At least in Medicaid, the 2009 stimulus helped stabilize the economy

The two parties continue to debate the full impact of the 2009 stimulus—A.K.A. the American Recovery and Reinvestment Act (ARRA). As detailed in a terrific new book by Michael Grunwald, ARRA had its imperfections. ARRA should have been larger.  It did not prove particularly popular. Despite an inconclusive political debate, evidence is accumulating among economists that ARRA preserved million of jobs.

This month, Berkeley’s Gabriel Chodorow-Reich and Zachary Liscow, MIT’s Laura Feiveson, and Stanford’s William Gui Woolston added to this evidence base, with an article in this August’s American Economic Journal: Economic Policy. (Ungated version here). Their paper, Does State Fiscal Relief During Recessions Increase Employment? Evidence from the American Recovery and Reinvestment Act,” examined the impact of $88 billion in ARRA aid provided to states through the Medicaid program….

As TIE readers know, Medicaid is operated by state governments, and is financed through a partnership between the states and the federal government. The federal government’s expenditure share lays between 50 and 83 percent, as determined by the Federal Medical Assistance Percentage (FMAP), with low-income states receiving more favorable rates.

One component of ARRA significantly raised states’ FMAP over the period October, 2008-December 2010.  As the authors describe:

The ARRA made three changes to the baseline FMAP calculation… First, the baseline FMAP could not decrease. Second, the FMAP was increased by 6.2 percentage points above the baseline for every state. The additional match applied retroactively from passage in mid-February back to October 2008, making part of the transfer purely lump-sum. Finally, through December 2010, each state received a further increase in its FMAP based on the largest increase in its unemployment rate experienced between the trough three-month average since January 2006 and the most recently available 3-month average. To qualify for the ARRA changes, states had to, at a minimum, maintain the eligibility standards, methodologies, and procedures of their Medicaid programs that existed on July 1, 2008.  Program benefits could, however, change. The law also forbade states from increasing the share of the non-federally financed portion of Medicaid spending borne by local governments, in effect extending the fiscal relief to local governments as well.

These transfers had large, immediate impacts on state policies. Moreover, the amount of the transfer differed greatly across the states. One can therefore explore the impact of these transfers on employment.  Chodorow-Reich, Liscow, Feiveson, and Woolston performed this analysis.

These authors find that a state’s receipt of another $100,000 was associated with an additional 3.8 job-years. In effect, ARRA ameliorated sharp budget cuts that states would have otherwise made in meeting challenges posed by an economic crisis. This is a substantial estimated employment effect. This paper underscores the value of one component of the 2009 stimulus in stabilizing the economy.

This paper also underscores the difficulties and policy failures of state governments that poorly-balance expenditures across business cycles. Effective state fiscal policy would include contributions to rainy day funds and other mechanisms during good times, and increased expenditures during recessions when tax receipts decline and demand for state services increases. For reasons of political economy, voter myopia, and because of institutional constraints such as balanced budget requirements, states have performed poorly in this task. The authors end with an intriguing passage:

[S]ome states have considered adopting rules that would require the state to contribute to their rainy day fund during healthy economic times. For example, a state could be required to contribute to its fund when the unemployment rate in the state falls below a given threshold, and be permitted to tap into its fund when the unemployment rate rises to a sufficiently high level. These regulations have the advantage of constraining politicians, while helping to alleviate some of the fiscal strain induced by a recession.

I fear that these proposals will receive less policy attention than they deserve.

In any event, this paper underscores the importance of strong federal support for Medicaid, and the important benefits of the 2009 stimulus, which are easily overlooked.

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