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30593_1970-1974

30593_1970-1974

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Response of State and Local Governments
 
to Varying Credit Conditions
By John E. Petersen
In June 1969, the Board of Governors of 
 
the Federal Reserve System in conjunction
 
with the U.S. Bureau of the Census began a
 
series of experimental surveys of State and
 
local government borrowing and capital
 
spending. Because of the importance of the
 
State and local sector to both the capital
 
markets and the economy, the Federal
 
Reserve has had a sustained interest in the
 
size and structure of the credit demands
 
of these governments and the impact of 
 
monetary policy upon their borrowing and
 
spending decisions. And, to be of greatest
 
usefulness, information about these demands
 
and impacts is needed on a continuing basis,
 
suitable for estimating national conditions.In view of these requirements, the series
 
of experimental surveys was designed to
 
provide the following types of information:
 
first, to gather advance, or
ex ante,
 evidence
 
about the planned long-term borrowing of 
 
State and local governments; second, to as-
N
ote
.
—This article is a product of the author’s
 
research at the Federal Reserve and while on assign ment with the Urban Institute, Washington, D.C. The
 
article has benefited from the contributions of many.
 
At the Federal Reserve, Edward Ettin, Chief of the
 
Capital Markets Section, was responsible for the in ception and supervision of the survey project. Much
 
assistance was given by Paul Schneiderman and
 
Eleanor Pruitt of that section and by Carol Siegler of 
 
the Division of Data Processing, who did the bulk of 
 
the computer programming. Special thanks are due to
 
David McNelis, Chief of the Governments Division,
 
U.S. Bureau of the Census, and to Maurice Criz and
 
Sherman Landau of that division for their invaluable
 
help in the collection and processing of the survey
 
data. Finally, Robert King and the research staff of the
 
Investment Bankers Association generously aided in
 
correcting and verifying the borrowing data against
 
their own records.
certain quickly the extent to which such
 
borrowing plans were realized under differ ing credit market conditions; third, to pro vide additional knowledge about the linkage
 
between borrowing and spending decisions;
 
and fourth, to permit comparisons of be havior among units of different types. This
 
article reports and analyzes the results of 
 
these surveys, which are based on the ex periences of a sample of approximately
 
4,600 State and local governments, for
 
fiscal year 1970.1The principal findings of the surveys are
 
summarized first. Then the objectives and
 
design of the surveys are discussed briefly.
 
The major portion of the article presents a
 
detailed examination of the survey results.
 
Particular emphasis is given to the relation ship between borrowing and capital spend ing decisions and the effects of interest rates
 
on these decisions, both over time and by
 
type of government. The mechanics and
 
structure of the surveys, together with the
 
two questionnaires used, are presented in
 
Appendixes A and B. Appendix C contains
 
an analysis of the influence of legal interest
1Throughout this article “governmental” and “gov ernments” refer to State and local government units,
 
including special districts and authorities, except when
 
specified otherwise. “Long-term borrowing” refers to
 
borrowing with original maturity of over 1year. The
 
surveys asked respondents to give borrowings by the
 
date of sale (the date when the bid was accepted or
 
when the underwriting agreement or other borrowing
 
agreement was signed), not by the date of issue.
 
“Fiscal 1970” refers to the period July 1, 1969,
 
through June 30, 1970. Unless preceded by the word
 
“fiscal,” years are calendar years.
209
 
March 1971
 
210FEDERAL RESERVE BULLETIN □ MARCH 1971
rate ceilings on the market for State and
 
local securities.
SUMMARY
Based on surveys of State and local govern ment borrowing plans and realizations, it is
 
estimated that the unsettled and restrictive
 
credit conditions of fiscal 1970 led to set backs (delays and decreases) in planned
 
long-term borrowing by these governments
 
amounting to nearly $7.4 billion. Through out much of this period, the difficulties
 
related to historically high interest rates
 
were compounded by legal limitations on
 
maximum interest rates that State and local
 
governments might pay. Such ceilings made
 
borrowing, even when desired, legally
 
impossible.Of the $7.4 billion in long-term borrow ing setbacks experienced by State and local
 
governments, $2.2 billion—though post poned—was still completed before the end
 
of the fiscal year. The remaining $5.2 billion
 
was effectively canceled for the fiscal year
 
and therefore represented a net shortfall
 
below planned levels for fiscal 1970. Thus,
 
it is estimated, had interest rate factors not
 
intervened, that State and local governments
 
might have accomplished $18.5 billion in
 
long-term borrowing rather than the $13.3
 
billion they actually borrowed during that
 
period.Borrowing difficulties induced by restric tive monetary conditions and interest rate
 
ceilings led to an estimated $2.85 billion in
 
setbacks of planned capital outlays. While
 
a combination of lower interest rates and
 
revisions in interest rate ceilings evidently
 
permitted $1.25 billion of these capital proj ects to be reinstated, an estimated $1.60
 
billion remained suspended at the end of 
 
fiscal year 1970. This equals 5.6 per cent
 
of total capital expenditures by State and
 
local governments in the preceding fiscal
 
year. However, because of lags involved inthe capital outlays process, the cutback in
 
spending is stretched out over time.The surveys were not explicitly designed
 
to measure the impact of interest rate ceil ings as a separate factor in borrowing and
 
spending decisions. Nevertheless, compari son of the behavior of units in States with
 
and without such ceilings suggests that ceil ings did contribute to disproportionate
 
amounts of borrowing and capital spending
 
shortfalls. In fact, interest rate ceilings may
 
have caused net spending cutbacks by State
 
and local units in fiscal 1970 roughly
 
double what they otherwise would have
 
been.State and local governments with approxi mately $4.5 billion in long-term borrowing
 
shortfalls associated with high interest rates
 
evidently were still able to proceed with
 
their original spending plans by changing
 
their financing arrangements. Thus, they
 
raised 60 per cent of the funds needed to
 
finance these projects by short-term borrow ing not subject to interest rate ceilings.
 
Reductions in actual or planned liquid asset
 
holdings were of secondary importance, and
 
the use of current revenues to substitute
 
capital for current expenditures were incon sequential.
BACKGROUND
High and rising interest rates may have a
 
negative influence on the long-term borrow ing and spending of State and local govern ments for a variety of reasons. First, in the
 
short run, an increase in the interest rates
 
raises the current cost of debt service. This
 
higher cost may make borrowing impossible
 
when current period expenditures cannot be
 
increased because of inflexible revenues. Or,
 
such increases in the cost of borrowing may
 
lead governments to await periods of lower
 
interest rates, in the hope that the burden of 
 
future debt service may be lessened. Second,
 
over the longer term, an increase in the cost
 
March 1971
 
RESPONSE TO CREDIT CONDITIONS
211
of borrowing means that the facilities them selves have gone up in price, perhaps beyond
 
a point where the government believes it
 
worthwhile to make the expenditure.Of special importance recently has been a
 
third reason for the negative response of 
 
State and local governments’ borrowing and
 
spending to high interest rates. Most juris dictions have a legal limit on the interest
 
rate they are allowed to pay. For many
 
governments these pre-set rate ceilings were
 
exceeded by municipal bond yields through
 
much of fiscal 1970. In such areas, the
 
ceilings prevented long-term borrowing and
 
thereby limited expenditures where alterna tive sources of funds were not available.2Several recent studies have documented
 
the responsiveness of State and local govern ments to varying credit conditions. Findings
 
have uniformly shown the long-term bor rowing of these units to be quite sensitive
 
to fluctuations in municipal bond yields. In
 
addition, past studies have found that the
 
capital expenditures of these governments—
 
which typically rely on long-term borrowing
 
for about one-half of their capital funds—
 
are also significantly influenced by the cost
 
of borrowing.3
DESIGN OF SURVEYS
Because of the large number of State and
 
local governments (about 80,000), it was
 
not feasible to conduct a canvass of the
2An extensive discussion of the possible reactions
 
of governmental units to the levels of and changes
 
in interest rates will be found in P. F. McGouldrick
 
and J. E. Petersen, “Monetary Restraint and Borrow ing and Capital Spending by Large State and Local
 
Governments in 1966,” Federal Reserve
Bulletin
 
(July 1968), p. 552. Appendix A of that article dis cusses the special institutional structure of State and
 
local governments and the market in which they
 
borrow, both of which are important in explaining
 
their fiscal behavior and influence on the design of the
 
surveys.3Hie findings of an extensive Federal Reserve
 
System survey of State and local experience during the
 
credit stringency of 1966 are summarized in J. E.
borrowing plans and realizations of all units.
 
Rather, it was decided to employ a sampling
 
technique similar to that used by the U.S.
 
Bureau of the Census for its annual survey
 
of local government finances. In particular,
 
all State and larger local governmental units
 
were canvassed and a stratified sample of 
 
smaller local governments was taken to
 
create a sample frame that could be used
 
as the basis for national estimates after the
 
application of expansion factors.To achieve a high rate of rapid response,
 
the survey was conducted in two stages. The
 
first stage (annual anticipation survey) con sisted of a one-page questionnaire that was
 
sent to all the units in the sample frame in
 
June 1969. Units were asked to indicate
 
their planned long-term borrowing, if any,
 
for the four quarters of fiscal 1970. On the
 
basis of this survey of borrowing anticipa tions, units that had indicated a plan to
 
borrow were followed up with second-stage
 
questionnaires (quarterly realizations sur veys) to determine whether the anticipated
 
borrowing had, in fact, been realized. If 
 
there were deviations from the expected
 
levels of long-term borrowing, units were
 
asked to explain why the discrepancies had
 
occurred and to estimate the consequences
 
for expenditures. Units were also asked to
 
give their borrowing plans for the remainder
 
of the fiscal year.Of the 4,590 State and local governments
 
in the original sample frame, 4,152 re-
Petersen and P. F. McGouldrick, “Monetary Restraint,
 
Borrowing, and Capital Spending by Small Local
 
Governments and State Colleges in 1966,” Federal
 
Reserve
Bulletin
(Dec. 1968). Recent studies that
 
focus on the impact of interest rates on State and
 
local spending include E. M. Gramlich, “State and
 
Local Governments and Their Budget Constraint,”
 
 International Economic Review
 (June 1969); C. D.
 
Phelps, “Real and Monetary Determinants of State
 
and Local Highway Investment, 1951-1961,
 Amer ican Economic Review
 (Sept. 1969); H. Galper and
 
J. E. Petersen, “Forecasting State and Local Govern ment Capital Outlays and Their Financing,” Urban
 
Institute Working Paper (Feb. 1970).
 
March 1971

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