We analyse whether US federal aid to state and local governments impacted economic activity through either direct or cross-state spillover effects during the COVID-19 pandemic. Deploying an instrumental-variables framework rooted in the funding advantage of states that are over-represented in Congress, we find that federal assistance had significantly less impact on state and local government employment, as well as broader measures of economic activity, than estimates from prior crisis responses would imply. The modest employment impacts we find stem largely from the direct effect of states’ own aid allocation, as opposed to spillovers across state lines. These findings point to an important role for variations in fiscal policy transmission mechanisms, namely that cross-state spillovers are less likely to be important when some of the key mechanisms for such spillovers, like robust interjurisdictional supply chains and patterns of consumption, are muted or shut down.
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