The Bond Market and Fiscal Institutions: Have Budget Stabilization Funds Reduced State Borrowing Costs?

Abstract

Since budget stabilization funds have the potential to aid states in mitigating periods of fiscal stress, they may reduce the default risk associated with state-issued debt. This paper explores how budget stabilization funds affect state borrowing costs. While the empirical results reveal that the typical state experiences a modest reduction in bond yields following the adoption of a budget stabilization fund, stabilization funds with different types of deposit and withdrawal rules are found to affect borrowing costs differently. The largest reduction in yields occurs in states that have budget stabilization funds governed by strict deposit and withdrawal rules.