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R E S E A R C H L IB R A R Y
Federal Reserve Bank
of St. Louis

I tide

ISSN 016 4-0 79 8

LIBRARY OF CONGRESS CATALOG CARD NUMBER: 16-7264
Federal Reserve Bank o f Richmond Publication Number:

P-l

Additional copies of this Annual Report may be obtained without chargefrom:
Public Services Department

Federal Reserve Bank of Richmond

P.O. Box 27622

Richmond, Virginia 23261

HenryJ. Faison
Deputy Chairman

Robert P. Black
President

e s s a g e

Anne Marie Whittemore
Chairman

1991
was a year o f dramatic challenges and changes for
the w orld, our nation and region, and the Federal Reserve
System. It was a difficult time for monetary policy and bank
supervision, and an important year for Federal Reserve Bank
operations. I thank my fellow directors with w h om I have
had the pleasure o f serving for their very thoughtful deliber
ations, and I extend to the Bank staff congratulations for an
excellent performance in responding to the demands o f these
times in a manner that can only be described as outstanding.
Monetary p olicy responsibilities presented major issues
for the Board o f Directors and our president in 1991, a year
that saw e co n o m ic activity start to pull us out o f recession
in the immediate aftermath o f the Persian Gulf War, but
subsequently decelerate sharply in the fourth quarter. In this
uncertain environment, extensive preparation and especially
careful deliberation preceded directors’ votes on the discount
rate and President Black’s votes on monetary p olicy actions
and targets. W e are hopeful that w e are on a course that will
revive e co n o m ic activity and continue to control inflation.
Consistent with the con viction that monetary p olicy
should focus on long-run price stability, this Report's

f r o

t h

h a ir m

a n

article b y Vice President Robert L. Hetzel
proposes a way to measure inflation e x p ec
tations through the use o f indexed bonds
and thereby assist m onetary policymakers.
The year was a demanding one for the
Bank’s supervision and regulation staff as the
Fifth District, like other regions in the cou n
try, experienced an increase in problem s at
som e o f its depository institutions. Mean
while, mergers created three o f the nation’s
largest bank holding com panies, w hich will
be headquartered in the District.
Important consolidation decisions were
also made within the Federal Reserve Bank
o f Richm ond and the Federal Reserve System
as a w hole. Within the Bank, the Richm ond
office began handling all book-entry securities
operations for the Fifth District. Within the
System, Richm ond was selected as the staff
headquarters for three com puter centers that
will eventually consolidate data processing for
all twelve Reserve Banks into three sites in
Richm ond, Dallas, and East Rutherford, New
Jersey. O f immediate critical service to the
System was the Contingency Processing
Center located in the Bank’s facility in
Culpeper, Virginia, w hich provided almost
four m onths’ backup for the disabled co m
puter system at the Federal Reserve Bank o f
Minneapolis.
I thank our mem ber banks and our other
constituents for helping the Federal Reserve
Bank o f Richm ond perform so well in this
challenging but extrem ely interesting year.

Chairman of the Board

I n d e x e d
t o

o n d s

o n e t a r y

a s

a n

o lic y

A principal long-term goal of Federal Reserve
monetarypolicy is to restorepricestability to the
UnitedStates economy. In thisarticle, theauthor
suggests that a measure of thepublic’s inflation
expectations would assist the Fed in attaining
its goal and proposes that, to provide such a
measure, the U.S. Treasury issue bonds in
dexed to eliminate losses resultingfrom infla
tion. The article ispresented here to stimulate
further discussion of issues related to the effort
to eliminate inflation. The views expressed are
the author's and not necessarily those of the
Bank or the Federal Reserve System.

The Proposal...........................................................................5
The Yield Gap as an Indicator of Monetary P olicy............... 6
Avoiding Inflation and Disinflation........................................ 6
Possible Distortions in the Yield G ap.................................... 7
Issues for Debt Management..................................................9
British Experience................................................................... 9
Summary and Concluding Comments.................................. 12
Endnotes...............................................................................13
References.............................................................................15

Robert L. Hetzel

ontracts requiring payment
o f dollars in the future for
future delivery o f good s
and services are a regular
•
part o f eco n o m ic life.
W orkers enter into c o n
tracts, formal and informal, for a dollar wage
for the next year. Colleges set tuition
payments on ce a year. Rents for apartments
are set annually and hom eow ners contract for
mortgage payments in dollars. The purchas
ing p ow er represented b y these dollar
payments, how ever, depends upon the rate
o f inflation realized after the contracts are
signed. People must forecast inflation in order
to estimate the purchasing p ow er o f future
dollar payments.
This article argues that it w ou ld be helpful
to the Federal Reserve System to have a
measure o f the public’s inflation forecast. The
Fed, through its control o f the m on ey stock,
controls the long-run rate o f inflation. There
is, how ever, always considerable short-run
uncertainty regarding the w ay in w hich
changes in its p olicy instrument (reserves or
the federal funds rate) will ultimately affect
m oney growth and inflation. A measure o f the
inflation forecast by the public w ou ld offer
the Fed a useful “ outside” assessment o f the
inflationary consequences thought likely to
follow from its p olicy actions. This inflation
forecast cou ld be inferred from the yield gap
betw een the interest rates paid on co n v e n
tional bonds and on bon ds indexed to the
price level.1 Unfortunately, indexed bonds are
not n ow traded in the United States. This
paper proposes that the U.S. Treasury issue
indexed bonds to create a measure o f the
p u b lic’s inflation forecast.

Indexed Bonds

THE PROPOSAL
A measure o f the inflation expected by the
public cou ld be created by legislation requir
ing the Treasury to issue zero-cou pon bonds
with maturities o f one year, tw o years, and
so on out to twenty years. A zero-cou p on
b o n d is a prom ise to make a future one-time
payment. Z e ro-cou p on bonds sell at a dis
count and yield a return through capital ap
preciation. Under the proposal, half the bonds
issu ed w o u ld b e c o n v e n tio n a l (n o n
indexed) zero-cou p on bonds that w ou ld
offer a principal payment o f a given dollar
amount. The other half w ou ld offer a prin
cipal payment in dollars o f constant purchas
ing p ow er achieved by indexing the principal
payment to the price level. For example, if
the principal payment o f the conventional
ze ro-cou p on b on d were $100 and the price
level were to rise by 5 percent in the year after
the sale o f the bonds, an indexed b on d with
a maturity o f one year w ou ld pay $105.2
Holders o f indexed bonds d o not have to
w orry about the depreciation o f the dollars
in w h ich they are paid. For a zero-cou p on
b on d sold in, say, 1992, both the amount bid
Figure 1

TIME PROFILE OF
EXPECTED FUTURE PRICE LEVEL

8
12
Years in the Future
Note: Hypothetical observationsarebasedonassumed4percent rateof inflation.

and the purchasing p ow er afforded by the
principal payment are measured in 1992
dollars. The discount on the bond, therefore,
is a measure o f the real yield (real capital
appreciation) offered by the bond over its life.
The yield on indexed bonds w ou ld offer a
direct measure o f the real (inflation-adjusted)
rate o f interest. Furthermore, the existence
o f indexed bonds o f different maturities
w ou ld provide a measure o f the term struc
ture o f real rates o f interest.3
Because holders o f the indexed bonds are
guaranteed payment representing a k now n
amount o f purchasing pow er, they d o not
have to forecast inflation. In contrast, holders
o f the nonindexed bonds would have to
forecast future changes in the value o f the
dollar. Consequently, the yield on the n on
indexed bonds w ould incorporate an inflation
premium to com pensate for the expected
depreciation in the purchasing pow er o f the
dollar, and the difference in yields betw een
the nonindexed and indexed bonds, there
fore, w ou ld measure the inflation expected
by investors over the life o f the bond. The
existence o f bonds o f different maturities
w ou ld offer a term structure o f expected
future inflation. Given the current price
level, this term structure w ou ld yield a time
profile o f the future price level expected by
the public.
Figure 1 illustrates a hypothetical
exam ple in w hich the public expects
future inflation to remain steady at
4 percent a year. (The contem pora
neous price level is also taken to be
138, the current value o f the CPI.) If
nonindexed and indexed zero-coupon bonds
are issued at maturities ranging from one
year to twenty years, the yield gap on suc
cessive issues w ou ld permit inference o f a
term structure o f future inflation. These
yearly expected inflation rates, when applied
to the current price level, w ould allow c o n
struction o f the time profile o f the future
price level expected by the public show n in
Figure 1.

1991 Annual Report

Consider an indexed one-year-maturity
zero-cou p on b o n d that is a prom ise to pay
$100 in one year, with the $100 indexed to
the consum er price index. If the real rate o f
interest were 3 percent, the b on d w ou ld sell
for $97. If the public believed that the oneyear inflation rate w ou ld be 4 percent, a
comparable nonindexed b on d w ou ld sell for
$93, returning 4 percent in com pensation for
the expected inflation and a 3 percent ex
pected real yield. The interest rate on the
n onindexed b on d w ou ld then be 7 percent,
with a 3 percent real interest rate on the
indexed bond. The “ yield gap” betw een
these tw o rates is the 4 percent inflation rate
expected by the market.

THE YIELD GAP AS AN INDICATOR
OF MONETARY POLICY
In order to achieve its inflation objective,
the Fed could, in principle, change its p olicy
instrument in response to discrepancies b e
tween the actual price level and a target
path for the price level. Because individual
p olicy actions affect prices only with long
lags, how ever, such a straightforward strat
egy cou ld be destabilizing. In practice, the
Fed m onitors indicator variables to deter
mine whether the changes in its policy instru
ment are consistent with the inflation rate it
considers acceptable.

om e econom ists have suggested
that the Fed change its p olicy
instrument in response to
m ovem ents in the prices o f
actively traded com m odities.
These prices do m ove freely
in response to changes in expenditure p ro
duced by monetary policy actions; however,
they often m ove in response to marketspecific disturbances. At such times, c o m
m odity prices might give misleading signals
about the thrust o f m onetary policy.

Milton Friedman has long advocated a low,
stable rate o f grow th o f M2 as the guide to
monetary policy. M2 has maintained a reliable
relationship to the public’s dollar expenditure
over long periods o f time. In fact, the ratio
o f dollar GNP to M2, k n ow n as M2 velocity,
is currently about 1.63, little changed from
its value in 1914 w hen the Federal Reserve
was founded. Over periods o f time as long
as several years, how ever, M2 velocity fluc
tuates significantly. Many econom ists also fear
that future financial innovation could alter the
long-run relationship betw een M2 and GNP.
It is possible that a consensus will never
emerge that a particular m onetary aggregate
is a reliable indicator o f the stance o f
monetary policy.
In contrast to these alternatives, the yield
gap between nonindexed and indexed bonds
w^ould offer a direct measure o f expected
inflation. This measure w ou ld offer useful
information to monetary policym akers b e
cause it w ould be form ed by market partici
pants w h o have a direct financial interest in
forecasting inflation.

AVOIDING INFLATION AND
DISINFLATION
The lag betw een changes in the Federal
Reserve’s p olicy instrument and changes in
prices means that it is difficult to associate
particular policy actions with inflation. This
difficulty lowers the cost o f exerting political
pressure for an inflationary policy; m oreover,
the quicker impact o f stimulative monetary
p olicy on output than on prices generates
political pressure to trade o ff immediate out
put gains against a delayed rise in inflation.
Indexed bonds o f the sort p rop osed here
w ou ld balance these pressures by threaten
ing an immediate rise in the yield gap between
indexed and nonindexed bonds. The Fed
w ould have a clear and m ore immediate justi
fication for resisting inflationary pressures.
Further, with indexed bon ds, public
pressure for an inflationary monetary policy

Indexed Bonds

that was associated with a rise in the yield gap
in itself w o u ld p rod u ce countervailing
pressure. Holders o f n on in dexed bonds
w ould suffer a capital loss w hen the yield gap
rose. All creditors receiving payment in
n on in dexed dollars in the future w ou ld feel
w orse off. The yield gap w ou ld restrain
pressure for inflationary policy by offering an
immediate and continuous market assessment
o f the potential impact o f such a policy.
Surprise inflation acts like a capital levy
im posed on m on ey and governm ent securi
ties. The essentially fiscal transfer that arises
from surprise inflation does not have to be
legislated explicitly. Federal Reserve inde
pen dence is designed to prevent monetary
p olicy from b ecom in g the handmaiden o f
fiscal policy. Institutional arrangements, like
the federal structure o f the Fed with its
regional bank presidents and long terms for
m em bers o f the Board o f G overnors, give
substance to central bank independence. The
continuous market assessment o f the level
o f future inflation offered by the yield gap
betw een n on in dexed and indexed bonds
w ou ld constitute an additional safeguard
against surprise inflation.

POSSIBLE DISTORTIONS IN
THE YIELD GAP
The inform ation on exp ected inflation
offered b y the yield gap betw een nonin
dexed and indexed bonds o f equal maturities
w ou ld be diminished if the gap fluctuated in
response to tax and/or risk premium factors.
These possibilities are considered in turn.
Tax D istortions
Ideally, for both the nonindexed bon d and
the indexed bond, incom e subject to taxation
w ou ld be indexed for inflation. That is,
holders o f both types o f bon ds w ou ld pay
taxes on ly on the increase in purchasing
p ow er gained from holding the bonds, rather
than on any increase in the dollar value o f the
b o n d that only com pensates for inflation.

In order to illustrate this point, consider the
follow in g hypothetical example. Suppose
that, for both the indexed and non in dexed
bonds, on ly the return that represents a gain
in purchasing pow er is taxed. As before, if the
real rate o f return is 3 percent, an indexed
b o n d that prom ises to pay $100 o f constant
purchasing p ow er next year w ou ld sell for
$97 in the current year. If, subsequently, in
flation turns out to be 4 percent, the holder
o f the indexed b on d will receive $ 104. In this
case, taxable incom e w ou ld be calculated as
the $7 in total incom e minus the $4 inflation
adjustment, w hich is a capital depreciation
allow ance to maintain the purchasing p ow er
o f the investor’s capital. The holder o f the
nonindexed b on d also w ou ld be taxed only
on the real portion o f the b o n d ’s yield.4

I f, alternatively, taxable incom e were
not indexed for inflation, an increase
in the inflation rate w ou ld increase the
H| taxes paid by the holders o f indexed
I t bonds, w hich w ou ld reduce the real
wMm after-tax yield on the bon ds even if
there had been n o reduction in the real
before-tax yield. Unless the tax cod e were in
dexed, the yield on the indexed b on d w ou ld
rise as inflation rose to com pensate for the
increase in taxes im posed b y higher inflation.
The yield on the indexed b o n d w ou ld then
offer a distorted measure o f the econ om y w ide real rate o f interest. With the relatively
m oderate levels o f inflation experienced in
the 1980s, how ever, the distortions caused
by the present absence o f inflation indexing
in the tax co d e w ou ld not greatly impair the
usefulness o f the indexed b o n d as a measure
o f the real rate o f interest. M oreover, if
the tax treatment for the n on in dexed and
indexed b on d were the same, information
about expected inflation contained in the
yield gap betw een the non in dexed and
indexed b on d w ou ld not be distorted by
changes in the rate o f inflation.

1991 Annual Report

Possible Risk Prem ium Distortion
Because the public might be willing to pay
something to hold an asset w hose value is not
arbitrarily affected by unanticipated inflation,
it is possible that a risk prem ium might bias
the yield gap upward. The yield gap w ou ld
then overstate expected inflation. Also, the
risk premium could vary so that the yield gap
w ou ld change even with n o change in e x
pected inflation. (Note that if the yield gap
incorporated a risk premium, the Treasury
w ou ld have to com pensate investors for the
inflation risk entailed b y holding its n on
indexed bonds. Indexed bon ds w ou ld not
carry this cost.)
W hether a risk premium w ou ld, in fact, be
incorporated in the yield gap is o f course an
empirical question. W ood w a rd (1990) exam
ined the behavior o f the yield gap betw een
n on in dexed and indexed British bonds and
con clu d ed that any risk premium must have
been very small.5 If the risk premium had
been significant, the yield gap betw een c o n
ventional and indexed bon ds w ou ld have
Figure 2

YIELDS ON INDEXED AND NONINDEXED BONDS
Percent

Note: Monthly observations of yields on indexed bonds issued in April 1982 and maturing
in August 2011 and of yields on conventional bonds maturing in August 2011. Data
were furnished by G. Thomas Woodward.

im plied implausibly low estimates o f e x
pected inflation for Britain for the 1980s. Fur
thermore, W oodw a rd’s measure o f real yields
(adjusted for preferential tax treatment o f
indexed bonds) produces surprisingly high
values. Because real yields averaged around
5.5 percent, it is implausible that holders
o f indexed bonds were foregoing m uch yield
as protection against surprise inflation. (See
Fig. 2.)
The magnitude o f a possible risk premium
also w ou ld depend upon monetary policy.
Suppose that the central bank had made a
credible com m itm ent to price stability. With
such a policy, random shocks w ou ld still
cause the central bank to miss its price level
target, but these misses subsequently w ou ld
be offset. Consequently, the price level w ould
fluctuate around a fixed value, and the
magnitude o f any discrepancy between yields
o f n on in dexed and indexed bon ds due to a
risk premium w ou ld decline as maturities
lengthened.
Alternatively, suppose that the central bank
allow ed contem poraneous price level shocks
to be incorporated permanently in the future
price level target. Consequently, the price
level w ould wander randomly over time. (The
central bank cou ld allow this kind o f pricelevel drift even if it did not introduce a
systematic bias in favor o f inflation.) The
difficulty in predicting the real purchasing
p ow er o f a prom ise to pay a fixed dollar
amount in the future w ou ld increase as the
time horizon lengthened. With this policy, the
magnitude o f any discrepancy between yields
o f non in dexed and indexed bonds due to a
risk premium w ou ld not decline as maturities
lengthened.
Even if the yield gap betw een non in dexed
and indexed bonds were to incorporate a risk
premium, changes in the yield gap w ould still
co n v e y important information to the central
bank. Increases in the yield gap w ou ld be o f
concern to the central bank even if they were
caused by an increase in the risk premium,

Indexed Bonds

rather than by an increase in expected infla
tion. A central bank must assure markets that
its independence is a safeguard against sur
prise inflation. An increase in the size o f the
risk premium caused b y increased con cern
for surprise future inflation w ould indicate to
the central bank a need to reinforce the
credibility o f its com m itm ent to m onetary
stability.

ISSUES FOR DEBT MANAGEMENT
The idea o f indexed bonds has been
advanced num erous times in the past. The
Treasury possesses the authority to issue
indexed bonds, but has always resisted
doing so. In congressional hearings on in
dexed bon ds (U.S. Congress, 1985), Francis
Cavanaugh, the D irector o f the O ffice o f
G overnm ent Finance and Market Analysis o f
the Treasury, detailed the reasons.
Mr. Cavanaugh argued that the Treasury
did not k n ow w hether anyone w ou ld buy
indexed b on d s.6 If there were no demand
for them, their issuance w ou ld increase the
Treasury’s cost o f funding the governm ent’s
debt.

costly, however, it seems implausible that no
savers w ou ld be interested in protecting
against such risk. Consider, for exam ple, the
experience o f som eone w h o bought and held
a 30-year governm ent b o n d 30 years ago. In
1961, the long-term governm ent b o n d yield
was 3-9 percent. On average, over the three
years 1959, I960, and 1961, CPI inflation
averaged 1.1 percent. Assuming, given this
experience, that in 1961 investors believed
that the long-term rate o f inflation w ou ld be
1.1 percent, a purchaser o f a 30-year b on d
w ou ld have anticipated a yearly gain in real
terms o f 2.8 percent (3.9 percent minus 1.1
percent). In fact, over the 30-year period
from 1961 to 1991, CPI inflation averaged 5.2
percent. The investor lost 1.3 percent o f his
capital each year (3.9 percent minus 5.2 per
cent) because o f inflation (not counting taxes
paid on co u p o n payments). Instead o f a 30
percent gain in capital from holding the bond
for 30 years, the investor lost 30 percent o f
his capital. Munnell and G rolnic (1986) make
a persuasive case that, at a minimum, pension
funds and holders o f IRAs w ould be interested
in indexed bon d s.8

BRITISH EXPERIENCE
. . . we have yet to see any strong evidence
o f potential demand for such an indexed
bond in this country. . . . An indexed bond,
because o f its novel features, would not
realize the full benefits o f the liquidity of
the conventional Treasury market, and its
relative lack o f liquidity would be reflected
in the bid price received by the Treasury in
an indexed bond auction. . . . Thus a require
ment that the U.S. Treasury issue indexed
bonds, especially fixed amounts each year,
could lead to significant increases in the
cost o f financing the public debt (U.S.
Congress, pp. 17 and 20).7

According to this argument, there is uncer
tainty over whether anyone w ould value the
inflation protection offered by indexing.
Because inaccurate inflation forecasts are

British Indexed Gilts
Britain has issued indexed bon ds (gilts)
since 1981. Unfortunately, indexing in Britain
is p oorly designed for measuring expected
inflation. British bonds are indexed to the
retail price index (RPI), w hich is a p oor
measure o f inflation because it includes the
cost o f mortgage interest payments. Also,
co u p o n and principal payments are indexed
with an eight-month lag.9 This eight-month
lag makes real yields on indexed bonds with
a maturity even as long as five years sensitive
to variations in inflation. The difference
betw een yields on non in dexed and indexed
bonds, therefore, cannot reliably be used to
measure expected inflation over periods as
short as a few years.

1991 Annual Report

The practice o f issuing only long-term
indexed bon ds com pou n d s the difficulty o f
measuring the p u b lic’s expected inflation
over periods as short as a few years. In order
to observe a yield gap on bonds o f short
maturity, it is necessary to wait until the
passage o f time reduces the maturity o f the
long-term bonds. Even though indexed
bon ds w ere first issued in 1981, there is still
a paucity o f indexed bonds with a short
period to maturity. As o f the end o f 1990, the
average maturity o f indexed bonds outstand
ing was 18.9 years. There were on ly <£1.05
billion o f indexed securities outstanding with
maturities o f five years or less. Also, for short
term maturities, the absence o f nonindexed
bon ds with exactly the same maturity as in
dexed bonds becom es m ore o f a problem .

n a personal com m unication with the
author, Alan Walters noted that in
Britain the Exchequer varied the rela
tive supplies o f nonindexed short-term
debt and long-term indexed bonds in
response to changes in the yield gap
betw een the tw o kinds o f debt. In order to
ensure that the yield gap reflects expectations
o f inflation, rather than relative supplies,
he recom m ended that in the future indexed
and nonindexed debt be issued in fixed
p rop ortion s.10

British Monetary Policy
The usefulness o f a yield gap betw een
nonindexed and indexed bonds as a measure
o f expected inflation has been questioned on
the basis o f the British experience. In an
article in the Financial Times (April 29,
1991), Anthony Harris stated that the “ gap has
tracked current inflation faithfully, but has no
forecasting value at all. . . . The market
forecasts the way a picnicker does— by look
ing out o f the w in d o w .” Therefore, he c o n
cludes, the nonindexed-indexed b o n d gap
cannot “ give a valuable steer on m onetary

p o licy .” Presumably, Mr. Harris has in mind
the failure o f the yield gap to predict the
increase in inflation that occurred in 1988.
A brief review o f British monetary p olicy in
the latter 1980s proves to be helpful in
understanding Mr. Harris’ contention that
b on d markets are not forward-looking.
In Britain, inflation fell from 20 percent in
1980 to an average o f about 3.5 percent in
1986 and 1987. (Figures for inflation are for
the RPI excluding mortgage interest pay
ments.) Until 1988, actual inflation m oved
fairly closely with long-term expected infla
tion, inferred from the yield gap between the
indexed b o n d issued in 1982 and maturing
in 2006 and a conventional b on d with ap
proximately the same maturity.11 (See Fig. 3.)
Over 1986 and 1987, in particular, the yield
gap averaged about 3.5 percent. Actual infla
tion began to rise in early 1988 and peaked
in 1990 som ewhat above 9 percent. The
yield-gap measure o f expected inflation did
rise steadily with actual inflation in early 1988,
but reached a peak o f on ly about 6 percent
in early 1990.
What caused the sharp rise in inflation,
which was understated by the yield gap? After
the Louvre A ccord on February 3, 1987, Nigel
Lawson, Chancellor o f the Exchequer, began
to peg the DM/<£ exchange rate informally at
3 to 1. At the same time, the real terms o f
trade began to appreciate steadily in Britain’s
favor. That is, British physical assets and
com m odities becam e m ore attractive. This
appreciation was prom pted by three factors.
First, the Conservative electoral victory in
1987 made Britain appear to be a safe haven
for foreign capital. Second, the rise in the
price o f oil after its 1986 trough and a large
oil discovery announced on March 8, 1988,
raised the value o f British exports. Finally, the
reduction in marginal tax rates, announced
March 15, 1988, increased the attractiveness
o f investment in Britain and reduced capital
outflow s.

Indexed Bonds

Figure 3

ACTUAL AND EXPECTED INFLATION IN THE UNITED KINGDOM
Annual Percentage Change
10

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

Note: Actual inflation is the annual percentage change in the RPI excluding mortgage interest payments over the preceding 12-month period. Expected inflation is
inferred from the yield gap between an indexed bond maturing in 2006 and a conventional bond with approximately the same maturity. The yield gap was
adjusted for different tax treatment inthe two bonds. The expected inflation series was supplied by G. Thomas Woodward.
With a pegged exchange rate, the appreci
ation in the real terms o f trade appeared as
a rise in British prices, w hich was a ccom
m odated b y high m oney grow th. G row th in
the monetary base went from about 4 percent
in the m iddle o f 1987 to m ore than 10 per
cent toward the end o f 1988. In the spring
o f 1988, Mr. Lawson allow ed the DM/<£ e x
change rate to rise, but only grudgingly. T o
retard the p o u n d ’s appreciation, he low ered
the UK bank base lending rate to a low o f 7.5
percent in May 1988, from a high o f 11 per
cent in early 1987. In June 1988, in response
to the sustained rise in inflation that began
in early 1988, Mr. Lawson reversed course
and began to raise the base rate, w hich
reached 15 percent in O ctober 1989.
In light o f this experience, were the holders
o f British bon ds making forw ard-looking
predictions o f inflation? In 1987, the holders
o f bonds maturing in 2006 were predicting
inflation o f somewhat less than 4 percent over
the next 19 years. Can this prediction be
defended as forw ard-looking in light o f the

increase in British inflation from som ewhat
less than 4 percent in 1988 to almost 10 per
cent in 1990? With the p ou n d pegged to the
mark, British inflation must equal German
inflation plus whatever appreciation (or minus
whatever depreciation) occurs in the terms
o f trade. Historically, German inflation has
varied around 3 to 4 percent. If changes in
the terms o f trade are inherently unpredict
able, then a prediction o f inflation o f 3 to 4
percent was a reasonable estimate.12
Ex post, predicted inflation in the 3- to
4-percent range n ow appears to have been
reasonable. Since Britain’s formal entry into
the EMS in the autumn o f 1990, the DM/<£
exchange rate has stayed very close to 3
to 1. With the cessation in the appreciation
in the British terms o f trade, British inflation
had to fall to the German level. By autumn
1991, it had been brought roughly into line
with German inflation o f about 4 percent.13
In short, there is nothing in the British ex
perience to indicate that bondholders are not
forw ard-looking.

1991 Annual Report

Can Bond M ark e ts Predict In fla tio n ?
On the basis o f an examination o f the
British experience, Gabriel de K ock (1991)
concludes that using a yield gap to measure
expected inflation as p rop osed here w ou ld
not be useful to the Fed. Based on the British
experience, he makes tw o assertions. First,
he asserts that the yield on the indexed b on d
does not offer a measure o f the e c o n o m y ’s
real yield. Second, he claims that the yield gap
betw een n on in dexed and indexed bonds
possesses n o predictive p ow er for future
inflation b eyon d what is furnished by recent,
actual inflation. The empirical tests De K ock
conducts, how ever, are not capable o f p ro v
ing or disproving these assertions.14
De K ock tests w hether the yield gap pre
dicts subsequent inflation rates over 12-, 24-,
and 36-m onth periods, respectively. Appar
ently, he chooses these rates because they are
o f “ primary concern to policym akers.” They
were not, h ow ever, what bondholders were
trying to predict. The author derives his
measure o f expected inflation from com par
ing the yield on n on in dexed bonds with the
yield o f indexed bonds o f roughly the same
maturity issued in March 1982 and maturing
in July 1996. For example, the first observa
tion used b y the author is dated March 1982.
The yield gap betw een nonindexed and in
dexed bonds then reflects the market’s expec
tation o f inflation from March 1982 to July
1996. The author com pares this expectation
o f inflation with actual inflation over the
m uch shorter periods beginning in March
1982 and ending in March 1983, March 1984,
and March 1985. In order to perform the kind
o f ex post test o f predictive pow er the author
wishes to conduct, it will be necessary to wait
until 1996 (or close to that date).15
Despite the inability o f De K ock ’s tests to
bring evidence to bear on the ex post predic
tive accuracy o f the yield gap as a measure
o f expected inflation, his w ork does raise the
interesting question o f h ow to interpret

evidence on ex post predictive accuracy.
W ou ld evidence that investors predict infla
tion poorly affect the value to the central bank
o f a yield-gap measure o f expected inflation?
The answer w ou ld appear to be no. What
matters in determining the real rate o f interest
is what inflation rate financial markets expect,
not whether ex post they predicted inflation
accurately. M oreover, evidence from a yieldgap measure o f expected inflation d em on
strating that the public in practice predicts
inflation p oorly w ou ld provide an incentive
to the central bank to alter m onetary p olicy
to ensure that at least in the long-term the
price level w ou ld be easy to predict.

SUMMARY AND
CONCLUDING COMMENTS
The yield-gap proposal advanced here
differs from earlier proposals for indexed
bon ds in its recom m endation that (1) equal
amounts o f nonindexed and indexed bonds
o f the same maturity be issued and (2) the
resulting yield gap be used as an indicator o f
whether particular m onetary p o licy actions
are consistent with the Federal Reserve’s in
flation o b jectiv e.16
The Federal Reserve determines the lon g
term rate o f inflation. The measure o f ex
pected inflation p rop osed here w ou ld allow
the Fed to observe w hether there was a
discrepancy betw een the rate o f inflation
expected b y the public and the rate o f infla
tion it seeks to achieve. Monetary p o licy
makers w ou ld then be in a better position to
make p olicy in a w ay that avoids discrepan
cies betw een expected and subsequently
realized inflation. The yield-gap measure o f
exp ected inflation w ou ld allow m onetary
p olicy to be evaluated on whether or not it
provides a stable m onetary environm ent
characterized by m oderate fluctuations in
exp ected inflation and the absence o f infla
tionary and disinflationary surprises.

ENDNOTES
1 See Hetzel (1990 and 1991) and Bondweek (1991).
The idea of indexed bonds is an old one. In his Review
article, “ The Concept of Indexation in the History of
Economic Thought,” Humphrey (1974) lists a number
of early economists who advocated indexed bonds:
John Maynard Keynes in 1924; George Bach and
Richard Musgrave in 1941; and Milton Friedman in
1951. Humphrey also notes two early examples of
indexed bonds. During the American Revolution, the
Massachusetts legislature issued bonds with interest and
principal tied to an index of the prices of staple com
modities. In 1925 the Rand Kardex Co., at the urging
of Irving Fisher, issued a 30-year bond indexed to the
wholesale price index. In 1985, Senators Quayle and
Trible introduced a bill to index government bonds
(S. 1088, the “ Price Indexed Bonds Act of 1985” ) and
Representative Lungren introduced a similar bill in the
House (H.R. 1773, “ The Price Indexed Bonds Act of
1985” ). See the U.S. Congress (1985) Hearings, “ Infla
tion Indexing of Government Securities.”

6 Treasury opposition to the issue of indexed bonds
also appears to reflect a general hesitation to innovate
in debt management techniques. “ A poorly received
Treasury issue, because of faulty design or a misread
ing of a new potential market, could adversely affect
Treasury’s credibility in the market. So we approach
innovation with great care” (U.S. Congress, 1985,
p. 20).

2 The bonds would be issued and retired just after the
middle of the month, when the CPI is announced for
the preceding month. The dollar principal payment on
an indexed bond would then be increased by the
percentage increase in the CPI from the month
preceding its issue to the month preceding its redemp
tion. Zero-coupon bonds avoid problems of how to
index partially accrued coupon payments when a bond
is traded before maturity.

8 Munnell and Grolnic (1986, pp. 4,5) note, “ Anyone
saving for a specific goal, such as purchasing a house
or sending children to college, should welcome the
opportunity to ensure that such savings will not be
eroded by inflation. . . . Moreover, in the United States
there may well be a niche for index bonds that has not
been adequately explored—namely, the financing of
fully indexed annuities for retirees. These annuities
could play an important role in protecting elderly
people against the erosion of their pension income
during their retirement years.” Munnell and Grolnic
then document that pension plans have not histori
cally adjusted payments to beneficiaries to compensate
fully for inflation.
They also note that there are no financial instruments
that can satisfactorily protect purchasing power against
inflation. “ Common stocks . . . seem to be a particularly
unsuitable investment for producing a stable real in
come. While over the past 30 years stocks have pro
vided a high average real return, this return has been
so volatile that investors have experienced significant
periods of negative real earnings. Long-term bonds have
fared even less well: their average real return has been
near zero and in recent years the variability has been
almost as great as that for common stocks. Treasury bills
do appear to offer a stable real positive return, but this
return is very low and these instruments are a less than
perfect hedge against inflation” (Munnell and Grolnic,
1986, p. 18).

3 Forward rates for individual years would be inferred
under the assumption that the yield over the life of the
bond is a geometric average of the yields over the suc
cessive individual years.
4 The issue of how to tax capital gains is perennially
contentious. There is a consensus among economists,
however, that taxing capital gains representing only
paper gains that compensate for inflation distorts in
vestment and savings decisions undesirably.
5 Woodward has published a series on the real yield on
indexed bonds and on the implied expected inflation
rate. A key feature of his series is an adjustment for
different tax treatment of nonindexed and indexed gilts.
In Britain, holders of indexed bonds do not pay taxes
on that part of the income due to capital appreciation,
while holders of nonindexed bonds pay taxes on the
inflation premium built into interest payments. This
difference in tax treatment increases the size of the
yield gap between the two kinds of bonds beyond
bondholders’ expectation of inflation. Woodward
reduces the gap by the estimated amount due to this
tax effect. Subtracting this reduced difference from the
yield on nonindexed bonds gives a tax-adjusted real
yield series. That is, it provides a measure of the real
yield that holders of indexed bonds would receive in
the absence of favorable tax treatment.

7 Mr. Cavanaugh actually expressed both the concern
that there would be no demand for indexed bonds and
that there would be too much demand. In the latter
case, their issue would be a problem because they
would compete with S&Ls for funds (U.S. Congress,
p. 23). It is hard to know what to make of the as
sertion that the market for indexed bonds would be
illiquid. If dealers in government securities find it
profitable to sell conventional debt, why would they
not find it profitable also to sell indexed debt?

9 An eight-month lag was adopted to simplify calcu
lation of accrued interest on bonds with semi-annual
coupon payments. With the eight-month lag, immedi
ately after a coupon payment, assuming the most
recently available price index is for two months in the
past, one can calculate the indexed value of the coupon
payment six months in the future.

1991 Annual Report

10 The Bank of England supplied the author with data
on outstanding debt by maturity for both nonindexed
and indexed debt. The yield gap between nonindexed
and indexed debt did indeed influence relative supplies
of the two kinds of debt. Relative supplies, however,
did not appear to influence the subsequent yield gap.
11 Data for expected inflation were supplied by Thomas
Woodward. They are derived from the yield gap be
tween conventional and indexed bonds after an adjust
ment for the favorable tax treatment of indexed bonds.
See endnote 5 and Woodward (1990).
12 In 1990, expected inflation measured by the yield
gap rose to about 6 percent, which was higher than the
trend rate of German inflation. Investors in British
bonds may have believed that Britain would abandon
the 3-to-l DM/<£ exchange rate to avoid the costs of a
severe disinflation. They may also have believed that
the trend rate of German inflation would rise because
of fiscal pressures from German reunification.
13 The DM/£ exchange rate began to fall in 1989. This
fall indicated that the terms of trade were no longer
appreciating in Britain’s favor. A pegged exchange rate
then required a convergence of British and German
rates of inflation. This convergence in inflation rates
required a drastic monetary deceleration in Britain. In
1989 and the first part of 1990, growth in the broad
monetary aggregate M4 was around 20 percent, while
growth in the monetary base MO was around 8 percent.
By autumn 1991, M4 growth had fallen to around
8 percent and MO growth had fallen to around 2
percent.
14 See De Kock (1991). De Kock supports the first
assertion by pointing to the absence of a negative rela
tionship between the yield on indexed bonds and
future changes in economic activity. Economic theory,
however, does not predict a negative (or any predict
able) relationship between these two variables. In fact,

in any macroeconomic model, the sign of the corre
lation between the real rate of interest and future
economic activity depends upon the kind of shock
impinging upon the economy. In a standard IS-LM
model, for example, a positive real sector shock
(rightward shift in the IS schedule) will lead to a higher
real rate of interest and a higher level of real GNP.
The author’s rationale for his test appears to rely on
the assumption that a rise in interest rates necessarily
reflects a tightening of monetary policy, and conversely.
For example, he argues that the yield gap could not
have been an adequate measure of inflation expecta
tions in Britain in the period from early 1988 through
mid-1990. Over this period, long-term market rates rose
(monetary policy was tightened according to De Kock)
and expected inflation (measured by the yield gap) rose,
rather than fell. Measured by growth of the monetary
aggregates, however, monetary policy was expan
sionary. Growth in the monetary aggregates M0 and M4
was quite rapid. Monetary deceleration did not begin
until mid-1990. Market rates could have risen because
expected inflation rose.
15 The favorable tax treatment accorded indexed bonds
widens the size of the yield gap. Because the author
fails to correct for this tax effect, he concludes that the
yield gap is a biased measure of inflation. That is, he
finds that the yield gap, which includes a tax effect,
consistently overpredicts inflation. Also, the author uses
a theoretically unsatisfactory measure of inflation. He
uses the retail price index that includes mortgage in
terest payments. It would have been better to use the
retail price index that excludes these payments.
16 In a personal communication to the author, Milton
Friedman argued for using the yield gap as a target. He
would instruct the Federal Reserve to eliminate the gap
over time.

Indexed Bonds

REFERENCES
Bondweek. “ Treasury to Get Proposal for InflationIndexed Bonds.” November 11, 1991.
De Kock, Gabriel. “ Expected Inflation and Real Interest
Rates Based on Index-linked Bond Prices: The
U.K. Experience.” Federal Reserve Bank of
New York Quarterly Review (Autumn 1991),
47-60.
Hetzel, Robert L. “ Maintaining Price Stability: A
Proposal.” Federal Reserve Bank of Richmond
Economic Review 76 (March/April 1990), 53-55.
--------------- . “ A Better Way to Fight Inflation.” Wall
Street Journal, April 25, 1991.
Humphrey, Thomas M. “ The Concept of Indexation
in the History of Economic Thought.” Federal
Reserve Bank of Richmond Economic Review 60
(November/December 1974), 3-16.

U.S. Congress. “ Inflation Indexing of Government
Securities.” Hearing before the Subcommittee on
Trade, Productivity, and Economic Growth of the
Joint Economic Committee, 99th Cong., 1st sess.,
May 14, 1985.
Woodward, G. Thomas. “ Should the Treasury Issue
Indexed Bonds?” Congressional Research Service
Report for Congress, December 31, 1987.
---------------. “ The Real Thing: A Dynamic Profile of
the Term Structure of Real Interest Rates and
Inflation Expectations in the United Kingdom,
1982-89.” Journal of Business 63 Ouly 1990),
373-98.
---------------. “ Evidence of the Fisher Effect from
U.K. Indexed Bonds.” Forthcoming Review of

Economics and Statistics.

Munnell, Alicia H. and Joseph B. Grolnic. “ Should
the U.S. Government Issue Index Bonds?”
Federal Reserve Bank of Boston New England
Economic Review (September/October 1986),
3-21.

ig h lig h t s

Automation and Operations
The Federal Reserve System’s Contin
g e n cy P rocessing Center in Culpeper,
Virginia, provided its first extensive backup
for a Reserve Bank com puter w hen the Min
neapolis Fed was forced to vacate its head
quarters after a broken water pipe flood ed
several floors o f the building. During the
crisis, Minneapolis staff w orked alongside
Culpeper staff to avert interruptions in ser
vice to Ninth District financial institutions.
The Federal Reserve Bank o f Richm ond
was selected as one o f three sites and the
headquarters for the System’s new ly created
Federal Reserve Automation Services fu n c
tion. The headquarters staff will oversee the

consolidation o f the 12 Reserve Banks’ main
frame com puter operations at Richm ond,
Dallas, and East Rutherford, New Jersey.
Carl E. Powell, form erly first vice president
at the San Francisco Fed, was chosen to head
the new System function, w hich will reduce
the costs and im prove the reliability o f many
Reserve Bank products such as wire transfer,
automated clearinghouse (ACH), and securi
ties services.
T o free space appropriate for Federal
Reserve Autom ation Services, the Bank
relocated Business Applications Services to
new quarters within the tow er and made
plans to m ove ch eck operations from the
tow er to underground floors. The m ove to
belowgrade levels will place check operations
close to the loading docks and eliminate the
need to use elevators to transport checks to
and from processing floors.
The Richm ond office participated in a pilot
program o f image tech n ology for processing
large-dollar ch eck returns. In the pilot p ro
gram, the Richmond Fed sent facsimiles o f the
return items to the participating banks o f first
deposit, w hich helped evaluate im prove
ments in information flow s and timing.

Senior management groupfor Federal Reserve Automation Services: Sharon
Reisdorf and Doug Fleming, senior vice presidents; Carl Powell, director;
Donna Kelley andJimAllen, senior vicepresidents.
16

All offices in the District com pletely im
plem ented check-processing software that
was d eveloped at the Baltimore office to
im prove on-line settlement o f checks and
returns. The new software reduced costs in
software maintenance and im proved quality
and p rod u ctivity in ch e ck operations.
Atlanta Fed offices are scheduled to adopt the
software in 1992, and other Reserve Banks
have expressed interest in this innovation.

The Bank’s newsegment of the Richmond Canal Walk.

The Bank added several new electronic
payment services. These included the elec
tronic delivery o f ACH statements, a data
base for converting paper ACH returns to
electronic media, and a Fed Online Ex
change (FOX) netw ork feature that allows
institutions to submit and receive Treasury
tax and loan (TT&L) information electroni
cally. Also, a new reporting option allows
institutions in the FOX com m unications net
w ork to file their w eekly reports o f deposits
electronically.
T o reduce costs and im prove efficiency,
the Fifth District consolidated all book-entry
securities functions in the Richm ond office.
The Baltimore office was ch osen as the
System ’s pilot site for testing secon dgeneration currency processing machines.
W hen these tests are successfully com pleted

in 1992, other Reserve Banks plan to begin
installing similar machines.
Many Fifth District financial institutions
ch ose to participate in the System ’s im
proved Functional Cost and Profit Analysis
Program, a cost-accounting program de
signed to help institutions increase their
earnings and im prove their efficiency.

Meetings and Other Activities
The Bank and the three R ichm ond univer
sities co-sponsored a seminar b y Dr. Edward
J. Kane, the Everett D. Reese Professor o f
Banking and Monetary E conom ics at O hio
State University and a noted authority on
financial regulatory matters, w h o spoke on
the deposit insurance problem . Dr. Kane’s
presentation, given in the Bank’s auditorium
in Richm ond to a large group o f business,

1991 Annual Report

com m unity, and academic leaders, was one
in an on goin g series on business and finan
cial topics featuring w ell-know n speakers.

distributed to all financial institutions and
libraries in that state. This Profile was the
secon d in a series on Fifth District states.

For the second consecutive year, D on
Patinkin, a w o rld -re n o w n e d m onetary
eco n o m ist and professor at the Israel
A cadem y o f Sciences and Humanities, spent
several days at the Bank as a visiting scholar.
During his tw o-w eek visit, Professor Patinkin
con ferred with Bank econom ists and pre
sented three seminars— one at the Bank and
on e at each o f the tw o local universities that
helped sponsor his visit.

In cooperation with the Councils on
E conom ic Education in the Fifth District, the
Bank began issuing a new newsletter, FOCUS
ON 5, for teachers o f econom ics in secondary
schools.

The Bank sponsored tw o conferences on
the Com m unity Reinvestment Act. Deputy
Chairman Henry Faison participated in a
con feren ce in Richm ond for senior bank
officers. The conference featured experts
w h o focu sed on the opportunities for bank
participation in community revitalization and
the problem s involved. The other c o n
ference, w hich was co-spon sored by the
South Carolina Banking Association and held
in Columbia, focused on community reinvest
m ent training.
The Bank helped further im prove the Rich
m on d riverfront by constructing a terrace and
public walkway as part o f the Canal Walk.
The project was initiated to reduce soil
erosion into the canal, ease the maintenance
on the portion o f the Bank’s property near
the canal, and create a m ore aesthetically
pleasing environment.
A new Bank publication, An Economic Pro
file of North Carolina and Its Counties, was

System Responsibilities
Board Chairman Anne Marie W hittem ore
was elected by her Reserve Bank counterparts
to lead the Conference o f Chairmen.
President Robert P. Black was a voting
m em ber o f the Federal O pen Market C om
mittee. Mr. Black began attending FOMC
meetings in I960 w hen he was an econom ist
at the Bank.
First Vice President Jimmie R. M onhollon
was chairman o f the Conference o f First Vice
Presidents and product director for the
System’s Functional Cost and Profit Analysis
Program.
The Director o f Research, J. Alfred Broaddus, Jr., chaired the System Com m ittee on
Financial Analysis.
H. Lewis Garrett, General Auditor, was
appointed Chairman o f the Subcommittee on
Audit Autom ation Consolidation. This sub
com m ittee and its parent, the System ’s
Conference o f General Auditors, will develop
a detailed plan to provide audit coverage
during and after the consolidation process.

Bank , Digest
D irectors/R ichm ond
Directors/Baltimore
Directors/Charlotte
Operations Advisory Com m ittee
Small Business and
Agriculture A dvisory Council
Comparative Financial Statements
Summary o f Operations
Officers

Directors

(December 31, 1991)

(Standing)A. PierceStone; PaulA. DelaCourt; C. R. Hill, Jr.; StephenBrobeck; R. E. Atkinson, Jr.; James G. Lindley
(Seated) HenryJ. Faison; Anne Marie Whittemore; EdwardH. Covell
Richmond
CHAIRMAN
Anne Marie Whittemore

Partner

Paul A. DelaCourt

Chairman

McGuire, Woods, Battle & Boothe
Richmond, Virginia

The North Carolina Enterprise
Corporation
Raleigh, North Carolina

DEPUTYCHAIRMAN

C. R. Hill, Jr.

President

Beckley National Bank
Oak Hill, West Virginia

Henry J. Faison

Faison Associates
Charlotte, North Carolina

Executive Vice President
James G. Lindley

R. E. Atkinson, Jr.

Chairman and Chief Executive Officer

Dilmar Oil Company, Inc.
Florence, South Carolina

Chairman, President, and
Chief Executive Officer

Chairman

Stephen Brobeck

South Carolina National Bank
Columbia, South Carolina

Consumer Federation of America
Washington, D.C.

A. Pierce Stone

Edward H. Covell

Virginia Community Bank
Louisa, Virginia

Executive Director

President

The Covell Company
Easton, Maryland

South Carolina National Corporation

Chairman, President, and
Chief Executive Officer

Member
Federal Advisory Council
Edward E. Crutchfield, Jr.

Chairman and Chief Executive Officer

First Union Corporation
Charlotte, North Carolina

Federal Reserve Bank of Richmond

Baltimore
CH A IR M AN

John R. Hardesty, Jr.
President

Preston Energy, Inc.
Kingwood, West Virginia

Richard M. Adams
Chairm an an d C h ief E xecutive Officer

United Bankshares, Inc.
Parkersburg, West Virginia
Daniel P. H enson, III

Senior D evelopm en t D irector

Struever Bros. Eccles & Rouse, Inc.
Baltimore, Maryland

Joseph W . M osm iller
Chairm an o f the B oard

Loyola Federal Savings and
Loan Association
Baltimore, Maryland
F. Levi Ruark
Chairm an o f the B o a rd a n d President

The National Bank of Cambridge
Cambridge, Maryland
Thom as R. Shelton
President

Case Foods, Inc.
Salisbury, Maryland
W illiam H. W ynn
International President

(Standing) RichardM. Adams; F. Levi Ruark; Thomas R. Shelton; John R. Hardesty, fr.
(Seated)foseph W. Mosmiller; Daniel P. Henson, III; WilliamH. Wynn

United Food & Commercial Workers
International Union, AFL-CIO & CLC
Washington, D.C.

Charlotte
CH AIRM AN

Anne M. Allen
President

Anne Allen &Associates, Inc.
Greensboro, North Carolina
Crandall C. B ow les
President

The Springs Company
Lancaster, South Carolina
Jim M. Cherry, Jr.
President a n d Chief E xecutive Officer

Williamsburg First National Bank
Kingstree, South Carolina
David B. Jordan

President, C h ief Executive Officer,
an d D irector

Omni Capital Group, Inc.
and OMNIBANK
Salisbury, North Carolina
Harold D. Kingsm ore

President a n d Chief Operating Officer

Graniteville Company
Graniteville, South Carolina
William E. Masters
President

Perception, Inc.
Easley, South Carolina
L. Glenn Orr, Jr.
Chairman, President, and
C h ief E xecutive Officer

Southern National Corporation
Lumberton, North Carolina

(Standing) DavidB. Jordan; L. Glenn Orr, fr.; Crandall C. Bowles; HaroldD. Kingsmore
(Seated) WilliamE. Masters; Anne M. Allen; JimM. Cherry, Jr.
21

d v is o r y

o u n c ils

O perations A d viso ry Com m ittee

(Standing) Gazelle, BeHage, Baldwin, Schmitt, Pillow, Nicks, Albert, Denton, Wilson
(Seated) Smith, Lanier, Monhollon, Bunting, Greear, Shearer, Purvis, Thomas

Sm all Business and Agriculture A d v iso ry Council

(Standing) Dickson, Hagans, Jefferds, Auman, Hane, Clark, Quicke
(Seated) Lynch, Reeves, Zimmerman, Blackshear, Stewart

Federal Reserve Bank of Richmond

Operations Advisory Committee
CHAIRMAN
William V. Bunting

Executive Vice President
Crestar Bank
Richmond, Virginia
William E. Albert

Vice President and Cashier

The First National Bank of Bluefield
Bluefield, West Virginia
Sunil F. Antani

Executive Vice President
Maryland National Bank
Baltimore, Maryland
Robert Baldwin

Senior Vice President
Crestar Bank, N.A.
Washington, D.C.
George E. Beckham

Senior Vice President

South Carolina Federal Savings Bank
Columbia, South Carolina
Robert L. BeHage

Operations Executive Officer

Sovran Bank, N.A.
Richmond, Virginia
Vernon D. Conway

Vice President

Kenneth L. Greear

James W. Ricci

United National Bank
Charleston, West Virginia
D C. Hastings

Educational Systems Employees
Federal Credit Union
Bladensburg, Maryland
Kenneth L. Richey

Vice President

President and Chief Executive Officer
Virginia Bank and Trust Company
Danville, Virginia
Walter A. Howell

Executive Vice President

Citizens & Southern National Bank
of South Carolina
Columbia, South Carolina
Charles C. Schmitt

Executive Vice President

One Valley Bank
Charleston, West Virginia
Ashpy P. Lowrimore

Executive Vice President and Cashier

Southern National Bank of South Carolina
Florence, South Carolina
Clement E. Medley, Jr.

Executive Vice President

Vice President

Senior Vice President—City Executive

President and Chief Executive Officer
First Federal Savings and
Loan Association of Dunn
Dunn, North Carolina
Ricky B. Nicks

Loyola Federal Savings and Loan Association
Glen Burnie, Maryland
H. Jerry Shearer

Bank of Charleston, N.A.
Charleston, South Carolina
Rita A. Smith

West Virginia Savings League
Charleston, West Virginia
Thomas J. Strange

Vice President

Senior Vice President

South Carolina Credit Union League, Inc.
Columbia, South Carolina
Charles E. Thomas

Vice President

West Virginia Credit Union League, Inc.
Parkersburg, West Virginia
Rick A. Wieczorek

Vice President

District of Columbia Credit Union League
Washington, D.C.
C. L. Wilson III

Wachovia Operational Services Corporation
Winston-Salem, North Carolina
Richard D. Pillow

Investors Savings Bank
Richmond, Virginia
Raymond L. Gazelle

Virginia Credit Union League
Lynchburg, Virginia
Charles M. Purvis

Citizens Bank of Maryland
Laurel, Maryland
Harrison Giles

First Carolina Corporate Credit Union
Greensboro, North Carolina

Senior Vice President

Executive Vice President

The Riggs National Bank of Washington, D.C.
Washington, D.C.
Daniel E. Lanier, Sr.

Mercantile-Safe Deposit & Trust Company
Baltimore, Maryland
David A. Denton

Vice President

President

Vice President

President

Senior Vice President

Branch Banking and Trust Company
Wilson, North Carolina

Executive Vice President

NCNB National Bank of North Carolina
Charlotte, North Carolina

Small Business and Agriculture Advisory Council
CHAIRMAN

C. Champ Clark

President

C. C. Clark Farm
Chilhowie, Virginia
William M. Dickson

Joan H. Zimmerman
Southern Shows, Inc.
Charlotte, North Carolina

VICECHAIRMAN

John W. Hane

Partner/Manager

Blackwoods Farm
Fort Motte, South Carolina
Watts Auman

President and Chief Executive Officer

Owner

President and General Manager

Spring Valley Farm
Ronceverte, West Virginia
Michele V. Hagans
President

Manager

Fort Lincoln New Town Corporation
Washington, D.C.
Joseph C. Jefferds, Jr.

President

Jefferds Corporation
St. Albans, West Virginia

Auman Farm
West End, North Carolina
Leonard A. Blackshear

Louise Lynch

Owner

Chairman

Courtesy Associates, Inc.
Washington, D.C.
Robert A. Quicke

Southside Transportation Co. Inc.
Blackstone, Virginia
George B. Reeves

President

Reeves Agricultural Enterprises, Inc.
Chaptico, Maryland
Robert W. Stewart, Jr.

Retired Chairman and CEO

Engineered Custom Plastics Corporation
Easley, South Carolina

Associated Enterprises, Inc.
Annapolis, Maryland

o m

p a r a t iv e

F in a n c ia l

t a t e m

e n t s

C O N D IT IO N
December 31, 1991

December 31, 1990

Assets
Gold certificate account
Special Drawing Rights certificate account
Coin
Loans to depository institutions
Federal agency obligations
U.S. government securities
Bills
Notes
Bonds
Total U.S. government securities
Cash items in process o f collection
Bank premises
Furniture and equipment (net)
Other assets
Interdistrict settlement account
Accrued service income
TOTAL ASSETS

948,000,000.00
961,000,000.00
98,795,794.25
105,000,000.00
478,120,549.04

$ 1,008,000,000.00
961,000,000.00
105,399,370.81
5,500,000.00
590,231,351.74

10,491,442,040.07
8,030,219,833.90
2,557,422,797.59

10,472,630,017.39
8,507,532,420.48
2,900,468,325.79

21,079,084,671.56

21,880,630,763.66

608,084,027.83
122,786,026.17
32,169,642.12
2,025,123,541.59
321,133,485.56
5,006,657.05

341,348,225.88
122,201,413.95
31,064,976.72
2,892,933,948.51
-5,673,760,517.80
5,122,043.92

$26,784,304,395.17

$22,269,671,577.39

$23,425,486,317.00

$18,904,361,212.00

2,210,349,620.36
9,165,000.00
65,775,164.96

2,653,964,940.55
9,300,000.00
15,557,083.89

2,285,289,785.32

2,678,822,024.44

541,202,140.88
191,311,951.97

118,955,637.30
271,411,903.65

$26,443,290,195.17

$21,973,550,777.39

170.507.100.00
170.507.100.00

148.060.400.00
148.060.400.00

$26,784,304,395.17

$22,269,671,577.39

Liabilities
Federal Reserve notes
Deposits
Depository institutions
Foreign
Other
Total deposits
Deferred availability cash items
Other liabilities
TOTAL LIABILITIES

Capital Accounts
Capital paid in
Surplus
TOTAL LIABILITIES AND CAPITAL ACCOUNTS

Federal Reserve Bank of Richmond

E A R N IN G S A N D E X PE N SE S
1990

1991

Earnings
Loans to depository institutions
FDIC assumed indebtedness
Interest on U.S. government securities
Foreign currencies
Income from services
Other earnings
Total current earnings

1,088,903.10
4,352,731.95
1,600,439,604.86
152,907,455.51
64,150,968.36
838,712.89
$1,823,778,376.67

5,208,025.73
14,830,154.07
1,791,699,651.19
160,792,748.66
64,590,429.92
757,144.90

$2,037,878,154.47

Expenses
Operating expenses
Cost o f earnings credits
Net expenses
CURRENT NET EARNINGS

107,354,220.08
14,382,148.18
121,736,368.26
$1,702,042,008.41

$1,925,241,755.79

11,254,136.75
23,177,649.40
5,911.71
34,437,697.86

5,866,671.72
132,642,248.68
13,033.49
138,521,953.89

0
61,619.22
61,619.22
+ 34,376,078.64

0
16,063.89
16,063.89
+ 138,505,890.00

6,210,205.74
6,947,500.00
18,464,922.00

6,766,914.72
6,446,700.00
18,507,249.00

$1,704,795,459.31

$2,032,026,782.07

Additions to current net earnings
Profit on sales o f U.S. government securities (net)
Profit on foreign exchange transactions
All other
Total additions
Deductions from current net earnings
Losses on foreign exchange transactions
All other
Total deductions
Net additions or deductions
Cost o f unreimbursed Treasury services
Assessment for expenses o f Board o f Governors
Federal Reserve currency costs
NET EARNINGS BEFORE PAYMENTS TO U.S. TREASURY

100,263,888.19
12,372,510.49
112,636,398.68

Distribution o f N et Earnings
Dividends paid
Payments to U.S. Treasury (interest on Federal Reserve notes)
Transferred to surplus
TOTAL

$1,704,795,459.31

8,693,666.59
2,014,703,415.48
8,629,700.00
$2,032,026,782.07

9,770,118.63
1,672,578,640.68
22,446,700.00

Surplus A ccount
Balance at close of previous year
Addition o f profits for year
BALANCE AT CLOSE OF CURRENT YEAR

148,060,400.00
22,446,700.00
170,507,100.00

139,430,700.00
8,629,700.00
$ 148,060,400.00

Capital StOCk A ccount (Representing amount paid in, which is 50% of amount subscribed)
Balance at close of previous year
Issued during the year

148,060,400.00
26,331,050.00
174,391,450.00
3,884,350.00

139,430,700.00
12,172,000.00
151,602,700.00
3,542,300.00

170,507,100.00

148,060,400.00

Cancelled during the year
BALANCE AT CLOSE OF CURRENT YEAR

u m

a r y

p e r a t io n s

Operation

Number

Amount (^thousands)

1991

1990

1991

1990

Currency and coin processed
Currency received and verified
Currency verified and destroyed
Coin bags received and verified

1,959,126,000
740,139,000
261,876

1,983,165,000
652,908,000
271,156

25,000,656
7,719,990

24,016,852
5,302,701
203,200

Checks handled
Commercial—processed *
Commercial—packaged items
U.S. government

1,550,648,000
367,468,000
60,422,000

1,526,891,000
339,774,000
66,707,000

Collections items handled
U.S. government coupons paid
Noncash items

24,358
106,172

32,859
126,268

55,108
278,960

10,603
278,658

Commercial book-entry
transfers originated

284,110

247,973

2,309,359,000

1,824,636,000

5,652,028

5,471,584

282,818,000

238,973,000

1,448,377

1,129,760

454

463

4,635,089

16,025,063

Funds transfers sent and received
Food stamps redeemed
Loans advanced

*Excluding checks on this Bank.

194,359

1,019,044,000 1,039,571,000
121,636,000
119,968,000
129,200,000
128,155,000

8,818,391,000 9,782,720,000

(December 31, 1991)

R ich m o n d

Robert P. Black, President
Jimmie R. Monhollon, First Vice President
Lloyd W. Bostian, Jr., Senior Vice President
J. Alfred Broaddus, Jr., Senior Vice President and

Director of Research

Roy L. Fauber, Senior Vice President
James McAfee, Senior Vice President and

General Counsel

Joseph C. Ramage, Senior Vice President
James D. Reese, Senior Vice President
Bruce J. Summers, Senior Vice President*
Fred L. Bagwell, Vice President
Dan M. Bechter, Vice President
William H. Benner, Jr., Vice President
Timothy Q. Cook, Vice President
William E. Cullison, Vice President
Wyatt F. Davis, Vice President
Michael Dotsey, Vice President
George B. Evans, Vice President
William C. Fitzgerald, Associate General Counsel
Marvin S. Goodfriend, Vice President aJid

Associate Director of Research

Robert L. Hetzel, Vice President
Thomas M. Humphrey, Vice President
Yash P. Mehra, Vice President
Michael W. Newton, Vice President
John W. Scott, Vice President
Andrew L. Tilton, Vice President
Walter A. Varvel, Vice President
Roy H. Webb, Vice President

Kemper W. Baker, Jr., Assistant Vice President
Jackson L. Blanton, Assistant Vice President
William A. Bridenstine, Jr., Assistant General Counsel
Bradford N. Carden, Assistant Vice President
Betty M. Fahed, Assistant Vice President
Sharon M. Haley, Assistant Vice President and Secretary
Eugene W. Johnson, Jr., Assistant Vice President
Thomas P. Kellam, Assistant Vice President
Anatoli Kuprianov, Research Officer
Harold T. Lipscomb, Assistant Vice President
Susan Q. Moore, Assistant Vice President
Joseph F. Morrissette, Assistant Vice President
Virginius H. Rosson, Jr., Assistant Vice President
G. Ronald Scharr, Assistant Vice President
Gary W. Schemmel, Assistant Vice President
Marsha S. Shuler, Assistant Vice President
James R. Slate, Assistant General Counsel
Robert E. Wetzel, Jr., Assistant Vice President
William F. White, Assistant Vice President
Howard S. Whitehead, Assistant Vice President
Bobby D. Wynn, Assistant Vice President
Arthur J. Zohab, Jr., Assistant Vice President
Malcolm C. Alfriend, Examining Officer
Whitley K. Crane, Information Systems Officer
Floyd M. Dickinson, Jr., Examining Officer
A. Linwood Gill III, Examining Officer
Jeffrey S. Kane, Examining Officer
Jeffrey M. Lacker, Associate Research Officer
Lawrence P. Nuckols, Examining Officer
Virginia W. Shelor, Information Systems Officer
Charlotte L. Waldrop, Examining Officer

H.
Lewis Garrett, General Auditor
Edgar A. Martindale III, Assistant General Auditor
B. Wayne Deal, Audit Officer
Susan A. Saavedra, Audit Officer

B altim ore

C ulpeper

Ronald B. Duncan, Senior Vice President
William E. Pascoe III, Vice President
John S. Frain, Assistant Vice President
Margaret M. Murphy, Assistant Vice President
William J. Tignanelli, Assistant Vice President
John I. Turnbull II, Assistant Vice President
R. William Ahern, Automation Officer
Patricia S. Tunstall, Operations Officer

John G. Stoides, Senior Vice President
James J. Florin III, Assistant Vice President
Thomas C. Judd, Assistant Vice President
Julius Malinowski, Jr., Operations Officer
C harleston

Richard L. Hopkins, Vice President

C harlotte

C olum bia

Albert D. Tinkelenberg, Senior Vice President
Samuel W. Powell, Jr., Vice President
Robert F. Stratton, Vice President
Jeff A. Walker, Vice President
Marsha H. Malarz, Assistant Vice President
Lyle C. DeVane, Operations Officer
Ronald D. Steele, Check Operations Officer

Woody Y. Cain, Vice President

"On leave of absence.

F ift h F e d e r a l R e s e r v e D is tr ic t O ffic e s
R ic h m o n d
701 East Byrd Street
Richmond, Virginia 23219
(804) 697-8000
B altim ore
502 South Sharp Street
Baltimore, Maryland 21201
(410) 576-3300
C h arlotte
530 East Trade Street
Charlotte, North Carolina 28202
(704) 358-2100
C h a rleston
1200 Airport Road
Charleston, West Virginia 25311
(304) 345-8020
C o lu m b ia
1624 Browning Road
Columbia, South Carolina 29210
(803) 772-1940
C u lp e p e r
Mount Pony Road, State Route 658
Culpeper, Virginia 22701
(703) 829-1600

Photo Identifications
Cover: View across Kanawha Plaza
Contents page: The Bank’s new public walkway and terrace along the Haxall Canal
Digest page: Southeast corner of the Bank’s building and grounds

Full text of Annual Report of the Federal Reserve Bank of Richmond : 1991 Annual Report

FRASER