June 2025 – J. W. Mason

Recovery from the Next Downturn May Depend on State and Local Governments

(I write a monthlyish opinion piece for Barron’s. A shorter version of this post appeared there in June 2025. My previous pieces are here.)

As recession fears grow, it’s natural to look back to the experience of past downturns to think about how we might better prepare for the next one. Here is one lesson: We’re less likely to see a deep and persistent downturn if we can sustain state and local government spending.

An underappreciated macroeconomic development of the past decade was the sustained turn to austerity at the state and local level. Between 2007 and 2013, state and local employment fell by 700,000 — a decline without precedent in US history. If public employment per capita were the same today as in 2005, there would be more than 2 million additional people working for state and local governments. (See the figure nearby.)

Some may see this as a good thing — fewer public employees means less government waste.

But in the American federal system, it is state and local governments that provide the public services that people and businesses rely on. In our daily lives, we depend on teachers, firemen, sanitation workers, librarians and road crews employed by our state, county or city. The only federal employee we are likely to encounter is the person delivering the mail.

And from an economic standpoint, spending is spending, whether useful or wasteful. There are still debates over whether the 2007 stimulus was big enough. But what’s sometimes forgotten is that increased federal spending was accompanied by deep spending cuts at the state and local level. As a share of potential GDP, state and local spending fell by a full point between 2007 and 2013, and has remained at this lower level ever since. As people like Dean Baker and Rivka Deutsch warned at the time, these cutbacks canceled out much of the federal stimulus.

Some might argue that these spending cuts, while unfortunate, were unavoidable given state balanced-budget requirements. It is certainly true that state governments have less fiscal room for maneuver than the federal government does, and local governments have still less. But balanced-budget rules don’t mean that these governments cannot borrow at all — if it did, there wouldn’t be a $3 trillion municipal-debt market.

Balanced budgets mean many things. In some states, balanced budgets are written into the state constitution, but in others, they are simply statutes that can be waived by a vote of the legislature. In some places, revenues and expenditure must actually balance at the end of the year, while in others, the adopted budget must balance but the state may end the year with a deficit if revenues end up falling short. Most important, balanced budget rules normally apply only to the operating budget; they don’t restrict borrowing for investment spending.

Yet it was state and local investment that fell most steeply following the Great Recession. Adjusted for inflation, state and local capital expenditure fell by 15 percent between 2007 and 2013, by far the steepest drop on record. In real terms, investment spending at the state and local level was no higher in 2022 than it was 15 years earlier.

Not surprisingly, this fall in state capital spending was accompanied by a fall in state and local borrowing. Over the decade of the 2010s, nominal state and local debt was flat. In other words, net borrowing by state and local governments was essentially zero — the first sustained period in modern US history where that was true. This persistent loss of demand may have done as much as the disruptions to the financial system to hold back recovery after the 2007-2009 recession.

In 20078, there was a fiscal response on the federal level, even if it turned out to be too small. In the current climate, that seems unlikely. So whether the next recession is followed by a quick recovery or turns into a sustained period of weak growth, will depend even more on how well state and local spending holds up.

It’s not hard to imagine governments feeling compelled to curbing spending in a downturn. Many are already stretched thin even in these comparatively flush times. Maryland and Los Angeles, for example, both recently saw their credit ratings downgraded. Washington DC, whose tax base is suffering from federal layoffs, already faces rising borrowing costs.

Even where the local economy holds up better, governments may feel it is prudent to cut back on investment — a classic example of a choice that may look individually rational but, when taken across the board, is collectively self-defeating, as spending cuts in one place result in lost income elsewhere.

Nor is state fiscal capacity only a concern in a downturn. It will take years for to return many federal services to their pre-DOGE levels, assuming future administrations even wish to do so. But demand for these services has not gone away. So states — especially larger ones — may find themselves forced to assume responsibility for things like food safety or weather data, for which they previously depended on Washington. States and localities may also find themselves paying more in areas where they already had primary responsibility, like education and transportation. All this will call for bigger budgets and, at least in some cases, more debt, not just in a recession but perhaps indefinitely.

What can be done to help states find the financial space to maintain spending in a downturn, or to increase it to compensate for federal cutbacks?

The most basic, but also most difficult, requirement is a change in outlook among state and local budget officials. The idea that government should spend more in a recession is a hard enough sell at the federal level; it’s not something state (let alone local) officials think about at all. The natural instinct of state budget makers to federal cutbacks will be to cut their own spending as well; it will not be easy to convince them that they should, in effect, steer into the skid by spending more.

But circumstances can force policymakers out of their comfort zones. The problems of providing public goods and stabilizing the macroeconomy will not go away just because the federal government steps back from solving them. Even if it’s impossible for other levels of government to fully replace the federal government, small steps in that direction are still worth taking. We can’t expect states and localities — even California or New York City — to recreate NASA or NIH. But it is certainly possible for state and local governments to do more with their budgets than they currently do.

In a number of states, even capital spending is financed out of current revenues rather than with debt. Unsurprisingly, public investment in these states appears to be more pro-cyclical than elsewhere. A taboo against borrowing even for capital projects means, in effect, letting fiscal space go to waste. This will be especially costly in a downturn if a federal stimulus is not forthcoming.

Almost all states have constitutional or statutory ceilings on debt and debt service. In practice, these limits are more important than balanced-budget rules, since they apply to borrowing for capital spending as well as operations. These are worth revisiting. There is nothing wrong with these in principle. But in some cases, they may be excessively restrictive, limiting the issue of new debt even in cases where the risks are minimal and the social value is great.

Of particular concern are limits that are based only on the most recent year of tax revenue or state income, rather than an average of the past several years. These rules can impart a pro-cyclical bias to capital spending, reducing it during a recession even though that is when it is most macroeconomically valuable, and when borrowing (and perhaps other) costs are lower. It’s a perverse form of fiscal guiderail that encourages states to borrow when interest rates are high, and discourages it when rates are low.

Another important limit on state fiscal space is credit ratings. State and local budget officials are deeply protective of their credit ratings; fear of a downgrade can discourage new borrowing even when there is no legal obstacle and when the capital projects it would finance are sorely needed. These concerns are certainly understandable, if perhaps sometimes exaggerated. The problem is that rating agencies may not be the best judges of government credit risk.

In the wake of the financial crisis of 2007-2009, there was a brief period of intensified scrutiny of rating agencies’ practices. The obvious problem was the AAA ratings given to mortgage-backed securities that, in retrospect, were anything but risk-free. But on the other side, rating agencies were giving systematically lower ratings to municipal borrowers than to corporate borrowers with the same chance of default. A review by Moody’s at the time suggested that the historical default rate on A-rated municipal bonds was comparable to that on AAA-rated corporate debt.

This problem has receded from view, but it was never really addressed. More recent studies have confirmed that, after adjusting for their different tax treatment, municipal borrowers pay substantially higher interest rates than corporate borrowers with similar default risk — a difference that might be explained, at least in part, by their different treatment by rating agencies.

More broadly, credit ratings are a problematic service for for-profit businesses to provide in the first place. By their nature, they need to be freely available to anyone who might buy the rated debt. Meanwhile the debt issuer, who pays for them, has opposing interests to those of the lenders who will use them. Credit ratings are public goods; there’s a clear case for them to be provided by a public rating agency, as some economists have proposed. If bond ratings were a public service, based on consistent, transparent principles, that might relieve some of the anxiety that deters state and local governments from making full use of their fiscal capacity.

A more radical idea would be a public option not just for credit rating, but for lending. A few years ago, there was a wave of interest in the idea of a national investment authority. These proposals did not really make sense in the form they were originally put forward; given that the federal government already enjoys the lowest interest rate of any borrower in the economy, there is no use in creating a new entity to issue debt on its behalf. But there is a better case for a new public entity to lend to state and local governments, which face more serious constraints on their financing.

Unfortunately, the same federal retrenchment that calls for a larger role for state governments, also means proposals like a public rating agency or a national investment authority are unlikely to get off the ground for the foreseeable future.

The one place where capacity does still exist at the federal level is the Federal Reserve. Indeed, thanks to the Supreme Court’s ruling in Trump v. Wilcox, the Fed’s stature has been elevated; it is now, apparently, the only independent agency constitutionally permitted at a federal level.

Many people (including me) have long called for the Fed to support the market for municipal debt, in the same way that it supports other financial markets. For years, there was debate about whether this was something the Fed had the legal authority to do. But during the pandemic, the Fed made it clear that it did, by creating the Municipal Liquidity Facility (MLF), which promised up to $500 billion in loans to state and local governments.

In the event, only a handful of municipal borrowers made use of the MLF. But as thoughtful observers of the program pointed out, this greatly understates its impact. The existence of a Fed backstop meant that muncicpal borrowers were less risky than they would otherwise have been, which allowed them to access private credit on more variable terms. A study from the Dallas Fed found that, despite its limited makeup, the existence of the MLF led to interest rates on municipal bonds as much s five points lower than they otherwise would have been.

Like many pandemic measures, the MLF was quickly wound down. But there’s a strong case that something similar should become part of the Fed’s permanent repertoire.This wouldn’t have to be an open ended commitment to lend to local governments; it might, for instance, be offered only in response to natural disasters — or recessions.

Supporting state and local borrowing is presumably not a role that the Fed wants. Stabilizing demand is definitely not a role that state governments want. In a more rational political system, these responsibilities would land elsewhere. But in the real world, problems must be solved by those who are in a position to solve them. If the federal government is stepping down, someone else is going to have to step up.

Against Money

I’ve mentioned various times on this blog that Arjun Jayadev and I have been writing a book about money. The book, now called Against Money, is finally done: After two rounds of revisions, Arjun and I sent the final manuscript to the publisher earlier this month.¹ The book itself will not be coming out until next spring; I guess that’s just the kind of schedule academic publishers work on. But since I recently had to write up a summary of the book, I thought I’d share it here a bit in advance.

The goal of the book is to take longstanding arguments about the nature and function of money from the Keynesian tradition and bring them into contact with concrete historical and policy questions. Central to these arguments is a rejection of the idea that money is neutral, a veil over a non monetary “real economy. (“The Veil” was one of the working titles for the book.)

Economists — and not only economists — tend to assume that money values merely reflect the inherent scarcity and usefulness of objects existing in the world, and that the organization of economic life via money merely reflects more fundamental relationships of production and exchange. Against this, we argue that many important historical developments — from the rise of household debt in the United States to the sovereign-debt crisis in 2010s Europe — can only be understood in specifically monetary terms. Similarly, we argue that the interest rate cannot be understood in terms of a tradeoff between present versus future consumption, but only in terms of the scarcity of money itself, and that statistics like GDP are merely the aggregate of a certain set of money payments, rather then reflecting some underlying “real” quantity. Money, we argue, plays a critical coordinating role in modern societies, which has facilitated cooperation between strangers on a vast scale but which has shaped society in particular ways that are often inimical to human flourishing, and which must ultimately give way to other forms of cooperation.

The title Against Money is trying to do a few different things. First, it highlights the distinction between the network of money payments and values, on the one hand, and on the other hand the concrete social and material reality that exists apart from them, and often in tension with them. In this sense, we mean “against” in the same way one might distinguish a figure against a background; by writing about money, we seek to clarify our vision of the social world that exists around, outside and in opposition to it. Second, the title announces our criticism of familiar ways of thinking, our challenge to the dominant view of money within economics. Finally, the title links the book to a political project that seeks to transcend markets and property rights as the organizing principles of society, and to imagine a future in which money no longer defines the scope and possibilities of our collective existence.

The first chapter points to the broad hold of the idea that money is, or ought to be, a neutral representation of some underlying “real” economy, and proposes as an alternative the idea that money plays an active role as a device for coordinating productive activity. We discuss this in terms of several fundamental tensions or paradoxes inherent in the nature of money: that it functions as an objective, quantitative measurement, but there is no external quantity that it is measuring; that as a unit of measurement, it is an abstract, universal equivalent, but that in use it must always take some particular form; that its coordinating function requires it to be both rigid and elastic.

Chapters two and three explore how the two great monetary aggregates debt and capital evolve according to their own autonomous logics, actively reshaping — rather than merely reflecting — the organization of material life. With respect to debt, we highlight the importance of inflation and interest rates — as opposed to new borrowing — for its evolution over time, as well as the importance of political choices by central banks.

With respect to capital, our starting point is the tension between the conception of it as a mass of concrete means of production, on the one hand, and of a quantity of money, on the other. While economic theory treats capital as a quasi-physical substance that grows through the accumulation of savings, in reality, we argue, long run changes in measured capital are almost entirely due to changes in the value of existing assets. These in turn are explained by liquidity and financial conditions, on the one hand, and shifts in the relative social power of asset owners as against workers and the broader society, on the other.

Chapters four and five are concerned with the interest rate, the subject of some of the most difficult and important questions around money. We begin by criticizing both the conventional account of the interest rate in terms of substitution over time in a nonmonetary economy, and the related concept of the “”natural rate of interest” that is supposed to link this theoretical concept with the financial contracts that we observe around us. After rejecting these approaches to interest, we turn to Keynes’ alternatives. Keynes, we argue, offered two distinct accounts of interest — first, as the price of liquidity, and second, as a conventional price determined by the self-confirming speculative dynamics of bond markets. Both these stories, we argue, offer important insights into the interest rate, but they are two different stories, with sometimes quite different implications.

Chapter six focuses on money as measurement, interrogating the conventional practice of adjusting monetary quantities with a price index in order to compute underlying “real” quantities. In our view, what is real in an ontological sense is precisely the monetary payments and quantities. The ubiquitous practice of treating deflated money quantities as objects with an independent existence is deeply rooted in a ideological vision of the world that naturalizes markets and property rights; it distorts our efforts to understand the world in important ways.

Finally chapter seven asks what it means to imagine a world beyond money. Here we return to the idea of money as a coordination device, introduced in the opening chapter. Money is one particular way of organizing human activity — one that is especially suited to organizing cooperation between strangers, and separating specific forms of cooperation from the larger social matrix in which they are normally embedded. Thus it has played a central role in the creation of the vast division of labor that is so much more extensive in the modern world than in any previous society. But this is a not a process that continues without limit. Ongoing relationships tend to become reembedded, and conscious planning tends to replace the anonymous coordination of the market. Because we are so accustomed to thinking of productive life in terms of money, we tend to overlook the extent to which production is already socialized. Freeing ourselves from the rule of money may thus be a less utopian project than it appears.

The book is intended for a range of social scientists and humanists interested in debates about money, as well as a broader public of activists and intellectuals, and not (just) for economists. We hope it will make a connection between the rich but often obscure currents of thinking about money in the heterodox economics traditions drawing from Keynes and Marx, and the wider universe of public debates.

We have been working on this book for a long time. I first announced it on this blog in 2020 (promising an early 2022 publication date!), but my earliest notes and outline for the book are from 2016.² One way of looking at the book is as an attempt to fill in the argument we sketched out in the conclusion of our 2016 paper on “The post-1980 debt-disinflation”:

It was one of the great insights of Keynes that modern economies cannot be conceived of only as ‘real exchange’ economies; many important questions can be answered only in terms of a model of a ‘monetary production’ economy… In a world where liquidity cannot be identified with any particular asset but is essentially a social relation, analysis of the financial side of the economy requires discussing the asset and liability side of balance sheets independently, rather than netting them out as the pseudo asset ‘net wealth’. Any discussion of debt, in particular, must start from the fact that it is a financial liability, and not simply a negative asset or an accumulated excess of consumption over income. …

Both mainstream and many heterodox economists tend to analyse debt in terms of real flows. … But, in fact, the financial relationships reflected on balance sheets and the real activities of production and consumption compose two separate systems, governed by two distinct sets of relationships. Explanations that reduce debt to the financial counterpart to some real phenomena ignore the specifically financial factors governing the evolution of debt. The evolution of demand and production has to be explained in its own terms, and the evolution of debt and other financial commitments has to be explained in its terms. …

As a historical matter, the evolution of household debt in the US bears little resemblance to any of the real variables whose financial counterpart it is imagined to be. … Indeed, as a first approximation, it would be better to imagine household income and expenditure as evolving according to one set of systematic relationships, and household balance sheets evolving according to an entirely separate set of relationships. Balance sheets and real flows do interact, sometimes strongly. But conceptualizing the two systems independently is an essential first step toward understanding the points of articulation between them.

Arjun and I have made similar arguments about the autonomous development of financial variables here, here, here and here, among other places.

The book also builds on our 2018 article (with Enno Schröder) on “The Political Economy of Financialization, ” where we wrote: “In addition to, or instead of, a method for allocating claims on productive resources, finance can be seen as a system for constraining the choices of other social actors.”

And it builds on my 2016 Jacobin piece “Socialize Finance.” There, I wrote about what money

is imagined to be in ideology: an objective measure of value that reflects the real value of commodities, free of the human judgments of bankers and politicians.

Socialists reject this fantasy. We know that the development of capitalism has from the beginning been a process of “financialization” — of the extension of money claims on human activity, and of the representation of the social world in terms of money payments and commitments. We know that there was no precapitalist world of production and exchange on which money and then credit were later superimposed: Networks of money claims are the substrate on which commodity production has grown and been organized. And we know that the social surplus under capitalism is not allocated by “markets,” despite the fairy tales of economists. Surplus is allocated by banks and other financial institutions, whose activities are coordinated by planners, not markets.

I can’t promise that the book fulfills all the promises made in those earlier pieces. But that is what is an attempt at.

Writing, as they say, is rewriting. Our first draft of the book was 200,000 words. The final version is just over 100,000 words. Some of this was the usual tightening, but a large part was the cutting of three substantial chapters. One was a historical sketch of debates about money and credit over the past two hundred years of economic thought. One was an extension of the chapter on money as measurement to the international context, looking critically at the use of purchasing power parity to compare “real income” across countries. And one was an exploration of the political economy of the corporation, as a central locus of the conflict between the logic of money and concrete productive activity.

The first of these excised chapters we will, I hope, publish relatively soon as a self-contained article. The second is going into the drawer for now; at some point in the future, perhaps it will form part of a successor to this book asking similar questions about a world with many different moneys. The third excised chapter, on the corporation, we are fleshing out into our next book. It is provisionally titled The Hidden Abode: Profits, Production and the Contradictions of the Corporation, and — knock on wood — should be published by the University of Chicago Press sometime in 2027.