The Effects of Credit Supply Shocks on Municipal Investment: Evidence from Build America Bonds

Abstract

Municipal bonds are tax-exempt debt instruments primarily used for the financing of capital development by local governments. Previously, this exemption has been described as an indirect federal subsidy. This paper assesses whether direct subsidy bonds, such as the Build America Bonds of the 2009-2010 program have significant effects on municipal spending as a benchmark for the suggested indirect subsidy. To do so, it utilizes an Instrumental Variable regression that accounts for pre-crisis firm exposure and finds that BAB participation considerably increased municipal expenditures, while also expanding the overall municipal bond market.