THE ROLE OF RAINY DAY FUNDS IN ACHIEVING FISCAL STABILITY

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Abstract
The discussion and design of fiscal stabilization at the state level has been hampered by the absence of an adequate framework to evaluate own-source revenue, expenditures, elasticities, and cash balances in a longer-run, dynamic context. The lack of clear concepts and measures of fiscal stability is part of this lack of an appropriate framework. The potential for design failures of formula-based rainy day funds documents the danger of not having an adequate analytic paradigm. We develop a framework and an objective measure of fiscal stability that helps to fill this analytic gap. Simulations using these analytic tools indicate that formula-based rainy day funds can be destabilizing if not properly implemented.