The Economics of State and Local Government Finance

Economist Joshua Rauh's research on the difficulties of state and local government employee pension funds relates directly to the work of the Federal Reserve's new effort, the State and Local Government Financial Monitoring Team (FMT). Rauh discussed his work at a Federal Reserve Bank of Atlanta Public Affairs Forum on October 26.

The FMT, a joint effort of the Federal Reserve Banks of Atlanta and Cleveland, is working to understand the ways in which state and local governments interact with and participate in financial markets, including the multitrillion-dollar state and local government bond market and public employee pension funds. The FMT's research and analysis are part of the Fed's legally mandated responsibility to pursue stability in the nation's financial system. Its work directly supports the Fed System's recently created Office of Financial Stability Policy and Research.

Atlanta Fed senior economist Paula Tkac, leader of the Atlanta Fed's FMT group, explained that city, county, and state governments altogether have more than $3 trillion in debt outstanding, held by banks, insurance companies, money market mutual funds and individual investors. Understanding how those investors value government debt and assess the potential for default—especially in a time when most governments face fiscal shortfalls—is helpful in assessing how stresses in this market could affect other parts of the financial system, and vice versa.

The FMT is also working to understand the financial activities and funding status of public employee pension funds. Many of these funds face significant shortfalls, the topic that Rauh addressed during his visit to the Atlanta Fed. Public pensions face unfunded liabilities exceeding $3 trillion, he said. The possible solutions are not inviting, including raising taxes and reducing payouts to public employees currently retired or looking ahead to retirement.