Fed Chairman Ben Bernanke spoke Monday at the annual meeting of the Southern Legislative Conference in Charleston, South Carolina. He addressed the economic outlook as well as fiscal challenges for state governments.

Bernanke stressed that while there are improvements in the economy, recovery is slow and many challenges remain. Overall, the economy is expanding at a “moderate pace,” he told the Council of State Governments. However, “notable restraints on the recovery persist,” including a weak housing market and a stunted labor market.

“Financial conditions–though much improved since the depth of the financial crisis–have become somewhat less supportive of economic growth in recent months,” Bernanke said, highlighting foreign debt crises as a major source of turmoil for global markets.

The U.S. banking system is still struggling, Bernanke admitted. There are some improvements – high bank capital ratios and a peak in loan loss rates – but strict lending standards and troubled loans continue to plague the industry.

In addressing the fiscal challenges states face, Bernanke said states have an “opportunity to serve as role models for effective long-term fiscal planning.” Among the challenges local governments face are funding pensions – compounded by the impending retirements of the baby boomers – and ever more expensive health care obligations. Bernanke noted that health care cost projections decades into the future is an uncertain science, but cited research from the Pew Center on the States that estimates state governments will need nearly $600 billion to fund retiree health benefits.

Bernanke encouraged states to maintain “rainy day” funds. He acknowledged that creating “a rainy-day fund during good times may not be politically popular, but it can pay off during the bad times,” noting that high reserve-fund balances helped lessen the “severity of spending cuts or tax increases in many states,” even if they didn’t fully protect embattled budgets.

While infrastructure is an important part of economic growth, Bernanke said, “for sustained economic development, investment in people–in their knowledge and skills–is even more important.” A high-quality workforce, he said, is especially important in “an age of globalization and technical change,” and is something “no economy can succeed without.”

Among the benefits of a well-educated workforce, Bernanke said, are a reduced dependency on social welfare programs, increased tax revenues and higher earnings for individuals.

Click here for text of the speech.