 Okay. Thank you. I hate to erupt all these conversations. It seems like everybody is so glad to see so many different people from so many different circles. But it's time for our next panel. This panel is on stabilization policies and federal systems. The panel will be chaired by Byron Lutz, one of our own, a senior economist in the fiscal analysis section of the research division here at the board. I won't say very much about Byron because as people have been saying, the bios are available. But I will say Byron's research spans a range of issues in public finance, urban economics, and labor economics. And something that's not in the bio, Byron is also the board's top expert on state and local expenditures and tax policy. Byron, I'll now hand it over to you. All right. So I wanted to start by saying how pleased I am to be here today. Although I only was able to interact with Ned on a handful of occasions in passing, I've certainly been greatly influenced by his work. Early on in my graduate school career, I came across some of Ned's work on intergovernmental grants. And my engagement with this work was one of the key things that led me to ultimately specialize in the area of state and local public finance. And similarly, when I first got here to the board and was getting up to speed with my policy responsibilities, I found the series of Brookings papers that Ned had written from the late 70s through the early 90s to be among the absolute most valuable sources out there on the topic of the connection between the macroeconomy on one hand and state and local governments on the other. And then just to set another example, just this week while working on a project on how state taxes mitigate income inequality, I found myself consulting a number of Ned's pieces, including one of the ones that Sheldon referenced in the first panel. So the topic of this panel is stabilization policy within federal systems. Stabilization as almost everyone here surely knows are just policies which aim to dampen business cycle-induced fluctuations in income, employment, and other economic outcomes. In the context of a federal system like we have in the U.S. with multiple layers of government, the question very naturally arises as to what the appropriate role of the different layers of government is. And this is particularly interesting as regards fiscal stimulus, changes in government spending, taxation, and transfers. Ned had quite a large body of work in this area, which at least in my mind could be broken up into two broad sets. The first looked at the possibility that the federal government could pass income down to states and localities in the form of grants during times of fiscal stress in the hope that the states and localities would use this income to mitigate expenditure cuts or put off tax increases. I think it's fair to say that the results of this agenda led Ned to be somewhat skeptical of this approach. The other agenda looked at the possibility that states might be able to act completely independently with their own resources as agents for stabilization. And Ned argued in a series of articles starting in the mid-80s that states could in fact do this. And as the panelists will discuss today, this put him pretty sharply at odds with the conventional wisdom in the field of public finance. So I'll now move to doing the introductions. I'll follow the lead of others by keeping this extremely brief. Our first panelist is going to be Jim Hines, who teaches at the University of Michigan in both the economics department and the law school. His work has focused on taxation, where he's worked on a truly wide range of topics. I think it's safe to say there's almost no corner of the field that he has not touched. Our next panelist will be Jerry Carlino, who is a senior economic advisor and economist at the Philadelphia Federal Reserve. Most of Jerry's work has focused on issues of regional and urban economics. He's the associated editor of several journals. And recently he's been working on an agenda on intergovernmental aspects of business cycle stabilization, which is what he'll be talking about today. Our final panelist is Michael Barr, who, like Jim, teaches at the University of Michigan in the Ford School and the Law School. He's served in a number of capacities in the federal government, most recently as the assistant secretary for financial institutions. And his research has mostly focused on financial services and financial regulations. Before I pass this off to the panelists, I'll give a quick overview of where the panel is going. So Jim is going to start us off with some big picture discussion of subnational fiscal stabilization within the U.S. Jerry is then going to hone in on this topic a bit more and provide some detail through the lens of work he's been doing with Bob Inman. And then Michael will broaden things out for us to finish, both geographically by bringing in some discussion of the European Union, as well as by bringing in discussion of the monetary policy and banking aspects of stabilization. So Jim, if you'd like to start. Thanks. For me as well, it's a real pleasure to be here today. Of course I knew Ned and really admired him. I met Ned in the mid-1980s and would see him every two years or so at conferences and things like that. And I realized, actually just today in thinking about it, I realized for me Ned was my image of what a Michigan professor was like. I've been now 17 years on the Michigan faculty and honestly Ned is still my image of what a Michigan professor should aspire to be like, a really terrific guy. I think we all agree on that. My topic is fiscal stabilization through state governments. And one of the issues that animated a lot of Ned's thinking was how should fiscal responsibilities be shared within a federalist system like the United States? He had a vision and the vision was that national fiscal policy should be directed in the long run toward thinking about, you know, adjusting the nation's savings rate. That the Federal Reserve, of course, through monetary policy had the primary function of stabilization over the business cycle. But that state and local governments, state governments in particular would have responsibility for stabilizing local cycles that can vary across the country. It's this third thing that was, you know, uniquely Ned's and I think it's safe to say we haven't really tried this one very well and that is going to be my topic for this morning. Indeed, we didn't really try the first one very well either in that the federal government hasn't, I think, done what the federal government would like to do in terms of encouraging US saving. Of course the Federal Reserve is doing, you know, a yeoman's service in trying to stabilize the business cycle but it's sometimes hard for the Fed acting alone in that way. And the challenge is that state governments have really not at all picked up the baton that Ned tossed in their direction. So the really, why is that? It's because, and I'll get back to this at the end as well, Ned's vision was one of optimizing governments and as our previous panel illustrated, those are not necessarily the governments that we have. So what has been the recent US experience? Well, you know, we had this episode that started in 2007 and then heated up after that. And the federal government did a significant expansion of government spending and in contraction and government tax receipts. So there was an incredibly heavy fiscal stimulus in the federal government for the crash of 2008 and its aftermath but state governments did not. To the extent that state governments did anything counter-cyclical during that period, it was basically because they got transfers from the federal government to do things like pay unemployment insurance and various welfare programs. But the state governments were hamstrung during the crisis. And the reason they were hamstrung is that their revenues fell dramatically because they rely to an ever-increasing extent on income taxes at the state level. And here's the thing about income taxes, they tax income. And so when income goes up, you get a lot of revenue and when income goes down, you get a lot less revenue. This is even more true if you tax corporate income, which is even more pro-cyclical than individual income. But it's true as well of individual income. There are a lot of reasons to want to have income taxes, don't get me wrong. But one of the challenges of income taxation is that the receipts go up and down over the cycle. And what happened in the crash of 2008 is that state receipts fell because incomes fell and when receipts fell, expenditures fell. So the state and local sector, in the middle of the crisis, is firing teachers and other state employees at the same time that you've got a jobs crisis going on in the country and absence of aggregate demand and a lot of other reasons to want to not cut state expenditures. But nonetheless, that's what happened. So here's what the pattern looks like. This schedule kind of takes us from World War II until now, until pretty recently. And the upper, the solid line is the federal government. These are expenditures as a fraction of GDP. The dotted line on the bottom is the state and local sector. And the shaded bars are NBER defined recession periods. What you see in this is that in general, both of these loci show expenditures going up, or what kind of looks like going up a bit as a fraction of GDP during recessions. That's mostly because GDP is falling during recessions. And if you take a ratio and GDP is in the denominator, then of course the thing is gonna start to look up a little bit. But it's also deliberate policy. I mean, there's a great big spike up over there on the right, which is, that's the stimulus, that's 2009, and that's what the federal government did in order to combat the recession. So what you see is that the federal government is a much more sharply counter cyclical agent than our state governments. And the reason is that state governments, it's not true that they run balanced budgets. It's their days when I very much wish they would run balanced budgets compared to what they do, but they're much more balanced than the federal government is. They've given themselves much less discretion to vary over the cycle. And as a result, it has proved very difficult for states to fight recessions in their own locations. There's nothing, as Gramlich's work points out, there's nothing intrinsic about that. There are a lot of reasons to think it would be a good idea for states to expand spending if state economic conditions are weak in order to try to stimulate them, and conversely, in a boom, not expand spending as much. It just hasn't been the practice. That's the issue. What we're seeing in the data is the practice, not what would be a better practice. There is this separate piece, which is if you break states down, larger states tend to be more pro-cyclical than smaller states, larger in terms of population, I mean like California, for example. This graph is plotting the income sensitivity of tax collections of different states. And the horizontal axis is the state's population. So the states to the right are big states, California, Texas, New York, Florida, et cetera. And the ones to the left are the Delaware's and South Dakotas of the world. And as we say in social science, what you see here is an upward sloping line. You just have to look at it correctly. So what that is telling you, this upward sloping line, is that bigger states have more income sensitivity of their tax collections. When state income rises, tax collections go up, but that's very true for California. By the way, the reason it's very true for California? California relies super heavily on income taxes. The top California tax, state tax rate is 13% currently. And California collects pennies from its property taxes, even though the property is terribly valuable there, but since Prop 13, they just haven't used property taxes. So you have very strong income sensitivity of tax collections, which isn't necessarily all bad, except that it is bad when you have this, which is this is the income sensitivity of state expenditures. And you'll notice you see roughly the same pattern now, with the big states spending, having much greater income sensitivity. So there we have California in the upper right again. When incomes go up in California, the state government spends a lot. When incomes go down, the state government cuts its spending a lot. That's exactly the opposite pattern of the one that Ned was urging, urging many very cogent and thoughtful pieces. Why does this happen? Well, in Sacramento they do what they want to do. And it's very difficult for some places to resist spending when money is available. And the only way you can cut spending is when it isn't available, which is when you're in a recession or incomes fall. It would be lovely if that pattern corresponded to prudent financial planning, but it doesn't, as a general matter, correspond to prudent financial planning. So part of the reason California was running chronic deficits was that you had enormous spending increases in the late 1990s, when you had the dot-com bubble and tax revenues suddenly rose. The spending proved they cut it, or had slower growth in the 2000s, although it's easier to increase spending, it turns out, than to cut it. And you just had this constant ratcheting up of state expenditures every time incomes grew in California. And so you have this irony of the richest state in the country winding up in the greatest debt, kind of like the lottery winners who wind up in debt at the end of everything, because they can't control themselves. And some of the, especially the big states, seem to be in that situation. You might have thought that the big states, like the Californians of the world or New York's, would be more like the federal government. I mean, the California is the size of many countries, but what has happened in our system is that the states have relied on the federal government to do the counter-cyclical work for them, and instead just kind of give in to the passions of the moment with their pro-cyclical policies. I believe that this is related to a phenomenon that Ned is the first one to write about, which is something known as the flypaper effect. Ned is certainly the first author to have written down the phrase, the flypaper effect. The flypaper effect for the two or three of you in the room who haven't worked on it is the phenomenon that money sticks where it hits. And what that, it was first observed in the context of intergovernmental grants, which is that when states would receive grants from the federal government, it would increase their expenditures, maybe not one for one, but very close to one for one, in a way that defied neoclassical logic. It's since been observed in many other contexts as well, and there's controversy about it, as Byron Lutz alluded to. He's got an important paper on this subject and so do others. Ned was doing a paper on intergovernmental grants 40 years ago and had a conversation with Arthur Oaken, who was then at Brookings, in which he was trying to describe this grant phenomenon. And according to Ned, Oaken said, well, you mean the stuff comes in and then it just sticks? They take the money in and then they spend it right away? He goes, yes. And Oaken apparently said it's like flypaper, which some of you will remember what flypaper is. Before we had screened windows, there were those smelly strips of paper that hung from the ceiling and insects would get stuck on them. The insects stick there, and it's likewise the expenditures stick. It was, frankly, the phrase that wound up sticking, which is Ned coined this the flypaper effect and in 2014 still we call it the flypaper effect. This is going on in the big states and it's a big problem from the standpoint of, from the standpoint of counter-cyclical policy and almost surely from the standpoint of wise policy. Well, why has this been happening? As I mentioned, it's part of what has happened for American states is that they've relied to an ever-increasing extent on income taxes. And the reason you've been relying on income taxes is that states have not been relying on property taxes. Property taxes used to constitute a much higher fraction of state and local finance. But what happened starting in the 1970s is you had an anti-property tax movement, which was part of a more broad anti-tax movement. But there was an anti-property tax movement in which you have many states, including, by the way, Michigan, but California, prominently, Massachusetts, many states have property tax limitations. And so the gap has been filled in with income taxes, which is fine if, I mean, it's not entirely fine because there are a lot of attractive features of property taxes, but it would be better if you could control yourself with the income tax revenues. But states, alas, have not done so. One of the consequences of income tax reliance is you have much more income tax volatility over the cycle. And there's been some terrific work by Nathan Sigurd is at Utah about this. Here is a plot of the deviations from trend of state and local tax collections. And what you see when you, and this is over the years, starting in 1950, what you see is that the amplitude of this cycle has, of course, revenues go up and down with the business cycle, but here's the thing, they're going up and down a lot more over time than they were before. That's what we're seeing here. These are in percentage deviations. If you ask, is it true of all 50 states? No, it's not true of all 50 states, just 45 of them. So 45, the lightly shaded states, which includes Michigan, have not seen dramatic increases in the volatility of their tax collections, but 45 have. So where does that leave us? I think it is fair to say that as an empirical matter, states have not handled revenue volatility very well. We rely more on income, states have relied more on income taxes, which doesn't have to necessarily be bad from a cyclical standpoint. In fact, there are some attractive features of income taxes from a cyclical standpoint because it's an automatic tax cut when incomes decline. The trouble is that states have not been capable of controlling their spending very well. And in particular, what counter cyclical policy requires is that you control yourself in the booms. When things are going well, you kind of take it easy. Yes, you can have spending go up, but not as much as revenues are rising. And that's been the challenge for state governments. The politics has just not worked that way. That is not what Ned Gramlich had in mind. What Ned Gramlich stood for was prudent, wise, forward-looking policy, and we would do well to pay heed to what he suggested. Great, thank you, Jim. I would add one comment. I very much agree with Jim that the states have not picked up the baton of acting as stabilization agents. It is worth noting though that they've at least made some attempts in this direction. At the time when Ned started writing about this topic, only 10 states had rainy day funds, which was one of the principal mechanisms by which you would engage in stabilization policy as a state government. Now 46 states have them. And the reserve funds in those rainy day accounts were at record levels by a wide margin as of 2008. They were simply swamped by a shock that was massively larger than ever anticipated. Of course, it's a very open question, as Jim alluded to, whether states politically could ever build up reserves in those accounts large enough to withstand such a shock. But it is interesting to note they've at least made some movements institutionally to try to do it. So up next we have Jerry. So I did not have the pleasure of knowing Ned. Clearly it was my loss. However, he has had a deep, I owe him a deep intellectual gratitude for, as I think you'll see in the presentation that I'm going to give today. So as Jim has already pointed out, states have plenty of tools to engage in counter-cyclical fiscal policy. And indeed, Ned was a proponent of states using these instruments to counter the business cycles. So why don't we do this? Why aren't states engaging in counter-cyclical fiscal policies? And there's a conventional view on this. And the conventional view is that that only national governments should engage in stabilization policy. And this goes back to Wally Oates in 1972. And there are certainly four main reasons for not engaging in fiscal policy. The first is that states are open economies. So they import and export a lot. And any stimulus would be sort of exported to other states. So there's high spillovers involved. Residents of the state don't get the full benefits of any fiscal policy. If that isn't enough, even if there weren't for the spillovers, there would be any demand for new jobs that was created as part of the fiscal policies would be diluted by the entry of other workers from other states and other countries. So that the benefits of the policy would not really accrue to state residents. The third point is that states face constitutional and statutory balance budget requirements, which makes it difficult for them to run deficits. And then finally, the future tax costs are the responsibility of the deficit-creating states while the benefits accrue to all members of the union. And by the way, this issue is not only important for US states, but it's also important for countries that are in a monetary union, such as the EU. So now, knowing Ned, you're probably not surprised that he called this the old taboo against state fiscal policy. And Ned challenged the conventional view and he pointed out that, look, he's pretty much just assumed that these important export propensities are large. They may not be that large. We don't know. He's also pointed out, why would workers migrate if the shocks are temporary? Workers migrate across states if they see one state has longer-run advantages than another state, but certainly they're not gonna migrate because of a short-term fiscal policy move. Yes, there are balanced budget requirements, but they differ across states and they largely refer to capital budgets, right? So that states routinely run deficits on their capital account. For example, they can borrow through their capital account to finance construction of roads. Another point is that many states already engage in some form of stabilization through their insurance trust funds and I would probably add to that, their highway trust funds as well. So Ed conducted a very nice simulation exercise and where he finds that it's optimal for states to alter their expenditure or tax rates in response to shocks by anywhere from 10% to 40% depending on the size of the states. Larger states would do more towards the 40% smaller states on the other direction. Importantly, he noted that this response is higher if the federal government is willing to bear the cost of some of the state's debt. Now, following in the guiding light of Ned, Bob Inman and I, sorry, Bob Inman and I looked at the ability of state deficits to influence states' employment growth and population growth over a roughly 40-year period. We used an all-encompassing definition of a deficit and we called own state deficit because we removed the federal transfers from the real, to get at the effects of the state deficit along. So what we look at is expenditures in the state less, you know, all state sources of, well we're looking at expenditures less revenue from all state funds which include the general fund, capital fund, insurance trust fund, and pension funds. So we have a very broad definition of expenditures and revenue. So our analysis uses a panel of states over a long period of time and we find for a representative state, a deficit of around $390 per person increases job growth by about 1.2%, which turns out to be about 34,000 jobs. So yes, states can stimulate their economies. However, we also find there are large spillovers. If we do a cost-benefit analysis, what we find that it cost about $72,000 for a state, for the typical state to create one job. A Bob Inman who did a back of the envelope calculation says that an average job is $45,000, so certainly this doesn't work, the numbers don't work. However, if we include the positive spillover effects to neighboring states, the collective tax per job falls to $44,000, which is more favorable in terms of the cost-benefit analysis, suggesting that some sort of coordinated policy among neighboring states might be a way to go. But given the significant spillovers that we find, each state has an incentive to free ride. And if that's the case, state officials will under-provide job creation policies for their residents. If so, then this is an argument for centralizing stabilization policy. But if we centralize stabilization policies, it seems reasonable to ask what's the role for states if the federal government is coordinating fiscal policies. And the argument there would be is that states have a lot of localized knowledge of their own economies. In addition, if the federal government wants to spend a lot of money and wants to spend it in a hurry, it really needs state government to help out. So in this view, states are agents of the federal government. However, states have their own agendas and there is often a disconnect between central government intentions and state responses. And this is especially through during times of deep recessions. Because of this concern, Ned studied the response of states to a national effort to stimulate the economy during the 1975 recession. And what Ned found was that didn't have much of an effect on the Niagara economy because he gave the money to the states and they saved it, they didn't spend it. Sure, they'll eventually spend it but they spend it after the recession's over. Again, following Ned's leave, Bob and I recently looked at data on grants and aid from the federal government to state governments for the period 1960 to 2010 and we again confirmed Ed's findings. I see this is on the next slide. So we find that an aggregate income multiplier for federal aid to states of only 40 cents for every dollar of aid. Federal transfers are again saved and slowly spent in future years. So what are we to do? Well, what Bob and I find is that in contrast, if masking aid is targeted for welfare services, which is only paid when spent, we find a bigger bang per buck associated with welfare aid. The multipliers associated with increased welfare aid are as large as 2.3 and these are statistically and economically significant even into three years. So welfare aid has a stronger and larger lasting impact on the private economy that does project aid or general fiscal relief to state and local governments. So what are the implications for our finding for the American Recovery and Reinvestment Act? So we applied our estimates to evaluate the relative performance of ARA style policies as a stimuli for GDP growth during the past recession and what we find is the most effective of the individual policies is direct tax relief to households and firms. The least effective are direct federal purchases and transfers to states in form of project aid, the shovel ready projects. The majority of the impact of welfare aid is somewhere in between. So in a simulation exercise, we reallocated the ARA money to the two most effective policies which resulted in about a 30% improvement in GDP growth relative to GDP growth under the original mix. So in sum, we would argue that Ned was right. State governments can stimulate their own economies but there are important positive spillovers across states as a consequence, coordinated policies will be preferred. Finding programs in institutions that best facilitate this coordination is an important next step. So that's pretty much a summary of. Thank you. Great, thank you, Jerry. Michael Barr will conclude. Like the other speakers, I wanna say what an honor and a privilege it is to be here today with you. Ned was an extraordinary individual and a wonderful mentor and friend and I feel honored to have had the chance to work with him on a number of issues starting in the 1990s around the subprime. What was, in the early 90s, we had already thought of as the subprime mortgage crisis and Ned was also a wonderful and welcoming me into the Michigan family when I moved out of the government into teaching at Michigan and so I'm just deeply honored to be able to say even a few words at this event in his honor. What I wanna focus on today consistent with the other panelists is fiscal and financial and monetary stabilization policies. I wanna do that around the fulcrum of the 2008 financial crisis and bring in a little bit of a comparative perspective by also examining the European Union. And I wanna make three basic points. The first is financial, monetary, and fiscal policy before 2008 was not so great. The second point is that in response to the financial crisis, policy was mostly in the right direction but not enough. And the third point is that in the wake of, sorry, in the US and not in Europe. And the third point in the wake of the financial crisis, a policy direction is again mostly in the right direction but not enough. So the basic story that you've heard with respect to Ned's work and is the starting point for this conversation here is that a subnational stabilization policy can be a useful compliment to primary role of the federal government which is using monetary policy to stabilize across cycles with the caveat in Ned's work that becomes important in this instance unless the contraction is severe and extended. Because the primary concern with fiscal stabilization policy at the national level is the lag time to recognize that one should have one and the lag in implementing it in any meaningful way. So in the lead up to the financial crisis we had the opposite of a counter cyclical policy. We had a pro cyclical policy relatively pro cyclical monetary policy although one can debate extremely pro cyclical regulatory policy and highly pro cyclical fiscal policies. So just on the regulatory side, massive increase in leverage in the system, huge increase in leverage in the financial system and increase in leverage in the household sector. And that fed a boom that was problematic. And this is just a look at cross country and you can see there's a bunch of variation but the general trend for countries that got themselves into trouble was an increase in leverage. This is just looking cross sectionally a significant increase in household leverage. And fiscally, lots of countries, very few countries using the boom to engage in sound fiscal policies, most countries with again some variation using this time to rack up a massive and unsustainable debt that left them in a weak position to respond to the financial crisis when it actually hit. Similarly, again, looking cross sectionally at the increase in the financial sector, big increases in the financial sector relative to GDP in all these countries and that is in part a regulatory problem. And again, looking now at the US only but looking at leverage in the large US banking organizations, you can see a relative decline in the amount of equity cushions held by those institutions in the lead up to the financial crisis. So instead of using a period of rising asset values and rising health in the economy to build larger cushions in the event of a downturn, the opposite was occurring, the system was getting much more leveraged and you could show a worse picture for the increase in leverage in the shadow banking systems if you looked at the financial sector as a whole, relative decline in equity positions on a risk-adjusted basis is much worse. Another way of looking at this is loan to value ratios and you can see loan to value ratios are instead of becoming more protective as asset values are rising in this period in the lead up to the financial crisis, loan to value ratios are deteriorating. One important but not only aspect but one important aspect of this story is of course the rise of subprime mortgage lending that was at relatively low levels in the late 90s but exploded in 2003, four, five and six until people realized that home prices could flatten or maybe even go down and then they did. And that obviously was the triggering event for an asset implosion in the housing sector that led to an asset implosion across the financial sector that led to massive liquidity runs and the near collapse of the financial system. And I'm gonna make some impolite, in politic remarks, there was a debate about this in the 90s and the 2000s and some people were frankly wrong about it and other people were right about it and Ned was right, Ned was right and Ned was right really early. Ned was right in the 1990s when most people had never heard of a subprime mortgage loan Ned was worried about it and fighting about it and trying to change policy about it and he was a real honest to goodness hero on this issue and underappreciated for his role in calling out the enormous abuses that were taking place in the marketplace and saying that federal policy had to address them and fix them and I think we would all have been extraordinarily better off if his voice had been heated in a much more rigorous way by policy makers. So that was the lead up to the crisis, what about the crisis response? The crisis response on a monetary, the level of monetary policy was extraordinary and rapid and massively effective in a way that Ned's theory would suggest and enormous creativity by this institution and its leaders in developing those policies under I think extraordinary circumstances, circumstances that the country hadn't seen in 80 years. And that emergency liquidity and monetary policy had a huge role in stabilizing the financial sector, stabilizing the economy and helping the health of the economy overall. And there was also at the same time, something that I think Ned would not have predicted which was a reasonably rapid fiscal response. And in the fall of 2008 and the spring of 2009 and then subsequently the federal government was able to act relatively quickly in dispersing extraordinary sums of money in ways that helped stabilize the financial system and the economy, the TARP funds that were dispersed largely through the financial sector and then the massive use of fiscal stimulus. First in the Recovery Act and then in a series of subsequent smaller steps that put lots of funds into the economy relatively quickly. And obviously there are two basic problems with this chart and one is that the amount and level of funding didn't keep going up for long enough to be as effective as people I think now think it would have been. So about 1.4 trillion in stimulus funds over the period 2009 to 2013 and maybe double of that would have been a lot better. Obviously enormous political opposition to this day both to what was already done and to the idea of doing more. And the second basic problem with this picture was of course that the same time the federal money was flowing at the door there was significant state and local retrenchment as both our earlier speakers were pointing out. State and local governments are firing school teachers and police officers and firefighters and construction workers when we needed to have more police officers and firefighters and school teachers and construction workers and that was a significant drag and still is on the ability of these fiscal measures to be helpful. In Europe just by point of comparison so why is Europe kind of interesting because Europe has a, not for all of it but for most of it a centralized monetary authority and it has a bunch of things that we call nations that have their own independent fiscal policy. So it'd be interesting to see whether sub-national in this case sub-supernational policies could be used to offset the effects of a financial crisis or to get ready for harder times by preparing in earlier times building up rainy day funds and the like and as with the sad experience that we discussed earlier that turns out not to have been the strategy employed in Europe. Again consistent with Ned's theory but contrary to what Ned would have wanted. So first on monetary policy just you know comparing the central authority in Europe with respect to monetary policy in part because it is something of a clutch that it is built together out of a set of political compromises among the member states acted more and partly because of ideology acted more slowly in responding to the financial crisis than the Federal Reserve did. And that was a problem for Europe in terms of its ability to grow and you can see also even though there's some significant movement there also even after significant decline eventually decline in interest rates and a gradual increase in the balance sheet of the ECB some mistakes that end up costing Europe a lot so premature tightening for example in 2011 significant drag for their system. Again some of that was a matter of ideology or choice and some of it a matter of the political structure of the ECB but as a matter of choice at least until Mario Draghi came in the end of 2011 there was a significant belief in the ECB that the right answer from a fiscal policy perspective was austerity and the right answer from a monetary policy perspective was maybe more muted than would have been helpful. There was also a problem in response to the crisis with respect to financial policies so the US benefited from a quite early a quite transparent series of stress tests that resulted in private sector capital raising for financial firms and Europe had a less successful set of stress tests in part because there was less rigor to the test they were less transparent and the inputs into the stressing included things that people knew were demonstratively false at the time that they were included like nobody ever can default on sovereign debt. You guys aren't laughing. I thought that was funny. I'm not as you can see beneath begging for my laughs I have to do it around the dinner table with my kids I have to do it in the classroom. Fiscal policy at the same time is again from the fiscal side you would think the sub-supernational units that is the nation states would use the opportunity of a severe set of recessions to engage in expansionary fiscal policy but most of the states either would not or could not do that. Some of them would not do that because they believed from an ideological perspective that austerity was the morally correct response to profligacy and some of them because they had been so profligate in the past that they couldn't actually plausibly spend in the wake of the financial crisis. And so thinking about the first category Germany the second category Greece and you can see them on that spread. So what about the future? I think the lessons of this financial crisis tell us a few things. First in terms of stabilization policy there actually might have to be a role for everybody. Monetary policy, fiscal policy at the federal level and importantly and additionally paying attention to financial regulatory policy in the lead up to and the aftermath of a financial crisis is absolutely critical. So all kinds of measures that are countercyclical capital measures for example or countercyclical LTV measures efforts to bolster the resiliency of the financial system in advance of a recessionary period are absolutely critical. And second still an important role for subnational or sub-supernational policies that is as yet largely unrealized and of which there is I think a significant opportunity for better work. Second thinking about how to measure this problem not just in terms of price stability and unemployment but also in terms of the brittleness or lack of brittleness of the financial sector that is an explicit focus on systemic risk as being an important factor in thinking about policy monetary, fiscal and financial policy. And third the basic point that in advance of a crisis is the right way of thinking about policy and building up buffers and during the middle of a crisis acting fast and massively would be better than acting slowly and intermittently. Thank you very much. All right, thank you Michael. I'll start by offering the panelists an opportunity to add any further remarks they'd like or to respond to each other. I agree. Okay, well before I, did you carry? Okay, well before I open it up to the audience then I'll take my prerogative as the moderator to offer a couple comments. The first thing, the first item is closely related to some of Jim's discussion. It involves the stabilization at the state and local government level. I think one of the really important but underappreciated fact about the last cycle was the different cyclical dynamics of the state and local sector's tax spaces. As Jim discussed, state taxes which are mostly sales and income taxes were extremely elastic to the cycle and simply plunged following the financial crisis. In contrast, property taxes which are almost all at the local level and constitute about one third of total state and local collections tend to instead follow the market value of real estate with a significant lag of a couple years. This is because property tax assessments are lagged and most states have some type of cap or limitation on growth in the tax which induces lags. So these different cyclical dynamics created an interesting situation where in 2008 and nine, state taxes simply fell through the floor but at the same time property taxes continued to rise in excess of 5%. The situation then reversed itself in 2011 where state taxes were rebounding quite strongly and property taxes had started falling by quite a bit. So these cyclical dynamics very inadvertently I think led to quite a bit of stabilization of the total tax revenue stream to the state and local sector and this inevitably gave the sector quite a bit more breathing room than it would have had otherwise. It's important to note though that it's not clear how relevant this will be in the future because lacking the important housing market element of a downturn you might not get the same dynamics. We could arrange for another housing downturn. Yeah. Okay, well. So we could study it better. Yeah. I'm not sure that would pass the cost benefit analysis but it would be interesting for those of us in this room I imagine so certainly. My second observation concerns some of Jerry and Bob's work. I think it's important to note that Jerry and Bob's work is part of a really growing and generally very well done literature on the possibility of grants to state and local governments affecting or increasing overall economic activity. On the face of it, this literature might be viewed as a little distressing because it comes to very different conclusions. We have a number of papers including Jerry's also worked by John Taylor and as well as some of Ned's work from the earlier period which simply suggests that this is not a great strategy for spurring overall economic growth. On the other hand by this point there are about 10 papers which find very much the opposite which suggests that it is very effective. The interesting thing about the dichotomy here is that all the papers that find a large effect are very narrowly targeted at looking at the current episode following the financial crisis and in one case during the Great Depression these were periods of immense fiscal stress and economic slack. Whereas the papers that do not find much of an effect tend to take a much longer view and do an analysis over a period which was not overall characterized by its fiscal stress or economic slack. And I think these contrasting results actually make a lot of sense. For one reason states and local governments may be much more willing to spend grant income immediately during a severe fiscal crisis simply because during a severe fiscal crisis your reserve funds have been depleted and your choice is if you don't spend the grant income you're gonna have to cut very politically sensitive things like firing teachers. Whereas during good economic times the stakes are just much lower. And I think in the context of today's proceedings it's very interesting to note that Ned himself in a 1979 American Economic Review article made this exact caveat to some of his own work which had concluded that grants aren't that effective. The second point here is that even if the money is spent by state and local governments that spending's impact on the economy or the multiplier may very well be larger during periods of extreme economic slack with high unemployment and low capacity utilization there may just be less scope for the crowd out of private activity that might mitigate the effect during normal times. So this is all just a long-winded way of saying that I think when we think about the ability of grants to state and local governments to spur economic activity and assess the literature it's just really important to think about the context of the time in which they're deployed. And I'm certainly not the first to make this observation. Valerie Ramey has a very nice paper that makes the same observation. So at this point I'd like to open it up to the floor. Thanks, I think there's a link between my discussion about poverty programs in this section which I hadn't thought about before. It's been a popular mantra among Republicans to block grant food stamps and Medicaid. And I've always thought that was a horrible idea for distributional reasons that they'd figure out a way to spend it on something others. But the stabilization effects would be dreadful because we got a huge stabilization effect from the automatic increase in food stamps and in fact the expansion of food stamps and Medicaid grants to the state. So I think there's, I've always thought about it. It's a terrible idea on distributional issues. You give it to the states and it will be a lot less anti-poverty effective. And the panel says it would also be worse on a stabilization basis. I think this is the point where we're all supposed to say yes. Hi, my name's Jack Gramlich. I'm here to ask a question. I was just wondering about how in times of like across the board economic growth, what there is for states to do to make themselves more attractive to businesses without moving towards like unnecessary or bad pro-cyclical fiscal policy. Bad policy doesn't make you attractive to business. I think good policies do. The issue is, it's a great question. And it a little bit puts the finger, I think, on a lot of the issues that have arisen throughout the morning, which is, you know, we've talked about how states are in different positions than the federal government. There is this open question, whether states make better decisions than the federal government. And it's an open question. This is something people have debated for centuries. You know, whether federalism is a good thing or a bad thing, how much you want to have of it. And it's a great thing to talk about because we don't know the answer. You know, we have different situations. States, to some degree, experiment. And to some degree, they do really dumb things. You know, but the same would be true of the federal government. And there is this, again, I think entirely unresolved question of which one you want to rely on more. And you know, how much discretion that you want to give to different levels of government. Completely unresolved. On the question of how you get, how you make things more attractive to business. Well, I mean, there's a lot of reason to think pro-business policies will do that. And there's plenty of evidence of that, too. But I think most of us think, with less evidence, to be sure, that the most effective of the pro-business policies are sustainable ones, which tend to look a lot like kind of smart policies generally. You know, that you want to live within your means and plan for the future and take care of your population and do the things that kind of everybody would want you to do. I would say invest in infrastructure and education. That's, and my reading of the literature confirms that. It's not just taxes, it's what you get for your tax dollars and spending on infrastructure and education is really powerful. And I think it's worth noting in the context of these comments on infrastructure, that state and local investment in infrastructure has simply collapsed over the last six years. It currently stands a full one-third where it stood around 2000. It has fallen, excuse me, by one-third since around 2005. I agree that infrastructure is probably pretty important. I do think it's hard to find powerful evidence of that. It doesn't mean it's not true. It may very well be true. I think it's hard to find powerful evidence of it. Adopted them. Curious if enough work has been done on the rainy day funds of the 45 states that have adopted them to make them meaningful and anything other than political illusions. You know, I'll offer, there actually hasn't been as much work on this as you might hope. Brian Knight has a couple of papers on this which generally suggests that they are effective at serving as a stabilization device. You know, in a number of states there are aspects to these stabilization funds which limit their usefulness. A couple of states have caps on how large they can grow and obviously removing these caps. I also believe that there's some evidence that rule-based rainy day funds, which when tax revenues grow by a certain percent, some of it has to go into the rainy day funds have been a bit more effective. But I think this is a topic that actually needs a fair bit more work. So this is a picking up on Jack's question and it hadn't occurred to me in quite this way before. So states, unlike the federal government, the federal government, when the economy is running hot, wants to cool it off, it doesn't like inflation. Some of us may remember inflation. But state governments, when the economy is running hot, except in very unusual cases, are saying, wow, this is great, employment's increasing, property values are going up, life is good. And with the exception of a few municipalities who sometimes really don't like growth, governors pretty much always like growth. So they have an asymmetric notion of what to do in the business cycle. In hard times they wanna spend more money for all sorts of good reasons, including keeping the school teachers employed and maybe stimulating the economy. And in good times they don't wanna spend more money, but they still wanna do things that will cause the state to grow. And so there really is, if you wanna think of states as agents of counter-cyclical policy, except for rainy day funds, it's very difficult to think, I think it's hard to think of what's going to make states want to be contractionary on the upside. Well, you have to wake up one day and realize not every day is Christmas, you know? And that's the challenge, because when the tax revenues are rolling in, you feel like every day is Christmas. And I think the answer is you need better politics. Now, I don't know how to get you that. I'd add that there's at least maybe a teeny glimmer of hope that California, who's been one of the worst offenders in this, actually has behaved relatively well over the last few years. And there's some sense that at least temporarily that they've learned the lesson that they need to save during the relatively good times. But even, I agree with my run on that, but even California, you know, the elephant, the fiscal elephant in the California room is they're not taxing property. They should be taxing their property. They have enormously valuable property and the politics are whatever they are. And so they don't, and it's crazy. Maybe they're anticipating that the coast is gonna fall into the sea. That must be it. That must be it. They're really properly priced now. And they have, they should have higher gas tax. Yeah, I would just add on to Jim's comment. Proposition 13 has been a huge problem for California as far as managing their finances by pushing the collections for the state as a whole at the state and local level onto very volatile basis. I would add one thing that was really interesting to me over this last downturn. You made the comment that even in contractionary times they wanna be stimulative. I think one thing I learned just sort of anecdotally was that that is not always the case. I recently had the opportunity to interact with about 30 budget directors on the executive side of state governments. And I asked all of them why they weren't engaging in more infrastructure spending, given that they're not subject to balanced budget restrictions in their capital budgets. And down to the last individual, the answer was as simple as we are in a period of austerity and it is not appropriate for us to be engaging and borrowing and spending. So I think there is, I'm not sure they're always seeking to be expansionary at all times, which was surprising to me. I think Byron's right. And I think it's part of the reason that there's also so much hostility across the country to fiscal stimulus. You know, if you talk to a normal human being, they would say, one times are tight, you tighten your belt, tough it out. And I think people translate that to the state level and they translate it to the national level and people end up being four things that are exactly backwards from what we should be doing at the state and national level. Hi, Andy Moxham from, I worked at the Census Bureau and we're hanging around one day and a billion dollars dropped on us from the ARRA and said go hire 100,000 people. And so we had 100,000, so we all of, you know, suddenly we spent a lot of money and that was one impact of the ARRA. OMB blessed us with about 150 pages of rules that came with the money, which was tracking spending, but also one of the rules was to spend it as fast as you can. Another agency in commerce with whom I also worked had some grants for called broadband grants that went out to different agencies, mostly other states and they were told to spend money over a certain period of time. That lasted about two years and still going on, as a matter of fact. Jerry, I was interested in what you said about the Recovery Act money. I'm also interested in the comments you had about the stimulative effect or anti, you know, cyclical effect of spending this money. And then you also hear about infrastructure. If you spend money on infrastructure, it's gonna come naturally slower than if you spend it on what we did at census, which was immediate jobs. Is there a balance there? And also, Byron, according to your little glimmer of hope comment, do you consider that the way they passed the Congress, past ARRA was actually a recognition of some kind of need for more robust anti-cyclical activity? Sorry to mush a whole bunch of questions in, but that's. So you have, yeah, so in our research, my research with Bob's shows is that, I guess the point of what I'm saying today is that states can engage in their own fiscal policy is not going to have a big effect because of these large spill overs. The best thing that a federal government can do is to use states as agents. The best policies are those that get money to credit constrained households because they spend it. And who are credit constrained households, poor people. So the programs, the matching aid programs, you would think in theory, you're going to have the biggest bank per buck and our evidence says that that's the case. So that's the message of, I think the bottom line of the work that I've done with Bob. I don't know if I address it as part of your question. I would address one part of the question about the infrastructure. I think you're right about the long lags to infrastructure spending. I think virtually everybody who has looked at this has concluded that all the CBO's work on this has found very long lags on this. I think, perhaps a little bit perversely in the current downturn because the weakness in economic activity extended much longer than was expected. This may have not been as big of a design flaw as it might have been. Plus at the end, you get infrastructure. Yeah. Yeah, which is an investment as opposed to consumption that has very different implications for growth. That's not useful for short-run stabilization. That's the problem. And the money's fungible. That's the other issue. Yes. Yes. I would agree with that. Sorry. Oh, okay. Just a couple of points in this country. We tend to get recessions every sixth year and 2015 is the sixth year, just a random observation. I also want to recognize Harvey Galper, who was a partner in crime with Ned in early work on state and local finance. Person who was doing the special analysis in OMB at the time, we read those things. I would recommend the issue of stabilization funds in states dependent on severance taxes like Wyoming, who got killed in 83 when they spent all the money from their boom and it went away. And then this last boom, they saved it and now they're spending from that. So that's a really important thing. But what I observed in the stimulus was so much of the Medicaid money was retroactive. Almost a quarter of it went out the first, Medicaid money went out the first month, just went to the balance sheets of the states, didn't stimulate anything, didn't save the program. And what I also saw despite the ongoing local tax revenues was that a lot of teachers got laid off by local governments and the states got back on transfers to local governments. And in the future, whether it be next year or the future, shouldn't the federal government pay some attention to investment in education in terms of a stimulus program? I mean, there was education money, but it really didn't go to education. I'm gonna answer first, because I know nothing about it, except you have to be right. I'd offer a couple observations. One is just the general observation that just because certain elements of state and local government spending fell does not constitute evidence, in my opinion at least, that the stimulus was unaffected. The shock to the sector's tax base simply had no historical precedent, making it extremely difficult to recover the counterfactual expenditures. Expenditures may simply have fallen less. I would also ask for the observation as far as the Medicaid. I agree that in large part that was just general aid to the states that because it was temporary, and it was a matching grant, but because it was explicitly temporary, it's unlikely they made programmatic changes in response to something that was only gonna last around two years, and that effectively converts that into just general aid. However, there is some really strong evidence by one of my colleagues here at the board, Laura Fivison, that that did spur additional spending in other areas of the state budget, and that that actually contributed to increased employment in the general economy across the states. As far as the severance payments, it's certainly the case that in a number of states in recent years, those have been wildly important. Over the last number of years, both Texas and Alaska have been sitting on rainy day funds that have exceeded 50% of their annual budgets. Yeah, North Dakota is another episode, but that's very limited. It's only a handful of states that are very dependent on natural resource extraction. Even in those cases, as the Wyoming example illustrates, we're not going all the way. When you think about the problem during the really bad times, say after the crash, the fiscal problem that we wound up in with this cutting expenditures and having difficulty even European nations, for that matter, having difficulty expanding, really the nature of the problem is what they were doing when the times were good. That's when the problem came in because they were not husbanding resources when the times were good, and therefore you didn't have them when the times were bad. You contrast what Wyoming or even Texas and Alaska are doing now with what Norway has done. Norway has a lot of revenue from North Sea oil, and it helps that you know that it won't last forever in the North Sea, but what Norway has done is taken those funds, put it into a trust fund, and only when it gets tons of revenue from taxing North Sea oil, it's only spending a tiny portion any given year because it's basically taking the return from the trust fund instead of spending the flow of the income coming, and that's like, okay, they're Norwegian and they're looking forward, but because the culture was built up with long winters and so you got to be forward looking. Why can't America do that too? Michigan to do that. Not like Norway. Was there in the back? So I'm wondering if the panelists can speak a little more to whether at the state level we can think a bit more about automatic versus discretionary stabilization policies. So at the federal level, the automatic adjustments, particularly in revenues, and also somebody mentioned food stamps, they're actually extremely important and may dominate even usually what we do on a discretionary basis, and the timing is actually just right, right? You get it, it happens automatically, usually at the right point in the cycle. And so quick two examples at the state level, but I hope you'll expand on one. Jim, you talk about the sensitivity of the tax collections, but the fall in tax collections at a state level is actually counter-sectoral, as you're saying, you do to it's adjustment on the spending side, you don't get that effect. And you could also argue that probably, because the states you're talking about it, when it's especially affected by capital gains taxes, you probably got the wrong people's incomes falling because they're probably not gonna consume that much more one way or the other. But another example would be pension policy where we have this horrible tendency among actuaries and economists even at times to say, well, let's figure out what the expected return on the pension plan is. And all of a sudden the stock market booms and interest rates fall. We say, gee, the expected geometric mean rate of return has increased when we measure from 29 forward when in fact the interest rates have fallen, the earnings price ratio has fallen. If we say in pension plans required that the assumed rate of return in the future fell when good times, if you know what I mean, and rows and bad times, that would be counter-cyclical. So I'm just curious whether there aren't several things like this we could think about on an automatic basis to take into account that the policy makers are still probably gonna do a lot of the things that you're talking about they're gonna do on a political basis no matter what. I thought when you were making your pension point that I could see David Wilcox's lips moving. So maybe I'll just say a word about pensions and then give it to Jim to tax. I totally agree with you. I mean, there's, it's not just a cyclical question for pensions, it's a fundamental accounting problem and it's all messed up in every state and every locality and it needs to get fixed. Yeah, I completely agree. I mean, the state pension funding situations and national tragedy that, you know, I think there's general agreement on that. The question is, you know, how do you, what do you do going forward? People have been talking about economic theories from the old days and I'm old enough to remember them too. And I was raised with something called the balanced budget multiplier and the balance budget multiplier for you young ones in the audience is a thing where if the government raises more money and spends the same amount of money that it raises, you nonetheless get basically Keynesian stimulus to the economy because there's less leakage from government expenditure than there is from individual incomes. And that's kind of what we've got going on at the state level, you're right, Jean, that the state tax collect income tax collections decline when incomes flag during recessions, but the problem is that spending declines too. And so you've kind of got the balanced budget multiplier going in the wrong direction during the recessions and then in the wrong direction during the booms. And so that's, you know, to the extent that one still believes in the balance budget multiplier, which, you know, I think is part of our thinking about counter-cyclical policy than we just have this problem. The pension, you know, this sort of gets back to the question from earlier about when we think about state pensions and we think about state policy in general, there is this question of like how wise are our institutions? Are they wise? Are they forward-looking? Can we rely on them? And the answer is, of course, they're never perfectly wise and they're never perfectly forward-looking because it's people and people are not. But is there a way that we can make them a little better so that we have fewer of these problems going forward that I think is part of our challenge? I would, on the pension question, I would offer the observation that it's pretty clear that many states over the last five years have actually used their pension funds to engage in deficit spending. Many of them have cut back on their contribution because they're not required to make any level of contribution on an annual basis. And in this way, we're able to mitigate the amount of expenditure reduction they had to do in their general budget or put off tax increases. This may have been beneficial in the short run, but of course the bill will come due. It appears it's coming due not that far in the future. As far- It would also be one thing if they were doing that in a downturn and then in a good time, they were putting in more than they are legally required to do and bolstering there, but none of them are doing that. That's a very good point. In fact, during the late 90s, many states instead of building up the trust funds responded by increasing the benefits, which didn't cause the trust funds not to build up enough. I mean, we had criminal versions of this in Detroit where people were giving out benefits that weren't even owed when the trust fund went up because the economy was doing better. So it's just horrible policy in both good and bad times. To respond to your automatic stabilizer question, so these are changes in state spending and taxes, which occur automatically with no action of state policy makers. I do have some work on that with my colleague, Glenn Follett, which shows that conditional on the size of the state and local sector relative to the federal sector, that the automatic stabilizers at the state and local level are much smaller than at the federal level. They're only equal to about one third. So they're not unimportant, but they're fairly much dwarfed by those at the federal level. Then you'll only miss five minutes of lunch. Before, okay, I'll give our panel a, so one small matter. Someone left a blackberry. The phone number is 267-844-300, I'm one of the chairs. So I won't be sitting up here. Trust experiment. Okay, we'll resume. There's an istial blackberry. Excellent point. We'll resume for our keynote speaker at one o'clock. Thank you.