The Role of Budget Stabilization Funds in Smoothing Government Expenditures over the Business Cycle

Abstract

The economic downturn that began in 2001 resulted in sizable budget shortfalls and arguably the worst fiscal conditions for state governments in decades. The use of savings to stabilize cyclical fluctuations in the budget has been institutionalized in most states in the form of budget stabilization funds. In this article, the authors explore how state expenditure volatility is affected by the existence, size, and structure of stabilization funds using multiple measures of expenditure cyclicality over the period from 1969 to 1999. The results indicate that while most states have not witnessed a reduction in expenditure volatility over the business cycle, states with rule-bound stabilization funds experience significantly less expenditure volatility from utilizing a budget stabilization fund. In fact, the authors find that state expenditures are approximately 20 percent less volatile following the adoption of a rule-bound budget stabilization fund.

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