of providing retiree health benefits – though certainly consequential – appear to be somewhat smaller than unfunded pension liabilities. for example, one recent estimate suggests that state governments have a collective liability of almost $ 600 billion for retiree health benefits. 4 not all of the longer - term issues facing state and local fiscal authorities involve closing budget gaps. for example, in light of the recent experience, an important question is whether see alicia h. munnell, richard w. kopcke, jean - pierre aubry, and laura quinby ( 2010 ), valuing liabilities in state and local plans ( chestnut hill, mass. : center for retirement research at boston college, june ) ; and robert novy - marx and joshua d. rauh ( forthcoming ), “ public pension promises : how big are they and what are they worth? ” journal of finance. see jeffrey r. brown and david w. wilcox ( 2009 ), “ discounting state and local pension liabilities, ” american economic review, vol. 99 ( may ), pp. 538 – 42. it should be noted that future pension accruals generally seem to be accorded a lower level of protection. see pew center on the states ( 2010 ), the trillion dollar gap : underfunded state retirement systems and the road to reform ( washington : pcs, february ). bis central bankers ’ speeches anything can be done to reduce the sensitivity of state and local budgets to the business cycle. as the past couple of years have shown, the balanced - budget rules under which most states operate can force sharp cuts in services and increases in taxes during recessions, which is just the time when many people in the state are economically most vulnerable. moreover, the instability in funding streams and tax rates associated with the business cycle can impede planning by both the public and the private sectors. by and large, the evidence suggests that balanced - budget rules provide valuable fiscal discipline for states, and i do not advocate eliminating them. 5 however, even with these rules in place, the question remains whether the effects of the business cycle on state budgets can be mitigated in the future. one strategy used by many governments is to build up a rainy day fund during good economic times. measured as a percent of general fund expenditures, the aggregate reserve - fund balances for all state governments stood at a record 11 - 1 / 2 percent at the end of fiscal 2006. these comparatively high reserve - fund

reserve and many private forecasters, states and localities may start to get a little breathing space. tax collections will rise with income and spending, and the use of medicaid and other income support programs should ease as the labor market improves. however, because the pace of near - term economic growth expected by most forecasters is relatively modest given the depth of the downturn, some time will likely be required before state and local fiscal conditions return to something approximating normal. continued evidence that states and localities are addressing fiscal shortfalls should help calm the municipal bond market. generally, that market seems to be functioning reasonably well. around the turn of the year, though, investor concerns about the fiscal situations of many governments, including those of some populous states, resulted in increased yields on municipal bonds relative to treasury bonds as well as a widening of credit default swap spreads for a number of states. fortunately, although these measures of risk in the municipal bond market remain elevated, they have been looking somewhat better recently, presumably reflecting expectations of continuing improvement in the finances of states and localities. the federal reserve will continue to monitor the municipal bond market closely. longer - run fiscal challenges for states and localities although my focus thus far has been on the near term, state and local governments are also confronting some difficult fiscal challenges in the longer term. indeed, with the retirement of public employees who are part of the baby - boom generation and the continued rise in healthcare costs, meeting obligations for pension and retiree health - care expenses will become increasingly difficult for many states and localities. estimates of state and local governments ’ unfunded pension liabilities for the nation as a whole span a wide range, with some researchers putting the figure in the neighborhood of $ 2 trillion to $ 3 trillion. 2 some governments are beginning to take difficult steps to address this problem, although their ability to change plan provisions is limited by the strong legal protection ( including, in some states, constitutional protection ) accorded to accrued pension benefits of public employees in many jurisdictions. 3 state and local governments also will have to address the burgeoning costs of retiree health benefits. estimates of these costs are subject to substantially greater uncertainty than are those for pension liabilities, largely because of the difficulty inherent in projecting overall health - care costs decades into the future. in addition, retiree health plans generally do not have the same degree of explicit protection as do pensions and thus may be more subject to change. with these uncertainties in mind, the prospective costs