State ready for potential recession
Published November 17, 2022
By John Hood
Just months ago, the housing market was blazing hot. Now median prices are dropping, even in states like North Carolina that continue to attract new residents. The Federal Reserve isn’t done pushing up interest rates to combat inflation. Consumers are responding to higher prices by cutting back on expenses.
Are we on the cusp of a major recession? Most economists surveyed last month by The Wall Street Journal said yes. I hope they’re wrong. But I’m also glad to live in North Carolina, where legislative leaders have made it a priority to hedge against worst-case scenarios.
As of September, the state had an unreserved General Fund balance of $5 billion. The dedicated savings reserve, our “rainy-day fund,” contained $3.6 billion. Another $309 million sat in two Medicaid reserves. Not counting other state savings accounts, these three categories alone represent nearly $9 billion in readily accessible funds — or roughly a third of North Carolina’s General Fund budget for the 2022-23 fiscal year.
Never before in state history have we been so well-prepared for fiscal turbulence. Most recessions produce budget deficits due to a combination of factors: lower-than-expected collections of revenue from struggling households and businesses and higher-than-expected demand for public-assistance programs such as Medicaid.
Because North Carolina is legally required to balance its operating budget, past administrations and legislative majorities have responded to recessionary deficits by raising taxes, slashing expenditures, tapping (borrowed) federal funds, and foisting more fiscal obligations onto local governments (which must then raise taxes, cut spending, or both).
I’m no Keynesian. I don’t believe government at any level should attempt to fine-tune the economy by artificially stimulating demand during recessions or artificially tamping down demand during booms. Such policies usually fail to accomplish their objectives. Political actors inevitably lack the information to make the “right” decisions about all this, and it takes too long for the effects of the policies to manifest themselves. In fact, precisely because they are political actors, they rarely stick to the theoretical script, anyway. They favor some sectors over others. And they shy away from tough decisions that might advance the public good but would anger some vocal political constituency.
That being said, state leaders rarely make good decisions in the midst of a crisis. I’m all for pursuing economy in government, but in the past governors and legislators have resorted to across-the-board cuts or gimmickry to close budget gaps rather than making prudent, long-term decisions about what to fund, what not to fund, and why.
As for the revenue side of the equation, raising taxes during a recession makes neither economic nor political sense. And grabbing more federal money to paper over budget holes is no solution, either. The national debt has grown so large that it fuels inflation and inhibits growth. Projected federal expenditures already exceed projected federal revenues by many trillions of dollars, primarily because of unfunded liabilities for Social Security, Medicare, and other entitlements.
The best way to avoid these calamitous decisions is to build up savings reserves. When recessions come, lawmakers should still set firm budgetary priorities and be willing to eliminate programs or positions that don’t comport with them. But with $9 billion in savings, North Carolina’s leaders can do so without slashing core services — and without raising taxes. Indeed, they can even raise the pay of public employees to offset inflation or to compensate them for taking on additional duties.
Here’s another underappreciated benefit of rainy-day funds: they reduce corruption in government! In a recently published study in Public Administration Review, economist Wenchi Wei found a strong negative relationship between the size of a state’s savings reserve and the rate at which officials are convicted on public-corruption charges. The policy “curbs officials’ discretionary power, reduces uncertainty in fiscal slack management, and ultimately restrains embezzlement and misuse behaviors,” Wei concluded.
Might the General Assembly’s past decade of precautionary saving prove unnecessary? Yes. The old maxim still applies, though: hope for the best, prepare for the worst.
John Hood is a John Locke Foundation board member. His latest books, Mountain Folk and Forest Folk, combine epic fantasy with early American history.