In a blog post yesterday Paul Krugman repeats a claim made by Christina Romer (in footnote 18 of a speech at Hamilton College last November) which he says answers “in devastating fashion” the empirical paper by John Cogan and me which shows that stimulus (ARRA) grants led to lower net borrowing by state and local governments. But Romer’s claim actually provides no such answer or rebuttal.
Romer argues that state balanced budget laws would have prevented states from increasing their borrowing by any significant amount in the counterfactual event that ARRA did not exist. Her argument does not apply to our paper for two reasons. First, state and local governments can increase and decrease their borrowing by considerable sums for infrastructure projects (schools, roads, light rail, etc.) within their balanced budget laws. Second, net borrowing (which is what Cogan and I examined) is the difference between the net increase in liabilities and the net acquisition of financial assets. As ARRA funds came in, state and local government increased their net acquisition of financial assets, and thereby reduced net borrowing compared to what they would have done in the absence of ARRA. Neither state balanced budget laws nor conditions in municipal bond markets, would, in the absence of ARRA, prevent the state and local government sector from increasing net borrowing simply by buying fewer financial assets.