Balanced Budgets and Business Cycles: Evidence from the States

This paper presents evidence that stringent balanced budget requirements enforced in some U.S. states have exacerbated business cycles in those states. The effect is not apparent directly. However, among states for which fiscal policy may have more macroeconomic consequences (large states), the difference in volatility between states with lenient and strict balanced budget rules is larger (more negative or less positive) than among states for which fiscal policy may be less relevant (small states). Two implications are suggested: (1) states’ fiscal policies have real macroeconomic consequences, and (2) strict balanced budget requirements have economic costs in the form of increased business cycle volatility.