I think Yglesias is Wrong

He writes:

"Atrios says “All the various cuts that our horrible new Republican governors are trying to implement aren’t just going to make the residents of their states suffer, they’re also going to work against the macroeconomy.”

I don’t really think that’s true. Federal spending cuts shrink the federal budget deficit and constitute a negative shock to aggregate demand. States have to balance their budgets, so the alternative to a lower level of spending would be a higher level of taxes. In AD terms, it’s basically going to be a wash either way. Its the failure of congress to enact some kind of state/local bailout appropriation that’s forcing the anti-stimulative state level stuff."

First, states don't have to balance their budgets, they choose to. One of the best things that could happen for both federalism and macroeconomic policy would be for the states to abandon that old shibboleth the way the federal government did eighty years ago. If they did, we'd see more robust states rights and a more stable macroeconomy.

But even setting that point aside, I still think Yglesias is wrong here. Issuing more government bonds helps get us from Keynes's economy to Hicks's economy. Keynes said liquidity preference (Brad DeLong would say highly-secure-financial-asset-preference) kept interest rates too high. Investment was depressed because the interest rate (the cost of capital) don't coincide with equilibrium in the loanable funds market. Running deficits and accomodative monetary policy pushes interest rates down and gets you to Hicks's economy. Hicks talked about an economy where the interest rate did coincide with equilibrium in the loanable funds market, but there was still slack in output.

How do we take care of that? Deficit spending, as Yglesias points out. "Shifting the IS curve". Also committing to inflation which will lower interest rates further and errode savings which will get people stuff less in their matresses. But these investment effects operate on the economy through the multiplier, and you can increase the multiplier by increasing the marginal propensity to consume. State-level spending will still do this regardless of how it finances it. Higher MPC means a higher multiplier for the private investment, deficit spending, and monetary policy going on.

UPDATE: waterzooi comments that he's not sure I'm right when I say that states don't have to balance their budgets, because most have balanced budget requirements. Allow me to clarify: states don't have to have balanced budgets - they choose to impose that constraint on themselves. There's nothing forcing them to constitutionally require themselves to balance their budgets. There was a time when this was not a constitutional requirement for most states, and many states did incur public debt. Many ran into trouble with that, which lead to a wave of these constitutional amendments. But they don't have to have those amendments and in my opinion they should probably be scrapped. I don't know the details, but even these constitutional requirements give some leeway, depending on how the books are kept on certain capital investments.