State and local governments will struggle with budget shortfalls even as the U.S. economy picks up speed, Federal Reserve Chairman Ben Bernanke warned.
"Governors, mayors and legislators will confront more tough decisions as they develop their budgets for fiscal year 2012," Bernanke said Wednesday in a speech in New York.
State and local governments have cut spending, laid off workers and raised taxes in an effort to close budget gaps. Those moves have been a "headwind on the economy recovery," Bernanke said.
Still, he said he believes the national economy will strengthen this year.
That might start to give states and localities "a little breathing space," he said. But he added that it will take "some time" for many states to regain their financial health. He didn't provide a timetable.
Bernanke ticked off a number of reasons why states and localities will continue to struggle even as the national economy improves.
Unemployment remains high at 9 percent. Businesses are operating well below full capacity because customer demand is growing, but not booming. Stimulus grants from the federal government are winding down this year and will largely have ended by next year.
And, demand on Medicaid and other social service programs will probably remain elevated. Medicaid caseloads rose to more than 50 million in June 2010, an increase of nearly 18 percent from the start of the recession in December 2007.
Even with stimulus grants from the federal government, many governments have laid off or furloughed workers, frozen salaries and cut other expenses, Bernanke said. Job cuts have been especially deep at the local level, where payrolls have fallen roughly 350,000, or more than 2 percent, over the past 2 1/2 years. Nearly, half of the local job losses have been in education, he said.
Deeper spending cuts by state and local governments weighed down economic growth in the final three months of last year. The government reported last week that economic growth increased at an annual rate of 2.8 percent in the final quarter of last year. That was down from an initial estimate of 3.2 percent.
Concerns about current state and local budget problems along with longer-term worries about their ability to fulfill pension obligations and provide health benefits have led to strains in municipal bond markets. Yields on municipal bonds have risen as jittery investors have left the market.
Even so, Bernanke said the municipal bond market "seems to be functioning reasonably well." And he said he hopes that steps by state and local governments to close their budget shortfalls will "help calm" municipal-bond investors.
Over the longer term, state and local government face more daunting challenges.
Bernanke said it will become increasingly difficult for many states and localities to meet obligations for pension and healthcare expenses as a wave of baby boomers retire and healthcare costs keep rising.
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