Anatomy of a State Budget Crisis


For those of you who can stomach enormous pdf files about economics, this recent analysis of California's budget woes, by UCLA's Daniel J.B. Mitchell, is a valuable reference document. One of Mitchell's more obvious points is worth remembering, as people compare Gray Davis' budget busting with George Bush's:

The fact is, however, that if California were a large country, it could do what the federal government does. It could run large continuing deficits. The federal government finances its deficits with bonds that are promises to pay dollars in the future. Since the federal government ultimately can create dollars, it can honor these future commitments. For that reason, federal securities are top rated by security rating services such as Moody?s, Standard & Poors, and Fitch. California cannot create dollars, although its bonds are also promises to pay dollars in the future. Therefore, as it increases its debt, its securities are viewed as more risky. Large continuing deficits, particularly if they occur in the context of legislative paralysis, will result in a higher and higher interest rate to compensate lenders for greater risk of default. Eventually, such deficits can lead to a refusal to lend at all.