Should the Federal Reserve purchase bonds of state and local governments during a recession? (Yes)

In a hearing yesterday, Democratic Party Representative Rashida Tlaib asked Federal Reserve Chairman Jerome Powell about extending counter-cyclical anti-Recession responses of purchasing of debt of corporations and the federal government to debt issued by local and state governments ("AOC Is Making Monetary Policy Cool (and Political) Again;," New York Magazine).

Powell responded that it isn't legal, but apparently it is.

A big problem during recessions is that even if there is new federal spending aimed at stoking demand during a recession, along with increases for unemployment funding and sometimes other types of social support payments, states and local governments and related agencies tend to contract significantly for two reasons:

1.  Property, income, and sales tax revenues contract
2.  By law, state and local governments can't run deficits.

This cancels out many of the benefits of increased federal spending during recessions and in fact, extends by multiple years recessionary pressures.

Apparently, the Roosevelt Institute released a report, A NEW DIRECTION FOR THE FEDERAL RESERVE: Expanding the Monetary Policy Toolkit, a couple years ago that included this point:

3. PURCHASING STATE AND LOCAL DEBT
Unlike the federal government, state and local governments do face meaningful financial constraints. Perhaps the single most powerful tool the Fed has to support aggregate demand and direct credit in socially useful directions is to purchase the liabilities of states, cities, and other subnational governments. This would greatly reduce the pressure for pro-cyclical cuts in public spending during recessions.

The balance sheets of state and local governments are complex—unlike the federal government, most have substantial financial assets, as well as liabilities, and the sector as a whole is a net creditor (Mason, Jayadev, and Page Hoongrajok 2017). But many individual governments do face acute limits on their access to credit, and concerns over credit are a constraint on spending and revenue decisions, even if their access to bond markets is currently unimpaired. These concerns become especially serious during downturns—exactly the period when, from a macroeconomic perspective, state and local governments should be increasing spending and avoiding tax increases.

From a social standpoint, public investment is less costly during a downturn, when a larger fraction of labor and other resources are unemployed. So it is perverse that borrowing constraints cause many governments to cut back investment spending in recessions.

Financial constraints on state and local governments impart a substantial pro-cyclical component to their budget positions, acting as a kind of “automatic destabilizer” that offsets countercyclical fiscal policy at the federal level.