The Next Stimulus Package

Some pundits and politicians have called for aid to states to be part of the next stimulus package, since this would fill holes in state budgets and help finance local infrastructure projects that may have been delayed by a lack of funds. At the same time, others have raised concerns that the resulting increases in the federal deficit could spook investors and lead to higher interest rates in the next few years.

If aid to the states is part of the next stimulus package, instead of simply writing checks to the states, the federal government ought to offer to buy an equivalent amount of new general obligation bonds issued by the states. These bonds could be structured with low coupon rates for the first few years, say, 1% above the rate on the U.S. Treasury bonds, with a reset to higher rates after three years. That ought to give the states the funds to cover their budgets and complete infrastructure projects, and give them an incentive to refinance the debt by issuing new bonds to the usual municipal bond investors after the economic downturn ends (with taxes likely higher in a few years, there would be more demand from affluent investors for tax-free municipal bonds). Knowing that the federal government would be repaid in a few years ought to assuage the market for U.S. Treasuries.

The photo above, from the NJ Department of Transportation website, is of part of a recently completed, federally funded $68 million local infrastructure project, the replacement of the Essex Street bridge and the reconstruction of the Route 17/Essex Street interchange.