State-level federal stimulus funds and economic growth: The American Recovery and Reinvestment Act

The American Recovery and Reinvestment Act encompassed a substantial fiscal stimulus in the form of intergovernmental transfers. The objectives of the act were to increase employment and stimulate economic growth. While the level of the fiscal stimulus is potentially endogenous, a direct analysis of its effects leads to biased results. To circumvent this, Klein and Staal (2017, International Advances in Economic Research) study the effect of the economic stimulus on economic growth by using the approach based on exogenous Medicaid spending levels of Chodorow-Reich, Feiveson, Liscow, and Woolston (2012, American Economic Journal: Economic Policy). A limitation of such an approach is the reliance on a specific instrumental variable, hence this paper considers a different instrument to solidify the evidence. The Chodorow-Reich et al. and Wilson (2012, American Economic Journal: Economic Policy) both concentrate on the effects on employment, while this paper is the second contribution to consider the effect on economic growth, using the approach based on exogenous highway spending levels of Wilson (2012). To do so, it uses the data in Wilson (2012) complemented by data on economic growth in the years 2008 to 2016 provided by the Bureau of Labor Statistics (www.bls.gov). The highway spending levels are used as an instrument in a two-stage least squares estimation procedure to quantify the effect of intergovernmental transfers on economic growth. The significant positive effect of the state-level stimulus on economic growth has direct policy consequences, as it shows that countercyclical intergovernmental transfers are quick and cost-effective in alleviating economic downturns.