Governing magazine columnist explores 2022 public finance outlook. Inflation is the key variable.

As state and local governments make their fiscal plans for the coming year – another year of uncertainty – Governing magazine columnist Girard Miller, a public finance and investment authority, identifies six themes of concerns. In his column, Miller writes,

…several macro trends now underway should make it easier in this new year for well-informed policymakers, professional staff and financial services providers to make better decisions that benefit the public sector at large. Here are six of the top themes to keep in mind, with the caveat that a global coronavirus mutation beyond pharma solutions — one requiring a new round of economic lockdowns — would be all-bets-off.

Here are the six, in short form:

1. Inflation will remain a monetary fact of life.

2. Payroll budgets will escalate.

3. Higher interest rates will present cash-management opportunities.

4. Higher muni bond yields are coming.

5. Public pensions will face a COLA pinch.

6. Fiscal uncertainty will continue to prevail in Washington.

We’d point out that items 1, 2, 3, 4, and 5 all are different ways of saying inflation. For our state, inflation, payroll budgets, and the COLA pinch on pensions may all be near-term budget concerns. 

Regarding inflation, Miller writes,

Three factors almost guarantee an inflation rate that ends 2022 well above the Federal Reserve’s long-term target of 2 percent: First, real estate prices and rental rates have not yet worked their way into the statistics, and that alone will drive employee wage demands and expectations higher; until interest rates move high enough to cool off the housing market, the costs of shelter will drive up cost-push inflation. Second, salaries, including those of public employees, will have to adjust upward to cover the recent surge in the CPI, and those costs of doing business will not be transitory. Finally, the elephant in the room is the massive increase in the money supply that the Fed’s monetary policies of the last two years has left in our midst.

…even an inflation rate as low as 4 percent next December would probably be enough to trigger an embryonic multiyear wage-price spiral, setting up a new trifecta of trends in the labor markets, the money market and the bond market, all of which will likely impact the finances of states and localities.

Higher inflation will play a role in the state’s next round of collective bargaining. Leading to Miller’s second point,

Employee unions won’t be gullible about inflation on the salary side, and in contract negotiations, their leaders would be derelict if they don’t push for “COLA plus X” provisions.

Regarding COLAs and pension, Washington may be in better shape than many states, but this still matters.

But the reality is that many plans that include cost-of-living increases in retirees’ pensions will experience an increase in their unfunded retiree liabilities as 2022’s COLAs exceed their actuarial assumptions. Of course, the payroll base will eventually grow to catch up, so pension contribution rates as a percentage of pay may remain stable.

Some things to watch.