The Option Value of Municipal Liquidity

States and localities are relied upon to implement macroeconomic stabilization policies and ensure service delivery in times of crisis. In April 2020, the introduction of the Municipal Liquidity Facility (MLF) added an emergency lending instrument to the policy arsenal, guaranteeing liquidity, but at a price. Using a regression discontinuity design that exploits MLF lending eligibility population cutoffs, we find that the MLF contributed to the easing of liquidity pressures and reduced perceived credit risk for municipal borrowers. Low-rated issuers experienced yield reductions of at least 26 bps. We also provide suggestive evidence that these liquidity effects translated into employment gains. (JEL E58, H71, H72, H75, H77)