Bernanke: States need rainy-day funds

New York State government and others ravaged by the recession should build up their rainy-day funds and continue spending on schools and building projects to lessen the impact of future downturns, Federal Reserve chairman Ben Bernanke said last night.

States are beginning to rebound from the 2007-09 recession with fewer facing budget deficits this year, though not New York, which has projected red ink of $10 billion. However, Bernanke said states now face huge bills for employee pensions and health care.

To stabilize their finances, states should accumulate reserves larger than those they nearly exhausted to pay expenses over the past two years as tax revenue had plummeted. He estimated states' rainy-day funds totaled more than 11.5 percent of spending in 2006.

"Even these historically high balances proved insufficient to fully buffer the budgets of most states," Bernanke told a Citizens Budget Commission dinner in Manhattan. "Building an adequate reserve fund during good times may not be politically popular, but doing so can pay off during bad times as well as lessen the tendency to overspend when times are good."

Substantial reserves also allow states to invest in construction projects during recessions. The projects create jobs and often are less expensive because builders desperately need the work, he added.

Still, Bernanke urged state officials to look beyond balancing the books to how state spending can spur economic growth and therefore more tax revenue. He said early childhood education and skills training for workers can yield significant gains.

"Preschool programs for disadvantaged children have been shown to increase high school graduation rates," he said in a 30-minute speech. "Because high school graduates have higher earnings, pay more taxes, and are less likely to use public health programs, investing in such programs can pay off."

Separately Wednesday, the Fed released economic updates from its 12 regions, including New York. The updates, known as The Beige Book, show continued, but slow improvement in the U.S. economy.

The New York region, which includes parts of Connecticut and New Jersey, mirrored national trends. However, the report cited a spike in vacancy rates for factory and industrial space on Long Island to the highest level in more than a decade. There also were more vacant offices in Nassau, Suffolk and Westchester counties than late last year.

January's crippling snowstorms dampened retail sales throughout the region by as much as 1 percent. They may also have contributed to the unusually large drop in tourism, particularly in New York City, the Fed said.