A Rule-based Time-consistent Path of Debt Use for Subnational Governments – Debt as a Countercyclical Fiscal Policy Tool

45 Pages Posted: 10 Oct 2011 Last revised: 21 Feb 2013

See all articles by Yilin Hou

Yilin Hou

Maxwell School, Syracuse University

Date Written: February 19, 2013

Abstract

This paper formulates a model of countercyclical use of long-term full faith and credit debt by subnational governments to finance infrastructure. The model incorporates long-term debt into budgetary policy, considering debt capacity, purposes and security of debt, and equity. The proposition is to retire debt in boom years to preserve debt capacity and reduce borrowing costs, and then incur more debt at a lower interest rate in bust years to help maintain service provision and pave the way for recovery. I conduct time series and panel data tests to answer: do subnational governments use debt countercyclically? What determines the cyclical patterns in subnational use of debt? Will countercyclical debt issue and retirement be applicable? Results using US states data show that overall, US states do not tend to use debt against the economic cycle; however, I obtain evidence that at least some states adopted countercyclical debt policies. Finally, I simulate the effects of the proposed optimal debt policy with New York State. Calibration shows that such a policy could have rendered the state a much better situation to encounter the Great Recession. Findings and results of this study provide timely insight into this important issue to scholars and policy makers.

Keywords: long-term debt, full faith and credit, counter cyclical, optimal fiscal policy, states

JEL Classification: H70, H72, H74

Suggested Citation

Hou, Yilin, A Rule-based Time-consistent Path of Debt Use for Subnational Governments – Debt as a Countercyclical Fiscal Policy Tool (February 19, 2013). Available at SSRN: https://ssrn.com/abstract=1941859 or http://dx.doi.org/10.2139/ssrn.1941859

Yilin Hou (Contact Author)

Maxwell School, Syracuse University ( email )

426 Eggers Hall
Syracuse, NY 13244-1020
United States
315-443-3114 (Phone)

HOME PAGE: http://www.maxwell.syr.edu/pa/cpr/Hou,_Yilin/

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