Coping with Extreme Events: On Solving Decentralized Budgetary Crises

Extreme events create both macroeconomic and budgetary problems for decentralized governments. Decentralized governments are unequipped for macroeconomic stabilization policies and have very limited fiscal space. At a practical level there are three options to replace lost funding from an extreme event: decentralized governments can anticipate and save for these budgetary rainy days themselves, they can issue debt, or the central government can step in and provide aid when such extreme events occur. In this paper we examine the impact of these options on the unemployment rate. Using the 2008 financial crisis of as our extreme event and employing a difference in difference approach, we find that both grants and rainy day funds during the crisis reduced future unemployment on the margin relative to periods outside of the crisis; the same is not true of debt. We also find that grants and rainy day funds are substitutes: greater grant funding implies a somewhat smaller effect of own savings on future unemployment.