This report uses U.S. state-level pension data captured during the pandemic to test whether pension funding gaps affect municipal bond yields, and if so, under what conditions. The main findings are as follows:
- Rising pension shortfalls during the pandemic led to significant increases in bond yields, but only in states that already had large shortfalls (exceeding the state’s annual revenue) prior to the pandemic.
- In states with small or no shortfalls prior to the crisis, bond yields were largely unresponsive to changes in pension shortfalls during the pandemic.
For policymakers and investors, the findings suggest that chronic underfunding may become costly under financial stress, when borrowing costs can rise sharply, impacting governments’ financial flexibility.