Apr 1, 2020

Skanda Amarnath, Yakov Feygin, and Elizabeth Pancotti on Municipal Bond Market Intervention and the CARES Act as Responses to COVID-19

Passing the CARES Act and enabling the Fed to buy municipal bonds are two steps toward a robust response to COVID-19 and its adverse economic impact.
David Beckworth Senior Research Fellow , Skanda Amarnath, Yakov Feygin, Elizabeth Pancotti

Hosted by David Beckworth of the Mercatus Center, Macro Musings is a new podcast which pulls back the curtain on the important macroeconomic issues of the past, present, and future.

Skanda Amarnath is the Director of Research and Analysis at Employ America, Yakov Feygin is the Associate Director of the Future of Capitalism program at the Berggruen Institute, and Elizabeth Pancotti is a research assistant at the National Bureau of Economic Research and at Tufts University. Together, they have put together proposals on how to better address the challenges of the COVID-19 crisis at the state and local level. They join Macro Musings today to discuss these proposals for a municipal bond market and expanded unemployment insurance, as well as what it all means for making the US economy more of an optimal currency area.

Read the full episode transcript 

Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to macromusings@mercatus.gmu.edu. 

David Beckworth: Skanda, Yakov and Elizabeth, welcome to the show. 

Skanda Amarnath: Thanks for having us. 

Yakov Feygin: Thank you. 

Beckworth: Yeah, I'm glad to get you on. You all have exciting proposals, very timely ones. And as it turns out, the bill going through the Senate, and we hope by Monday, by the time the show comes out, that will be passed. In fact, this, for the record, the show is being recorded on March 27th, it'll be aired April 1st. So, some of these discussions might be enacted in law by the time this comes on air. But nonetheless, we will talk about them because they're timely and important. 

Beckworth: And before we do that though, I would like to hear a little bit about yourself. Tell our listeners who you are and what you're doing, and how are you coping? How have you adapted to the lockdown where you are? Now, Skanda, you've been on the show before, listeners know who you are. But for those who don't, tell us about yourself and maybe tell us about Employ America. 

Amarnath: So, I'm the Director of Research and Analysis at Employ America. And Employ America's mission is to get the macroeconomic policy mix right so that we can advance labor market outcomes, and really mitigate recession. So, that's a real focus, especially right now on what monetary and fiscal policy can do to mitigate this crisis, and hopefully get us back on track to tight labor markets, and better jobs and wages for all Americans. 

Beckworth: And how have you adapted, Skanda, to living with the lockdown? You're in New York City, the epicenter of the ... the hot zone, so to speak, here in the US. So, how has life changed for you? 

Amarnath: Relying a little bit more on delivery trying to stock up well ahead of time. So, on both sides it's been actually not so bad for me, but I have ... I live right by Broadway, and- 

Beckworth: Oh, wow. 

Amarnath:... I can see the foot traffic gradually diminish, which is good. But, it's obviously a pretty difficult time for a lot of people in the area. So, I really hope we can get through this- 

Beckworth: Right, absolutely. 

Amarnath: ... with minimal additional damage from here. 

Beckworth: Okay. Elizabeth, how about you? 

Elizabeth Pancotti: Thanks so much for having me, David. Yeah, I'm a research assistant at Tufts University and the NBER, so I'm more on the academic side. I partnered with Employ America to put out a policy proposal for unemployment insurance expansions, and what we can do to assist workers, a lot of whom are going to be losing their jobs over the next few months if they haven't already as governors put out shelter in place or orders or closing non-essential businesses. 

Pancotti: So, I partnered with them, they've been great partners to work with in doing this, and obviously have a great mission that's quite aligned and relevant right now. I am hunkered down in our very small apartment in Boston. So, my boyfriend and I live together with our two dogs. And normally we both work in separate offices, and our dogs have free range of our large couch, and they are quite irritated that we are encroaching on their space. 

Pancotti: But, we've both been remote for about two weeks now. So, somewhat adapting to this new reality and I think it would be helpful to know when it's going to end, to know when the light at the tunnel is coming. But for right now, just playing it by ear. Boston has been pretty empty. We live around the corner from MGH, and really the only people walking around on the streets here are people going to and from grocery stores or to and from work at MGH. But, we haven't noticed any big changes here in terms of other things. But traffic has certainly diminished, and lots of business closures. 

Beckworth: Okay. So, we got New York City covered, we got Boston covered. Now, Yakov, I understand you're on the West coast, is that right? 

Feygin: Yes, I am. So, I'm Feygin. I am the associate director of the future of capitalism program at the Berggruen Institute out in LA, which is where I'm calling in from. Our Institute is fairly new, especially the area of anything involving economics. I'm an economic historian who did a PG actually in the, kind of, monetary history of the Soviet Union, if that can be believed. It does happen. 

Beckworth: Wow. Yeah, fascinating. 

Feygin: And, I decided no one really ... well I care about it, but not as many people as I'd like to do. So, I kind of moved to policy. And I still do some academic research too. And, yeah, that's me. And, I'm adapting. It's been a little hard, honestly. I'm working from home. I'm actually self-quarantining right now fully because I've had a few symptoms over the last days, but I'm okay so far. LA is very shut down, but unfortunately my partner, my girlfriend still has to go to work because she's one of those people who the American economy isn't serving as well in this situation, because she's a semi necessary of service and still working hourly. And you keep going in to keep the insurance. So, we'll see how that turns out. 

Beckworth: Well, she is a hero in this war on the virus. 

Feygin: Yeah. Well, it's complicated. 

Beckworth: It's complicated. Okay. Well, thank you all, again, for coming on the podcast. As you know, we've been running a series of podcasts on the pandemic, what it means for policy. And I really like what we're going to do today with you three, because we're going to focus at the state and local level more. And, again, that's where we really see policy implemented. That's also where policy makers are more in touch with the local communities, and have a better sense of what can be done. 

Beckworth: And so, you have two bold proposals here that really help in that direction. And the first one is one that was written by Skanda and Yakov, and the title of it, I'll read the title and we'll talk about it. But the title is, "The Fed Can and Should Support State Government Efforts to Respond to COVID-19 Right Now." And this is about municipal financing challenges at the state and local level. 

Beckworth: And so, maybe you could walk us through that. What typically happens at times of business cycles, and at the state and local level in terms of financing. And then how can the Fed ... so this proposal really is directed at the Fed, and how the Fed could step in. And walk us through ... there's a lot of things here, but walk us through your proposal and what difference it can make. 

How the Fed Can Respond to Municipal Financing Challenges at the State and Local Level 

Amarnath: So, just to start off with, state and local governments are budget constrained, and are not afforded the same degrees of freedom that the US Treasury and the Federal government have. What I mean by that, especially in recessions, is we see that tax revenue goes down, but whereas the US Treasury just issues more debt to cover up for that budget shortfall, and has license to engage in countercyclical fiscal policy with the full knowledge that the Fed is also keeping rates low in recessions. That's not available to state and local government in the same way, at least based on how the Fed itself has positioned monetary policy. 

Amarnath: So, what ends up happening is, that state local governments, because of their budget shortfalls, are really dependent on the private market. They're dependent on the private financial market, private investors being willing to buy their debt. Private investors without any central bank backstop are really looking at the credit ratings of the state and local governments. Are they doing a good job of ... Moody's and S&P, if they view these state and local governments as being responsible, then they'll keep investing. But if they don't, then typically they'll get shut out of the bond market, or at least it'll become prohibitively costly. 

Amarnath: What we have right now, especially with the Fed not really engaged in the Muni market in a direct way, is when economies go into recession, and when sales tax revenue and other sources of revenue that are typically tied to the business cycle collapse, state and local governments then have to drastically cut back on other expenditures, whether that's infrastructure, whether it's public health expenditures. Public services are typically in higher demand in terms of business cycles.  

Amarnath: So, it's kind of getting hit from both directions, and without a release valve in terms of being able to finance your way through what is ultimately a temporary crisis in the sense that recessions do come to an end, and ideally you would want financial markets to be in a position to help tide over state and local governments. But what actually happens is, they're so fearful of a ratings downgrade and losing the investor base as a result of that, that they engage in sharp cutbacks. And we get the opposite response of what we want right now. 

Amarnath: Right now we want state governments to act ambitiously to take the necessary measures. And with interest rates in general being so low, we want them to be willing to issue debt to get through this as opposed to cutting back on other necessary public services, and deepening what's already proving to be a very deep economic crisis. 

Right now we want state governments to act ambitiously to take the necessary measures. And with interest rates in general being so low, we want them to be willing to issue debt to get through this as opposed to cutting back on other necessary public services, and deepening what's already proving to be a very deep economic crisis. 

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Beckworth: Right. And so, we see it at the local level, for example, governments cutting back on teachers, on cops, on road work. And maybe you could walk us through a concrete example of this, the Great Recession. What happened then? 

Amarnath: So ... Yakov, you like to go ahead? 

Local Government Cutbacks During the Great Recession 

Feygin: Yeah, sure. What we saw coming out of the Great Recession is that, while there was quite a bit of federal fiscal stimulus, it wasn't enough to actually offset the spending cuts within the States. And you saw, first of all, large tax increases, which is not great for countercyclical policy in order to make the gap. And then you saw massive cutbacks. First of all in state services, including education, especially secondary education, which is one of the reasons you saw the debt market, kind of, go up. Because universities were forced to drive up their tuition because of the loss of state support. 

Feygin: You saw huge cutbacks in medical services for rural communities. You saw cutback in law enforcement services, any kind of service you can imagine. And that's not just a quality of life issue or a building out issue in the economy. It's an issue of a lack of spending. So, all the stimulus you're doing at the federal level, you're losing that traction because the states, which are responsible for something like at some point 70% of government spending actually in this country. I need to check the statistics, but it's in the article, are actually cutting their spending down. 

Amarnath: Yeah. I think what you're referring to there is about, sort of, infrastructure outlays itself is what they're ... they may be funded by the Federal government, but obviously when it comes to the actual control over expenditures, that's ultimately done at the state and local level. And this was a, sort of, overhang that existed even while we had the end of the recession around June, 2009, it was a very weak recovery, one where we, obviously, needed to start thinking a little more imaginatively about monetary frameworks, like  nominal GDP targeting. 

Amarnath: But it was also a period when we saw that elevated unemployment in large part driven by state and local government austerity policies. These are policies that were aggressively tightening state and local government spending, raising taxes as Yakov just mentioned. And that really didn't end until around 2012. Depends on the state, obviously. But, this was a three-year phase in which we really should have had all this sort of excess capacity room for stronger nominal GDP growth. And we didn't really get either. And one of the main mechanisms that was shut off at that time was, the state, local governments were not ... they were also, sort of, retrenching just as the private sector also was trying to be leveraged as well. 

Beckworth: Yes. That's interesting because for the casual observer, you don't think about this. You don't think about the state and local spending cuts. I suspect most people when they think back to 2008 through 2009 when they hear fiscal policy or government spending, they're thinking purely at the federal level, which they saw this big Obama's stimulus bill, and that's all they think about. 

Beckworth: Now, maybe if they're working at the state local level, they experience it, but it's important for us to grasp the enormity of what happens at the state and local level, and that often flies under the radar. So, I think it's a great point that you brought out that there was contraction at the state, local level up to 2012. The recession itself ended in 2009, so we're going three years after that. And there's a squeeze going on in the state and local level. 

Beckworth: And so, the bigger point here is that, state and local finances tend to be procyclical. They tend to exacerbate or strengthen the business cycle as opposed to work against it. So, you two have a proposal that's going to, hopefully, push us in that right direction, and hopefully some of those will be incorporated into the Senate bill that has passed the Senate and will be discussed Monday hopefully, and passed by the House. And maybe be passed by the time we have this show come up. But, walk us through what you would like to see done. Tell us about the legality of it, the innovation of it, and has it been tried before? 

Details of Skanda and Yakov’s Proposal 

Amarnath: Sure. So, on the Senate bill and what it achieves is relative to Fed authority. So, the Fed currently has actually through section 14 of the Federal Reserve Act, has the ability to buy short-term, state and local government debt as part of its open market operations. And I think Yakov can really speak to the history of this authority, and how the Fed has actually used this in the past. It's been a while, but they have. 

Amarnath: But, what the bill does is through this 454 billion dollar fund that Treasury is making available to the Fed to lend to, and that could obviously be leveraged up to a total lending amount from the Fed of about four and a half trillion dollars. Among those potential institutions that the Fed can lend to are state and local governments, or state-owned, or state-controlled corporations as well. 

Amarnath: So, that is an innovation, something they did not do in the global financial crisis. They are doing this through some of the Fed's emergency lending powers that are, again, I'm going to legal ease of this, but it's Section 13(3) of the Federal Reserve Act, which the Fed used for lending to all sorts of financial institutions during the financial crisis. 

Amarnath: So, this is an emergency power that the Treasury has ... if this bill passes, and the Treasury authorizes the Fed can lend to state and local governments directly for securities of all maturities, not just short term state and local government debt, which they can already do. 

Beckworth: So, Skanda, why are they waiting for Congress to fund off on this? You already mentioned they have the legal authority in Section 14(2)B. 

Beckworth: Why are they trying to go through section 13(3) to address the Muni situation? 

Feygin: I think I can speak to that a little bit, and maybe Skanda can add something. One of the reasons is, as far as we understand this, it feels like a very relatively new thing for the Fed to do, because in its modern history, the Fed has not used this authority. And the Fed is, by its very nature, a very conservative institution. 

It feels like a very relatively new thing for the Fed to do, because in its modern history, the Fed has not used this authority. And the Fed is, by its very nature, a very conservative institution. 

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Feygin: And, my understanding of the politics of it is that the Fed it feels they might be overstepping the bounds between monetary and fiscal policy without congressional authorization. I don't necessarily think that's the correct view, to be honest. I think the line between monetary or fiscal policy is always thin and always changing over time with the larger cycles of how capitalism itself changes over time. 

Feygin: But for the Fed to do that, it requires some institutional learning. And I think that's where it's going to be very interesting, is how this might force some institutional learning beyond this crisis. 

Beckworth: Fair enough. And with 13(3) you get the sign off of the Treasury Secretary. 

Feygin: Yeah. 

Beckworth: So, it looks more credible. That's a great point. You're going into uncharted waters here. Where at 14(2)B, you'd really be doing something radical. So, well historically you're going to tell us it's not radical, but- 

Feygin: Yeah, it's not that radical at all. 

Beckworth: Why don't you go ahead and walk us through the history, because that's really fascinating. I was reading your piece on that, what a fascinating history. So, tell us how we at one point were using municipal bonds for the Federal Reserve, and then we didn't. And, what I got from your paper is really what you're proposing is to come full circle. To come back to from where we started. So, walk us through that. 

The History of the Fed and Municipal Bonds 

Feygin: Yeah. So, Peter Conti-Brown, who I know has been a guest on this show a before. I'm a fan. Honestly, he makes a really good point that the Federal Reserve really had three foundings, right? 

Feygin: In that famous paper of his. And that those foundings have changed the mission and particularly, kind of, the micro operations of the Fed quite a bit. So, the first founding of the Federal Reserve, which you start seeing 1913, it's an institution that's not thinking like a modern central bank is. It's an institution that's mostly copied on the Bank of England, which is having these real bill concerns. 

Feygin: And what the Real Bills Doctrine is, is that the Fed shouldn't be buying government debt necessarily, or any kind of long-term debt, or any debt that's not easily tied to commercial liquidation in the short run. Now, what's interesting about the US Federal Reserve is it's founded ... is it does include municipal debt... as one of the collaterals it's interested in. 

Feygin: And there is actually a bit of a debate about that in the Senate hearings about why it does that. Because, some of the senators justifiably feel like, "Look, this is going to mean that the monetary base of this new institution might be overly expanded by the states, and it's going to lose control." And the reason for the argument for why you would include this is multiple fold. 

Feygin: First of all, they're extremely important in the early 20th century, the late 19th century as instruments. They're actually somewhat of the safe asset of their day because there's not a lot of Federal debt, but these very short term bills are very attractive to large institutions such as trusts, banks and insurance companies because they're usually backed up by a tax flow. They're tax offset.  

Feygin: The other reason why is, it's a gold standard issue. These are really popular with foreign investors, and that because of that intervening in that market, at least in the hearings they say, is going to be useful for managing gold inflows and outflows. 

Feygin: Now, what I think is very interesting is, is almost as soon as those hearings end, those rationales are still there and they're still being used in these operations, but they kind of lose themselves on two levels. First of all, the Fed introduces regulation E in its original set of regulations, which says they can't actually buy municipal debt of any municipality under 10,000 people without approval of the board. And the regional banks can't. 

Feygin: But almost immediately, you see the board approving most of these things, partially because they understand that they want to support their member banks that deal with local small communities for political reasons, because they understand that that's something necessary to build legitimacy. 

Feygin: The next big shift is World War One. Almost as soon as the Fed is founded, and Perry Mehrling was actually one of my advisors, kind of, pointed this out in his book, its mission changes immediately. It's in uncharted territory. Because, instead of buying these short term real bills, it's now becoming the government's bank, right? The state's bank. 

Feygin: And, in 1917 just almost a year really after they started the first major wide-scale open market operations, they leave the municipal debt market. They explicitly say so in their yearly report. They say, because of this national emergency, we have to support the federal debt market, which is now actually for the first time, large enough for it to be a market. 

Feygin: After the war, they actually tried to go back into municipal market several times. Never on the scale they did before the war because of the need to discharge some of the federal debt, but they're back and they're buying local municipal debt until 1933, which should be a significant date because that's when the Fed starts to reorganize along the New Deal. 

Feygin: The year before that in 1932, they're actually thinking in one conference at least I found of using their power to buy municipal debt to support local fiscal stimulus during the great depression. But Marriner Eccles amongst others believes that that's not as effective as just building a bigger government infrastructure and supporting the RFC in doing that. They shift out of that, and by the 1950s, they've essentially established the doctrine where they're only buying short-term treasuries. 

Feygin: And that holds until 2008, which I would argue is an interesting thing. Because in 2008 we really ... we've had the end of Minsky and big government capitalism. And we're really in the world of money manager capitalism, financial globalization. Now wait, with QE, with the short term commercial paper facility in the swap lines, they've really, I think, figured out that they're working in a kind of multi ... what I call a multilevel governance world, and they've definitely taken care of the international level, but they haven't taken care of the regional level. And because we're in an era of globalization, the regional level isn't really synced up as tightly with the national level in all times in all places anymore. 

Feygin: The Fed should be, I think, thinking about coming back to its roots, and working on all these levels precisely because of the early 20th century is far more globalized than any time in the mid-20th century. 

Beckworth: That's a great history. There's a couple of observations. One, what you just ended on, the Fed really is coming full circle if it does go back to Munis. It started there, and you called that period if I got it correctly, the financial capitalism period. And then you went to big government capitalism, kind of, the New Deal, heavy handed government, post 1970s we're moving back more towards money manager capitalism. And we see maybe the full manifestation of that in 2008 when the Fed is backstopping every market except corporate and local municipal bond markets, which is when you think about it, you step back, what's kind of odd is, why leave that one out and save markets overseas, other big markets home. 

Beckworth: So, I think it is a kind of a recognition of coming full circle. The other thing though, just briefly, I don't want to spend too much time on this though. You mentioned a debate between Fed chair William McChesney Martin and New York president of the Fed Allan Sproul where Martin wanted to do the Treasury bill approach. She was, kind of, going along that path that the Fed was doing, but Sproul wanted to include municipal bonds and actually resigned when he realized he couldn't win that debate. 

Beckworth: And this made me think of, there's actually is a debate in central banking literature about what is a neutral footprint? And there's the German view, and I brought this up on the show before. There's the German view, and then there's the UK, US view. So, the German view is if the central bank is going to be buying securities, it should do so in a manner that matches or best replicates the average or typical investor, which would be a wide portfolio of assets. That's the German view. 

Beckworth: We see that reflected at the ECB, they can buy a wide range of assets. The US and UK view as well. You think that's neutral, the real neutral version is what we say, and what we say is, if we buy just treasuries from the consolidated balance sheet perspective, it's kind of canceling out, or we're minimizing our footprint because if we buy treasuries, it's an asset to us, liability to the treasury department. It's a wash. 

Beckworth: So, there's two views on what's a neutral footprint, the US, UK view, and then there's the German view. And I would suggest that, you know, maybe what you're suggesting here is more in line with the German view, which I actually I'm more sympathetic to myself. I think some of the proposals, for example, from George Selgin to open up and buy all types of assets makes more sense, of course, with haircuts and properly done. And along those, let's move into your actual proposal. So, walk us through how you guys would implement this, and address some of the concerns that might come up along the way. 

How to Implement the Proposal: Buying Short Term Municipal Debt 

Amarnath: So, our proposal is for the Fed to use its 14(2)B authority at least in terms of offering to buy short term municipal debt, specifically state and local government debt. And the Fed could make a preordained commitment to buy the securities for at least as long as is needed for the crisis response, and the recovery. Very similar to the timeline that the Fed ended up structuring for the commercial paper funding facility in 2008 to 2010. 

So, our proposal is for the Fed to use its 14(2)B authority at least in terms of offering to buy short term municipal debt, specifically state and local government debt. And the Fed could make a preordained commitment to buy the securities for at least as long as is needed for the crisis response, and the recovery.

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Amarnath: So, the Fed effectively said, "We will roll over commercial paper issuance, and we will continue to keep this facility open." And they kept the facility open for at least 18 months, I want to say. And that is what was necessary. Even though it's three month instruments, commercial paper is typically issued on a one month or three month maturity. And if you have the confidence that you can keep rolling that over through a pretty turbulent period, that obviously opens up at least one important degree of freedom for those companies that relied on commercial paper issuance to fund their operations. 

Amarnath: Here, the challenge in some ways is that the municipal debt market tends to be a little bit more ... there's not a lot of short-term issuance out there. It's actually typically a longer term market because the liquidity conditions themselves are great for issuing short-term debt. So, it's a little bit of a chicken or egg situation where state, local government treasurers are more worried about the idea of issuing short-term debt because if you're a buyer, if the Fed were able to step in and backstop and constrain the yields on these securities, because mind you, all 50 state governments are investment grades, at least last I checked. 

Amarnath: I know Moody's and S&P are in the process of downgrading all sorts of different institutions, but all 50 state governments are investment grade. And if the Fed were able to step in and provide a backstop and facilities that the Fed would purchase short term debt as needed, I think one, you'd see a more liquid market, and also give state treasurers a little more confidence that they can issue debt to help deficit finance their way through this crisis, at least, to some degree. 

If the Fed were able to step in and provide a backstop and facilities that the Fed would purchase short term debt as needed, I think one, you'd see a more liquid market, and also give state treasurers a little more confidence that they can issue debt to help deficit finance their way through this crisis

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Beckworth: Now, you mentioned in your proposal, one nice thing about this is that this wouldn't count towards their budget rules, or this wouldn't be considered as additional outline under their budget rules. 

Amarnath: So, there are balanced budget laws, and they vary just different degrees across States. And so, I'm not an expert on every single state's set of laws, but there's usually a few different exemptions at play that allow states when they really need to finance a service that they can. One is that there's exemptions for capital expenditures. So, typically in infrastructure projects, anything that, these are new equipment, or new buildings are all things that get exempted from those balanced budget laws. 

Amarnath: Second is  the statute itself in the Federal Reserve Act also allows the Fed to fund, are called special districts or what are now known as special districts by the census. And so, special districts in every single ... there are special districts in every single state that are typically dedicated to particular public services that need to be funded. 

Amarnath: And what this ends up allowing for is when states really need to prioritize funding for what's called fire services, a reclamation district, an irrigation district. They show up in every single state in various forms. The Fed has the authority to also lend to those special districts, which the state typically creates to make sure that essential services are able to be funded and are not constrained by those balanced budget laws. 

Amarnath: As I said, there are variants across the states, but typically California has a health and hospital district. In the case of Texas, it's a little harder to create a special district, but Texas also exempts for hospital financing, but that usually would be exempted under the capital budget. 

Beckworth: Okay. Now, one question before we move to what the Senate bill is actually doing with this idea. Could the Fed work through a special purpose vehicle to have, say, these longer term securities securitize into a new asset that was shorter term that met the letter of the law? So, maybe it creates some, kind of, securitized bill that's- 

Amarnath: Yeah. 

Beckworth: ... backed by longer term bonds? Okay. 

Feygin: Yeah, I mean that was proposed. There's actually a history to that proposal. Right after the recession, I know there was a proposal, it almost became  law that New America put out to establish essentially a vehicle that repackages these things into acceptable- 

Amarnath: I think there's actually a lot of room for standardization in this market because the municipal bond market is quite fragmented. So, if you look at ... you can pull up a Rhode Island debt yield curve on Bloomberg, but it's just not ... there's not that much debt outstanding, and it's all on various maturities, and it's just a very thin market, fragmented and there's not enough standardization that ... honestly if the Fed ... the Fed could play a pretty constructive role here in making it more standardized, I would probably help to lower overall cost of borrowing, especially if these markets had a stable source of support. 

Feygin: Yeah, that's absolutely true. If you look at the buyers for this, it's not actually large institutions, a lot of is individuals looking for tax exemption on their buying, or very over the counter mutual funds. 

Beckworth: So, if they did securitize it, you might get more buyers into the market, is what you're saying? 

Feygin: Mm-hmm (affirmative). Absolutely. 

Beckworth: And the Fed could be a pivotal catalyst. So, let me just play devil's advocate here for all those out there who are freaking out like, "Oh my goodness, what are you guys doing?" Your proposal, though, sets clear guidelines and criteria. You're not saying the Fed will be in there 24/7, 365 days a year. You're saying only during a crisis period like the commercial paper facility, right? 

Feygin: Mm-hmm (affirmative). 

Amarnath: Yeah. 

Beckworth: So, how would you ... what would be the off switch? How would you- 

Amarnath: I think you want to set some parameters. And again, I kind of go back to how the commercial paper facility in 2008 to '10 was set, which was the Fed for the period when we have a national crisis, this sort of collateral damage to individual states is probably ... The reason why we're in this crisis is not because Illinois' public finances, their problems are pretty well documented. But that's not the reason why we're in this crisis. 

Amarnath: And, I think it makes sense to close these ... foreclose the option of buying state and local government debt when we exit the national crisis. And that's why there should still be some incentive for being fiscally prudent if we make this, sort of, unleashed for every single state and local government. Obviously, there are ways in which you can get unhinged, but it's also just not that smart to have this be ... have national crises that hit every single state, and then make the judgment that actually now we're going to create a new ... state and local government effectively gets shut out of bond markets as a result of this because it's not really a problem of one specific state's doing. And recessions are typically not cases where we have 25 states or 30 states in recession and 20 or 25 states out of recession. There usually is times when every state's in recession. 

Beckworth: Right, systematic. 

Amarnath: Exactly. 

Beckworth: Yeah. Walk us through the few minutes we have left on this part of the program dedicated to Muni markets. What is the status of the Senate bill, and how would it cover your proposal or come close to it? 

How Does the Recent Senate Bill Cover the Municipal Market Issue 

Feygin: Ambiguous? 

Amarnath: Yeah, that's exactly right. 

Beckworth: Okay. 

Amarnath: I think you can ... it's just a little bit of an amorphous black box because the 454 billion dollars that was dedicated to Fed facilities. The Fed has the option of lending to a variety of these facilities, but there's no strong allocation principles that decide what the Fed thinks is most important. 

Beckworth: Well, that's why you have the paper out, and that's why you're on the podcast. So, all the Fed officials who are listening, take it to heart. Okay. That's been a fascinating conversation. We'll have a link to the paper. Elizabeth, let's move to your fascinating proposal on unemployment insurance. And, why don't you walk us through what is unemployment insurance? I know some people know, but I learned a lot reading your proposal. I kind of knew the broad contours of what it is, but walk us through the current state of it, and what you proposed, and what the CARES Act will actually incorporate. 

Pancotti: Yeah, that's a lot to unpack. So, I'll break it into a couple of parts. 

Pancotti: So, first for anyone who has never been laid off, or has never gone through the unemployment insurance system, I'll do a quick overview of what that looks like on the worker side. And then I'll briefly cover how states and the Federal government play a role in designing those programs. And then we'll talk about what the CARES Act will do to that for the short term. 

Overview of Unemployment Insurance 

Pancotti: So, essentially a worker will get laid off, and then files for unemployment. In most cases they'll have to wait about a week before receiving a paycheck. And that's, sort of, a week to begin any verification and paperwork and all of that sort of stuff. A lot of governors in the past two weeks have waived those requirements, and the CARES Act plays a small role in that. 

Pancotti: And then, in most states they get to totally set how much workers get paid. So, on average workers make about 50% of their previous wages, but states establish their own maximums. These maximums vary widely. So, in Mississippi, the maximum is about $235 a week, which is a $12,000 per year salary. And in Massachusetts, the highest state is $823 a week, which is about $43,000 a year. The average is in the middle of that at $450 a week. 

Pancotti: So, what would happen is if you were a worker who made $50,000 a year, the state would multiply that by 50% and go to 25,000. And then if that in Mississippi, that would be over the maximum. And so, you would be cut down to their maximum. And in Massachusetts, that would be below their maximum, so you would receive 50% of your wages that those get paid out on a weekly basis. In most states, workers receive benefits for about 26 weeks. In previous times of economic downturns when in recession, the Federal government has stepped in and extended those benefits by 13, and then more, and then more weeks. And so, in most states during the recession, workers were eligible for 99 weeks of unemployment.  

Beckworth: Can I ask you a question about that briefly? 

Pancotti: Yeah. 

Beckworth: Who funds unemployment insurance? 

Pancotti: So, each worker when ... the cool thing about being a microeconomist, is that a lot of us have worked with this data. And so, the nice thing is that if you talk to labor economists writing papers right now, many of them will have used UI data. And a lot of people don't know what that means. And that's because what happens is employers submit payroll taxes for unemployment insurance for every worker. And the nice thing is it creates one, a funding source for when those people get unemployed, but two, it creates this really rich set of data where we know a lot about what workers make, where they work because states have to report that to then pay them. 

Pancotti: So, that money, let's say Amazon, for example, has a million employees. They then pay about 5% of their employees, and 5% to 6% of their employees’ wages into a fund that states then put into the unemployment trust fund. So, that sits at the treasury. I can talk more about specific numbers in that trust fund, but after the recession, a lot of those trust funds, their reserves were very low. 

Pancotti: And so, we have been in a funding issue, or a funding crunch for unemployment for a while. And it hasn't really mattered because unemployment has been very low in the past few years. As we face up to 20% unemployment in the coming months, it's a big issue. But it would have been a large issue even if these reserves were at 200% of what they would've been. So, we're in a pretty bad place for unemployment insurance. The nice thing is that the Federal government under the CARES Act has topped off some of those benefits. 

Pancotti: So, Senator Bennett proposed something more along the lines of my proposal, which was to top replacement rates up to 100% up to people making about $75,000 per year. The issue is that these states have not written the physical software code in the background in decades. And so, states said, "We have no way to adjust these replacement rates. Either one, they're written into our state laws, and it would be met with a lot of ... not resistance, but it would be a hassle to change them." And we would have to, in states like Texas where they meet every other year for six months, they're not in a legislative session versus in Massachusetts lawmakers are on Beacon Hill right now. 

The Details of the CARES Act 

Pancotti: So, changing those was a big process on the technology side and on the legislative side. So, then the CARES Act instead proposed whatever you would get under your state's proposal as an unemployed worker we will top that off and give you 600 additional more dollars a week for four months. So, now where you asked how do we fund these things? The Federal government's going to pay for all of that. It's also going to add 13 weeks of benefits. 

So, then the CARES Act instead proposed whatever you would get under your state's proposal as an unemployed worker we will top that off and give you 600 additional more dollars a week for four months. So, now where you asked how do we fund these things? The Federal government's going to pay for all of that. It's also going to add 13 weeks of benefits. 

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Pancotti: So, in most states, workers get 26 weeks of benefits, now they'll get about 39. In some states they're as low as 13. I think in Georgia they're 13 or 14, and in Montana they're 30. Most states are in that 26 range. So, after this we'll see about 39 weeks workers are eligible for unemployment insurance. Additionally, the CARES acted a thing that we have not seen really. And it added benefits for people who don't normally qualify for them. 

Pancotti: So, most people have heard in the news about how they're focusing on gig workers and freelancers who are now covered. So, if you were an Uber driver and you can no longer drive for Uber, or if you own your own business, and you're just like a consultant, then you are now eligible for unemployment through this. It's a pandemic, it's like emergency unemployment insurance for the pandemic. 

Pancotti: But, this also allows people who need to use unemployment insurance as paid leave if they get Coronavirus, or if their children get Coronavirus, and therefore they have to stay home. If they, because a lot of school districts around the country are closing and they need to stay home with their seven-year-old children that no longer has school, they can receive unemployment benefits for that leave. And if they have to quit their job because of Coronavirus, they're now eligible. 

Pancotti: The way that those benefits will be determined, is that it's the average income in that state multiplied by 50% plus 600. So, it does mean that if you quit your job ... I saw a post going around Twitter last night, and it does mean that if you quit your job, you might actually receive more than you would have if you were laid off. And, it also ... some people would argue that it incentivizes people to either convince their employers to lay them off or to quit their jobs, especially because now the replacement rates can exceed 100%. Say if you were a waitress in Mississippi making $7.25 an hour, federal minimum wage, you quit, you would get half that. And you'll now $745 per week, whereas you would have made $145 per week under Mississippi employment, and about $290 per week when you were a waitress. 

Pancotti: So, we're giving people more money than they made when they were employed, and in some cases a lot more than they made when they were employed. There was some opposition to this. So, Senators Graham and Sasse and I think Scott all said, "Wait a minute, we're going to cause a bunch of nurses to quit so they can sit home and make $24 an hour." And I think there are some arguments to say that this bill creates more perverse incentives than we would have if we just topped replacement rates up to 100%. But in the sense that we, one, have to work very quickly to make sure that these workers are able to file for unemployment and get increased benefits. 

Pancotti: And two, we're able to cover things like paid leave for people who get Coronavirus and whatnot. I think this was the middle ground solution to say, we want these benefits to extend to everyone who could possibly need them, and we want them to be enough to pay the rent, and put food on the table while people can't work. 

Beckworth: Let me ask a question, and just to follow up what you said. You know, it's the fog of war to be pragmatic, and get something passed. Deliberate too long, and there might be people falling through the cracks. And that's really my question, does the expansion of unemployment insurance plus the $1,200 check ... I mean, are we going to capture most people, will there be people who still fall through the cracks? 

Will These Measures Be Enough? 

Pancotti: I think there will still be people who fall through the cracks. This doesn't include people who aren't working, who are considered not unemployed but just not working. So, very low income people, the homeless population for example, or very low income people who aren't counted in the labor force at all. Those people will maybe get $1,200 checks, but a lot of those people we know don't have bank accounts. And so, I think, don't file taxes because their incomes are so low. 

Pancotti: And in this bill, I think, it was either written into the bill or we saw an estimate somewhere, it would take about four months to get those $1,200 checks out. Whereas for people like you and me who file our federal taxes and the IRS has our direct deposit information, we'll get checks, or we'll get a direct deposit within a couple of weeks. Those people aren't going to see checks for four months, and it's very possible that we just don't know where these people live. We have no idea how to find them. 

We saw an estimate somewhere, it would take about four months to get those $1,200 checks out. Whereas for people like you and me who file our federal taxes and the IRS has our direct deposit information, we'll get checks, or we'll get a direct deposit within a couple of weeks. Those people aren't going to see checks for four months, and it's very possible that we just don't know where these people live. We have no idea how to find them. 

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Pancotti: And so, I think the Federal government should use coordination between SNAP offices and WIC offices, and social services where these very low income people are already in the system. It would be probably advantageous to go through those roles and say, "Hey, have we missed anyone?" The good news is, we're doing the census right now. I wish we had the census data already, but it would be really nice to know who people are, and where they live. That data is coming in, but won't be collected for another year, and we've actually stopped in person collection. 

Pancotti: So, I think there are people who will still fall through the cracks here. I think lawmakers in Washington when they pass this bill, didn't realize, is that states are being just totally slammed with the amount of calls, emails and claims that they're getting right now. So, yesterday at a press conference, governor Baker in Massachusetts announced that the UI call center, which normally has about 50 people, has 300 people, and needed to increase to 400 or 500 more in the next week or two. 

So, I think there are people who will still fall through the cracks here. I think lawmakers in Washington when they pass this bill, didn't realize, is that states are being just totally slammed with the amount of calls, emails and claims that they're getting right now.

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Pancotti: So, these offices are ramping up even for unemployed people. So, let's not even count the very low income people who aren't in the labor force, who aren't going to get on this from both of these measures. But, even the unemployed people who are now eligible States don't have the capacity to quickly go through these claims. I think especially for that self-worker piece in this, sort of, paid leave expansion of people who are eligible, states’ systems aren't built to process claims for those people. 

Pancotti: These systems were built to say, you received your unemployment insurance taxes over the past year, and we have record of your income and who you were. And as a result we can quickly process your claim and get you the amount of money. And we have the software and people in line to do all of that within a week. We have no idea. States don't have a process for doing that for all of these new people who are now eligible. 

Pancotti: So, I think it will take quite a bit of time to get those systems online. I hope the time is as short as it can be, but I'm worried that it'll be six to eight weeks before they'll ever see their unemployment insurance benefits even though we've now passed the legislation. 

Beckworth: Yeah, that's my concern in general about anything that's been going on is just the infrastructure capabilities, it's sending the checks out. Can the IRS get them out in a timely fashion? Because a lot of people, a lot of checks, it's the tax refund season already. Massive number of claims, unemployment insurance centers. So, that'll be something to watch, for sure. So, last question on this, is there anything else you would add or fix for the unemployment insurance programs? And we touched on this a little bit, but just imparting, what would you say is needed the most to make it as good as you would want it? 

How Can the Unemployment Insurance System be Fixed?  

Pancotti: So, I think two days ago I would have had much more to say about this. I personally did a lot for beefing up unemployment insurance. My plan called for higher benefits, longer benefit period, and leading weeks and expanding the pool of eligible workers and, CARES thankfully did all of that. We didn't see work share programs really mentioned. There is some federal funding who'll cover partial benefits. But we didn't see incentives for firms to keep people on even if they reduced their hours by 20% or 30% or 50% or 80%. 

Pancotti: So, in these states there are work share programs in place where essentially if I worked at Whole Foods and they cut my hours from 20, Whole Foods would consider continue to pay me for 20 hours a week, and then unemployment insurance would pay some of the gap. And that allows me to stay on my health insurance benefits or a vacation or paid sick time. It keeps me on the payroll in the books, and then after this is all over, they can increase the 40 hours as opposed to hiring an entirely new worker, and onboarding them and training them. 

Pancotti: So, I think it would have been very nice to see some, sort of, incentives for firms to keep people on payrolls, and for states and the Federal government to pick up the rest of that. I think there've been quite a number of proposals to give firms directly cash to keep people on payroll. And some money has been appropriated back, but not nearly enough. And I think business just don't have the cash reserves to pay two or three or six months of payroll without being open. 

I think it would have been very nice to see some, sort of, incentives for firms to keep people on payrolls, and for states and the Federal government to pick up the rest of that. I think there've been quite a number of proposals to give firms directly cash to keep people on payroll. And some money has been appropriated back, but not nearly enough. And I think business just don't have the cash reserves to pay two or three or six months of payroll without being open. 

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Pancotti: And as UI offices are inundated with claims, we could basically pay firms to act as UI employees and keep them on payroll, and we could fund all of that as opposed to having them call a call center. That, I think, requires one a lot more thinking through. And so, it's probably a good thing to include it in this first round of legislation, or I don't think we would've seen it move as quickly as it did. But as we pass the fourth and maybe fifth and sixth phases of these stimuli bills, I think we should really think about how to support states and firms in doing those sorts of things. 

Pancotti: Finally, I would just say we should really have states eliminate work search requirements for unemployed workers right now. Many States have done this just through legislatures or governors. You don't have to look for work, but in most states you have to submit three or four job applications or prove that you went to a job fair. We probably shouldn't tell people with Coronavirus, or to write cover letters from hospital beds or to attend job fairs right now. So- 

Pancotti: I think that governors can take a very quick step to just say, "We don't expect you to write cover letters from hospital beds right now." 

Beckworth: Yeah, great point. Well, thank you Elizabeth. That's fascinating. And again, it'll be interesting to see how this all unfolds, and what happens a few weeks from now, these subsequent stages of policies have been passed. Well, this has been a great discussion. I want to step back. I mentioned earlier, I wanted to, kind of, frame this from a broader perspective, in particular the whole shifting of economic policy at the state and local level to more countercyclical perspective, versus its procyclical one. 

Beckworth: And, Skanda and I have talked about this before, but one of the reasons we have a dollar zone, or we have one size fits all monetary policy in the US, is we believe that the US is largely in line with what we'd call an optimal currency area. You can have a currency for one area if one or two of these conditions hold or bit of both. One is that, all regions have a similar business cycle. And that doesn't hold as much in the US as it may have in the past. 

Beckworth: There's definitely idiosyncratic shocks affect different states differently. In fact, we saw with unemployment claims, some states got hammered more than others, so we know things are happening at a different pace. But, if you don't have a perfectly aligned business cycle across the whole country, you can have shock absorbers built into place. And what you've been describing to me is an absence of them. 

Beckworth: Now, we have had in the US relative to Europe, some good shock absorbers but still not perfect. So, one of the shock absorbers is labor mobility. So, you're working in Michigan, Michigan is in a recession, Texas is in a boom, you could move from Michigan to Texas. Alternatively, if you are in Michigan, you can't move. People in Texas are doing better, their income goes up, they pay higher income tax, they send it to folks in Michigan. So, there's a fiscal transfer. 

Beckworth: So, maybe Skanda, maybe you can help me out here. How would your policies make the US more in line with an optimal currency era? I think we are closer than Europe, but there has been a decline in labor mobility in the US, which has pushed us away from not a lot, but a little bit away from being optimal currency area. Do you see your proposals, both your unemployment insurance proposal and your municipal bond market proposal pushing us closer to an optimal currency framework? 

Moving Closer to Being an Optimal Currency Area 

Amarnath: Well, I think it really helps on the risk sharing side in terms of it actually sharing risk across states and regions. Right now, it is an asymmetric shock in one sense because we have certain states that have much bigger burdens thus far from the Coronavirus. I think all 50 states have seen a pretty big surge in jobless claims actually including Alaska and Hawaii. 

Amarnath: So, it clearly has permeated across different states, but differentially and that I think just gets the fact that we're seeing how states and local governments who are in charge of administrating a lot of programs that are vitally necessary in recessions. So, especially if we think about what Elizabeth just went through on unemployment insurance, and how states have a lot of control, but have systematically under-invested in precisely the kinds of systems that are necessary in these moments. And when these moments come up, there's not necessarily the funding available. 

Amarnath: This is precisely the time when now we're hearing talk from any governor. DeWine talked about how there would need to be spending cutbacks in a number of areas in Ohio as they try to cope with what is a surging pandemic there too, surging number of cases of Coronavirus. So, the ability to actually offset the risks that different states bear at different times is really critical to have a system that works, and that's aligned on the right dimensions here. Because, we're going to have state control over these phenomenon, and to some degree there are some advantages to having that. 

Amarnath: But if it doesn't come with the appropriate financial flexibility to get through it, I do think it's going to be incredibly challenging not for this a crisis to get a lot worse in terms of state and local cutbacks, a lot of that pro cyclicality we talked about earlier from really exacerbating the chances of getting to a stable path for a national income, for people's livelihoods. That's something that we're seriously at risk of right now. 

If it doesn't come with the appropriate financial flexibility to get through it, I do think it's going to be incredibly challenging not for this a crisis to get a lot worse in terms of state and local cutbacks, a lot of that pro cyclicality we talked about earlier from really exacerbating the chances of getting to a stable path for a national income, for people's livelihoods. That's something that we're seriously at risk of right now. 

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Amarnath: And, I think if we compare that to what's happened in the US and in Europe back in 2008 to '12 when you saw that the fiscal impulse was sort of disjointed in a way. At least, there was some federal support for state and local governments, but it was not enough. And the Federal Reserve really covered for that. So, the Federal Reserve was able to be extremely accommodative, and that really made a bad situation from getting much worse. But it wasn't a great set of outcomes in general, but we had a dollar depreciated for much of that period. 

Amarnath: We had a set of offsets that, at least, did a better job than what we saw in the Eurozone. You had no ... fiscal policy was even tighter there. But also on top of that you had an ECB that pretty much did not play any major role in providing accommodation until Mario Draghi really stepped up. So, that was ... I think those two are fairly important fiscally. If you think about fiscal and monetary policy working together to offset some of these business cycle shocks so that it is actually easy to absorb these risks, and you don't see the asymmetries getting exacerbated. 

Amarnath: What I think is actually worrisome in some ways because Congress ... we're putting a lot of the eggs in the basket of Congress in terms of getting fiscal policy right. And that is where during the 2009 stimulus there wasn't enough aid to states. So, you can see this in the state and local job growth data. And once the funds run out from that stimulus for state and local governments, they start to slash jobs in terms of cops, firefighters, teachers, they all saw significant employment cuts in those areas. 

Amarnath: And even now, we had 150 billion that was dedicated to state aid, and that is soon to be passed, it looks like. But, that 150 billion is probably going to fall well short of what's needed. And then the question is, do the States have any kind of financial flexibility after that? Do they have any financial flexibility, or do they have to keep relying on Congress to calibrate perfectly what fiscal policy should be for in terms of appropriations to states during these crises? So, I think there's just more room for institutional backstops that really help to reallocate risk across the states for these sorts of events. 

And even now, we had 150 billion that was dedicated to state aid, and that is soon to be passed, it looks like. But, that 150 billion is probably going to fall well short of what's needed. And then the question is, do the States have any kind of financial flexibility after that? Do they have any financial flexibility, or do they have to keep relying on Congress to calibrate perfectly what fiscal policy should be for in terms of appropriations to states during these crises?

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Feygin: And you know, if you want to see those in action, actually, I just remembered look north of the border, Canada does have these kind of fiscal backstops that are much more aggressive than the US. And because of that you see the municipal market being much more liquid for Canadian provinces. 

Beckworth: Okay. We are nearing the end of the show. Our time has come to the end. Before I do that, any final thoughts from any of you? 

Pancotti: As we were on this call, the House passed the bill. So, a lot of things we just called for are now in action, hopefully. 

Beckworth: Wow, you guys are influential. Who knew? So, well, thank you to each of you. Thank you to Skanda, Yakov and Elizabeth for being on the show today. It's been a real treat. 

Amarnath: Thank you. 

Pancotti: Thanks so much, David. 

Feygin: Thanks. 

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