How to Effectively Stress-test Government Reserve Levels

August 4, 2014

By Dan White

The current recovery will go down in history as one of the longest and most lackluster in decades. It has taken nearly five years for the U.S. economy to regain all of the jobs lost during the Great Recession. One of the reasons for the persistent sluggishness has been the fiscal drag from slow-to-recover state and local government fiscal conditions.

While some governments were overwhelmed by forces beyond their control, many were simply underprepared for an economic downturn, regardless of the size. This lack of preparation left some policymakers budgeting without a net at the absolute worst time.

In order to safely navigate the twists and turns of the business cycle, states and local governments should have adequate reserves set aside to avoid having to make extraordinary fiscal actions which may exacerbate an already declining economy or slow recovery.

Gauging the size of adequate reserves is important, particularly as some governments have more volatile tax structures and can see their revenues rise and fall even more dramatically than the overall business cycle. What’s more, mandatory social spending programs, particularly Medicaid, are growing faster than revenues even under stable economic conditions. An economic downturn can exacerbate that mismatch even further.

Simultaneously, policymakers need to also be conscious of being too conservative, so as not to deprive important programs of much needed funding. The economic impacts of inadequate funding for education and transportation in particular can have devastating long-term economic effects. The question then posed to state and local government policymakers is how much to set aside to avoid a major fiscal correction without stunting economic growth.

In the wake of the Great recession, the private-sector has become acutely aware of the necessity of planning for economic downturns. In fact, the public-sector in some cases has begun to mandate that the private-sector, specifically banks, plan and “stress test” for a rainy day.

In order to direct some of those same standards back onto the public-sector, and help policymakers determine just how much reserves are enough, the Stress-Testing State Reserves webinar will demonstrate methods to test the effectiveness of subnational government reserve levels by utilizing stress testing and Moody’s Analytics’ alternative economic scenarios. 

Dan White is a senior economist at Moody’s Analytics, responsible for state and local government fiscal concerns, and works closely with a number of state and local governments in a consulting role. Dan also developed and maintains the firm’s state and local government tax revenue models, as well as forecasts for Medicaid and capital gains.