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The Impact of Covid-19 Related Policy Responses on Municipal Debt Markets

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Abstract

Municipal (muni) bonds are an important source of funding for state and local governments. During the Covid-19 pandemic, muni debt markets became severely distressed. In response, the Federal Reserve established the Municipal Liquidity Facility (MLF). Meanwhile, Congress enacted extensive fiscal measures that included direct aid to cities and states. To understand whether and how these policies worked, we employ a state-level regression model to estimate the relative efficacy of monetary and fiscal policy interventions for the term structure of muni-Treasury yield spreads. We find that fiscal and monetary policy together reduced those spreads by as much as 245 basis points. Fiscal policy contributed twice as much as monetary policy to the notable decline in shorter-term muni-Treasury spreads. At longer maturities, the contribution of fiscal policy was at least three times as large as that of monetary policy, suggesting that it addressed fundamental credit concerns.

Suggested Citation

  • Robert Bernhardt & Stefania D'Amico & Santiago I. Sordo Palacios, 2021. "The Impact of Covid-19 Related Policy Responses on Municipal Debt Markets," Working Paper Series WP-2021-14, Federal Reserve Bank of Chicago.
    • Handle: RePEc:fip:fedhwp:93028
    DOI: 10.21033/wp-2021-14
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    as
    1. Michael D. Bordo & John V. Duca, 2021. "How the New Fed Municipal Bond Facility Capped Muni-Treasury Yield Spreads in the COVID-19 Recession," Working Papers 2101, Federal Reserve Bank of Dallas.
    2. Sumedha Gupta & Kosali I. Simon & Coady Wing, 2020. "Mandated and Voluntary Social Distancing During The COVID-19 Epidemic: A Review," NBER Working Papers 28139, National Bureau of Economic Research, Inc.
    3. Raj Chetty & John N. Friedman & Michael Stepner & The Opportunity Insights Team, 2020. "The Economic Impacts of COVID-19: Evidence from a New Public Database Built Using Private Sector Data," NBER Working Papers 27431, National Bureau of Economic Research, Inc.
    4. Andrew F. Haughwout & Benjamin Hyman & Or Shachar, 2021. "The Option Value of Municipal Liquidity: Evidence from Federal Lending Cutoffs during COVID-19," Staff Reports 988, Federal Reserve Bank of New York.
    5. Marco Cipriani & Andrew F. Haughwout & Benjamin Hyman & Anna Kovner & Gabriele La Spada & Matthew Lieber & Shawn Nee, 2020. "Municipal Debt Markets and the COVID-19 Pandemic," Liberty Street Economics 20200629, Federal Reserve Bank of New York.
    6. Michael Schwert, 2017. "Municipal Bond Liquidity and Default Risk," Journal of Finance, American Finance Association, vol. 72(4), pages 1683-1722, August.
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    More about this item

    Keywords

    Monetary Policy; Policy Effects; Stabilization; Bond Market; Security Markets; Government Bonds; Local Government Bonds;
    All these keywords.

    JEL classification:

    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
    • G51 - Financial Economics - - Household Finance - - - Household Savings, Borrowing, Debt, and Wealth
    • H74 - Public Economics - - State and Local Government; Intergovernmental Relations - - - State and Local Borrowing

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