people see what’s going on from an Economic point of view. Good to see Dr. Mak is still kickin’! My paper with him was on the economic impact of A Convention Center…so it’s been a while! LOL.

  5. Lacking grants from the Federal government, it’s hard to see how Hawaii gets out of the fiscal hole w/o substantial cuts to payroll and/or default. Lot’s of questions. According to your link, the Honolulu population is too small to qualify for the ”Municipal” program. So the State would have to share with the counties. And how to skirt the balanced-budget requirement and pay back the $3 billion after two years (or somehow refinance?) is unclear.

  6. MAHALO for showing a wider view of economic impact from government worker paycuts and possible solutions to the projected shortfall!

    1. Sumner La Croix

      Hi BB, In a situation that none of use have faced before, it’s critical to think out of the box. Cutting wages and spending further depresses the economy to achieve budget solvency for the state. This was a disaster for the US economy during the Great Recession in 2007-2010. We need to make sure we consider all possible options before we use a traditional option that depresses the economy further. Thanks for your comments and concerns!



    1. Sumner La Croix

      Hi Mits, What’s important is to consider all possible options before using the option of wage and spending cuts. Not only do they harm state workers but they have the effect of further depressing the economy. Before moving to this option, we need to consider borrowing to cover the deficit and lobbying Congress to provide more relief to states and municipalities. Thank you for your comment and concern!


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