2.Paying off State Debts instead of Boosting Expenditures

As stated from reading the materials in the module, grants of federal funds to state governments accumulated after 2008 and the net borrowing of state governments declined. Many state governments were heavily in debt at the end of 2008, with borrowings more than $160 billion. For these states, the receipt of discretionary federal grants beginning in 2009 was a godsend, because it allowed them to start paying off a number of existing debts.

Debt Repayments are not Immediate Flows of Spending

The funds intended by the federal government to enter the nation's flow of income and expenditures did not reach that flow. States sent them to creditors.

Rather than direct the federal funds to additional spending, therefore, the state governments used the bulk of ARRA federal grants to pay off part of debts generated by spending projects completed in prior years. Most estimates indicate that of the federal "stimulus" funds given to state governments, less than 5 percent were directed toward new spending within the nation's flow of income and expenditures. Thus, a 95 percent direct fiscal offset resulted. Instead of providing an immediate boost in state infrastructure spending on roads, bridges, and the like, nearly all of the federal funds transmitted to state governments for spending instead were saved.

a. Why might federal spending on roads, waterways, or national security be less subject to direct expenditure offsets than spending on health care or education?

b. What might account for the fact that estimates of effect time lags for fiscal policy often differ considerably across different types of government expenditures?