View PDF

The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.

Federal Reserve Bank of Minneapolis
1978 Annual Report

Eliminating Policy Surprises:
An Inexpensive Way
to Beat Inflation










Eliminating Policy Surprises:
An Inexpensive Way
to Beat Inflation

Federal Reserve Bank of Minneapolis
1978 Annual Report







Last year our Annual Report contained an article that
characterized the “rational expectations” approach to
macroeconomics as a challenge to established views of
policymaking. The preface of that article stated that the
theory of rational expectations had profound implications
for the conduct of monetary policy.
During the last year, while serving as a voting
member of the Federal Open Market Committee, I have
tried to apply the theory of rational expectations to policy­
making. In participating in the debate on how best to
eliminate inflation in the United States, I have argued that
the cost of fighting inflation through the use of tighter
macroeconomic policies has been greatly overstated by
forecasts from traditional models. These models assume
that decision makers are irrational-i.e., that they can be
fooled for long periods of time by changes in policy. But if
in fact decision makers are rational, then restrictive policy
actions, when implemented properly, can lower inflation
without severely disrupting the economy. The efficiency
with which decision makers process information ultimately
determines the costs of fighting inflation with tighter macroeconomic policies.
The followig article extends the 1977 Annual Report.
After providing an analysis of the policies previously used
to cope with inflation, policies we believe were seriously
flawed, we propose that the monetary and fiscal authori­
ties continue the efforts they began last fall to decrease
the rate of growth of money and government debt gradu­
ally but steadily. Given the much underestimated ability of
the public to adjust to such actions, we believe that this
policy can eventually eliminate inflation in the United States
without high costs in terms of output and unemployment.

Mark H. Willes
President
Federal Reserve Bank of Minneapolis







Contents
1 Eliminating Policy Surprises:
An Inexpensive Way
to Beat inflation
9 1978 Performance
11

Statement of Condition

12

Earnings and Expenses/Volume of Operations

13

Directors and Officers


1


Eliminating Policy Surprises:
An Inexpensive Way
to Beat Inflation
M ost e c o n o m ic analysts believe that inflation co uld be
fo u g h t by low ering the rate of g ro w th of m oney and cutting
the federal b udget deficit. They feel that this w o u ld slow
real e c o n o m ic g ro w th and, in turn, ease inflation by
low ering capacity utilization rates in plants and factories
and by causing h ig h e r— perhaps significantly h ig h e r—
unem ploym ent.
Som e analysts argue in favor of such an anti-inflation
plan because they feel it’s necessary even if it causes m ore
une m p lo ym e n t. O thers think that h ig h er u n e m p lo ym e n t
is so undesirable that the g o ve rn m e n t should fight infla­
tion by im posing e c o n o m ic co n tro ls on wages, prices, or
credit.
In the last tw o decades, inflation in the United States
has been fo u g h t with a b ru p t cuts in m oney and debt
g ro w th that reduced real e c o n o m ic activity. Inflation
slowed in response to these policies, but because
u n e m p lo y m e n t rose substantially these policies were
soon abandoned. In o rd e r to achieve a pe rm a n ent
reduction in inflation, p o licym a ke rs m ust avoid politically
intolerable rises in u nem ploym ent. To do this in today's
political and e c o n o m ic e nvironm ent, cuts in m oney and
debt g ro w th m ust be gradual and a n n o u n ce d well in
advance.
W hat p o licym a ke rs m ust do to fight inflation effec­
tively, in other w ords, is to elim inate, w h e n eve r possible,
surprises in m onetary and fiscal policies. They m ust build
a set of policies that the public has faith in and will take
into a c c o u n t w hen fo rm in g expectations of future inflation
and spending. In short, policy m ust be credible. And the
only way to m ake policy credible is to a n n o u n c e it, im ple­
m ent it faithfully, and avoid shifting it abruptly.

Why Policy Surprises Are Costly
The c o n c e p t of a policy surprise is im p o rta n t because
policies affect real e co n o m ic activity principally th ro u g h
surprises. This point can be illustrated m ost easily with an
exam ple that ignores som e of the com plexities of the
w o rld we live in. A lth o u g h this exam ple is sim plified, m ak­
ing it m ore co m p le x o r m ore like the real w o rld w ould not
ch a n g e the co nclusions. S uppose that existing w ages
and their rate of g ro w th w ere established in co n tra ct
negotiations between firm s and w orkers, negotiations
that w ere undertaken in the belief that the inflation rate
w ould rem ain constant because the m onetary authority

w ould keep the g ro w th of m oney unchanged. Putting
aside uncertainties fro m so u rce s other than the g o ve rn ­
ment, labo r contra cts w ould allow w ages to g ro w at a rate
equal to the rate of productivity g ro w th plus the expected
rate of inflation.
N ow suppose that the m onetary authority considers
the inflation rate too high and unexpectedly decides to
reduce the g ro w th of m oney. This lowers the g ro w th rate
of aggregate dem and, and businesses, in o rd e r to m axi­
mize profits, m ust raise prices m ore slowly than they had
expected. They soon find it in their best interests to lay off
so m e w orkers, because each w o rk e r p ro d u ce s the ex­
pected a m o u n t of goods, but the g o o d s now have low er
m arket value than expected and bring in less revenue
than was expected w hen w age rates w ere established. In
effect, m arginal w o rk e rs are priced out of their jobs.

As a result of the surprise policy change, the econ ­
o m y has achieved a low er inflation rate. But production,
e m ploym ent, personal incom e, and profits are also lower.
[See boxed m aterial below fo r a m ore form al discussion
of the effect of policy surprises on o u tp u t and prices.]
O nce the policy ch a n g e is recognized, an adjust­
m ent process begins. Since there are w o rke rs w ithout
jobs and since the inflation rate is low er than previously
expected, newly negotiated labor co n tra cts specify slow er
w age g row th. M arginal w orkers, w ho had been laid off,
return to th e ir jobs as their w ages no lo n g er outstrip the
value of th e ir output. A ggregate o u tp u t then returns to its
original level. That is, after the policy ch a n g e is recog­
nized, the system adjusts. It regains its initial level of
e c o n o m ic activity and real incom e, but price and w age
increases b e co m e sm aller.

How Policy Surprises Affect Output and Prices
A d justm en t to a policy su rp rise is illustrated in the
ch art below. The curve D0, the aggregate dem and
curve, represents the o u tp u t dem a n d e d by co n ­
sum ers, investors, and g o v e rn m e n t at each price
level before the surprise policy change. The curve
S0, the aggregate supply curve, represents the
o u tp u t supplied by all p ro d u ce rs at each price level
before the surprise policy change. The price level is
P0 and o u tp u t is equal to Q 0.
Before the surprise policy change, private de­
cision m akers w ere expecting aggregate d em and
to rise to Df. W age co n tra cts w ere settled that called
fo r w age increases just sufficient to m aintain real
pu rchasing pow er, that is to push the aggregate
supply c u rv e —o r w hat is the sam e thing, the e co n ­
o m y ’s co st c u rv e —to S t. If the su rp rise policy
ch ange did not occur, prices w o u ld rise to P® and
o u tp u t w ould rem ain at Q0.
But w hen the surprise policy c o m e s and the
slow er g ro w th of m oney takes effect, aggregate
dem an d rises less than expected, to
Prices, as a
result, rise m ore slowly than expected, reaching P,
instead of Pf. This slow er g ro w th in prices, how ever,
low ers the value of the o u tp u t of w orkers. In fact,




fo r all w o rk e rs the value of o u tp u t is less than ex­
pected w hen w age co n tra c t settlem ents were
reached. A nd fo r m any m arginal w orkers, this
value is below their w age costs. S om e w o rke rs are
laid off and o u tp u t falls to
.

2

If firms and laborers were able to anticipate the
monetary authority’s decision to reduce the rate of
money growth, inflation would slow without higher
unemployment or lower output. The temporary rise in
unemployment and shortfall in output could be avoided if
the monetary authority announced well in advance that
money growth was going to be reduced and if people
believed this announcement. Firms and workers could
then negotiate appropriate wage contracts. They could
agree to clauses that permit money wages to be adjusted
in order to keep real wages constant. Or they could
negotiate the growth in their money wages, taking into
account the new and lower money supply growth and
the new rate of inflation. It is in their own best interests to
do this. If they don’t, they make their labor too expensive
and encourage firms to lay them off.

Fighting Inflation
with Surprise Policy Changes:
The Last 15 Years
The theory that surprise policy changes affect the econ­
omy quite differently than well announced, well understood
policy changes does much to explain the accelerating in­
flation in the United States during the last 15 years. During
this period, as Figure 1 shows, there have been three
times when inflation was considered rapid enough to call
for restrictive monetary and fiscal policies. The first was in
1966, the second in 1968-69, and the third in 1973-74.1
But as the figure also shows, these actions were abruptly
initiated and abruptly discontinued.
Perhaps because they were so abrupt, these actions
seemed to be surprises. In the spring of 1969, for in­
stance, a leading forecasting service commented that the
restraints considered by government policymakers
(retention of the 1968 tax surcharge, strict monetary
policy, repeal of the investment tax credit, increases in
Social Security taxes, and cuts in expenditures) were
“highly unlikely.” But what was judged unlikely turned out
to be what happened. Again, at the beginning of 1974, a
time when the economy was at a standstill as the result of
past restrictive policies and the OPEC oil shock, many
forecasters expected the Fed to permit faster growth of
money, which in turn would allow short-term interest
rates to edge down. As before, this assessment of how
policymakers would behave was off the m a rk - money

'The behavior of prices was. of course, a concern af other times, including
1971 when mandatory price and wage controls were set in place. However, it was
only in these periods that government policies were attempting purposively to curb
aggregate demand in order to slow the rise in prices. All three periods were preceded
by years in which policy had been expansionary. And in 1973-74, the inflation stem­
ming from past expansionary policy was aggravated by the release of mandatory
controls, permitting increases in previously suppressed wages and prices, and by the
quadrupling of oil prices by OPEC.


http://fraser.stlouisfed.org/
3
Federal Reserve Bank of St. Louis

growth was further slowed and interest rates rose to
record highs at midyear. If these policy changes were
surprises, as seems likely, then they contributed to the
losses in employment and production that subsequently
developed.
The attempts of 1968-69 and 1973-74 to abruptly
check the growth of aggregate spending and thereby
lower inflation were partially successful. Rates of inflation,
responding after a lag to the restrictive policies, declined
as desired. Almost simultaneously, however, production
slipped lower and unemployment rose. These effects
were sufficiently prolonged and extensive for the periods
December 1969 through November 1970 and November
1973 through March 1975 to be designated recessions.
Reacting to the high unemployment that preceded
these recessions, policymakers changed direction again.
They tried to stimulate spending with expansive policies.
As Figure 1 indicates, they did this just before or, at the
latest, just after the recessions. The changes in policy
reflected their concern over declines in production and
employment, but ironically their previous policy changes
had contributed to these declines, at least to the extent
that the changes were surprises.
The surprise reversals of policy-from checking to
stimulating aggregate dem and-helped to revive produc­
tion and make the economy grow. Each time policy
became expansive, however, it did so before inflation
could drop to its preceding cyclical low, as shown in
Figure 2. In no case did inflation return to its starting level,
even when monetary and fiscal policies were supple­
mented with wage and price controls in 1971. With each
cycle the economy moved further from the goal of price
stability.

A Fundamental Fallacy
Virtually all economists would agree that tighter macroeconomic policies can lower inflation. (See page 5 for a
discussion of the relationship between money, govern­
ment debt, and inflation.) But based on past experience,
many believe that even a modest cut in the government
budget deficit or in money growth would cause massive
unemployment or long periods of slow economic growth
and high unemployment. Such beliefs are based on a
confusion. Because labor markets often have not ad­
justed immediately to surprise policy actions, some
observers believe that any policy action aimed at cutting
money growth and the federal budget deficit will produce
high unemployment, no matter how it is implemented.
They seem to assume that labor markets adjust very
slowly, if at all, to changes in policy.
If restrictive policies were pursued and were some­
how kept as surprises, it would take many years of high
unemployment to bring the inflation rate down to zero.
But this is not very plausible. A new permanent policy can

Figure 1. Growth of Money and Federal Debt"
1 9 6 0 -1 9 7 8

1960

65

70

75

*M oney is a 3-quarter m oving average of M r Federal debt is a 3-quarter m oving average
of the total interest-bearing federal pub lic debt.

Figure 2. Rate of Inflation
(G N P D eflator 1 9 6 0 -1 9 7 8 ]

be a su rprise year after year only if people can be fooled
fo r very long periods of tim e and if th e ir expectations of
future inflation are based exclusively on the policies and
e co n o m ic c ircu m sta n c e s of an earlier p e rio d .2
In reality, w hen policy changes, d ecision m a ke rs’
expectations change. T h e ir expectations are based not
just on past inflation rates but on all available inform ation,
including info rm a tio n on new policies o r new anti-inflation
pro gram s. T h eir expectations m u st ch a n g e w hen policy
changes if people do indeed behave as e co n o m ists fo r
the last 200 years have said they b e h a ve —in their ow n
best interests. W hen people believe that m oney g ro w th o r

12

10

2For example, Paul A. Anderson of the Federal Reserve Bank of M inneapolis
used a prom inen t econ om e tric m odel to sim ulate what w ould happen if the m oney
grow th rate doubled perm anently. He then asked the m odel to com pare price expec­
tations used in the m odel over a three-year period with the actual perform ance of
prices over that sam e period. In the m odel, expectations w ere way off. For the threeyear period, according to the m odel, people w ould not even begin to respond
accurately to the increased inflation. Their estimates of inflation w ould stray further
and further from the actual perform ance of prices and w o uld begin to im prove only in
the fourth year. See Rational Expectations: How Im po rtant fo r E conom etric Policy
Analysis?" Q uarterly Review, Federal Reserve Bank of M inneapolis [Fall 1978).




4

Growth in Money and Government Debt Fuel Inflation
E co n o m ic po licym a ke rs have repeatedly lauded
the tw in goals of high e m p lo y m e n t and stable prices
m andated by the E m p lo ym e n t A ct of 1946. But
m a c ro e c o n o m ic policies, particularly d u rin g the last
15 years o r so, have p ro d u ce d a steady acceleration
in the rate of inflation in the U nited States. As show n
in the ch a rt below, this surge in inflation has g e n e r­
ally been a cco m p a n ie d by an increase in the rate of
g ro w th of m oney CM,, o r c u rre n c y plus de m a n d
deposits) and in the o utstanding sto ck of U.S.
g o v e rn m e n t securities.
D uring the past tw o decades a heated and s o m e ­
tim es divisive debate has taken place between differ­
ent sch o o ls of e c o n o m ists on w h e th e r and how
m uch m oney m atters in the e c o n o m ic system .
E conom ists now generally agree that m onetary
g ro w th is a key d e te rm in a n t of the rate of inflation.
They co n tin u e to disagree a b o u t how rapidly an
increase in m oney w o rk s to increase prices and on
the cha nnels th ro u g h w h ich it w orks, but not a b o u t
its im p o rta n ce to the beh a vio r of prices.
In addition to m oney grow th, deficit fin a n cing by
the federal g o v e rn m e n t can also increase aggregate
spen ding and drive prices higher. W hether o r not it
does de pend s in part on w h e th e r the d ebt is retired
in the future. If it is, then taxes will have to be in­
creased to pay the interest and repay the principal.
Rational individuals, taking a c c o u n t of these future


http://fraser.stlouisfed.org/
5
Federal Reserve Bank of St. Louis

tax obligations, will alter th e ir c o n s u m p tio n and
savings plans e n o u g h to retire the debt. In this case,
a ggregate d e m a n d will be unaffected by the
te m p o ra rily increased deficit.
But the case is quite different w hen the new
g o v e rn m e n t d e b t is not to be re tir e d -w h e n it is a
p e rm a n e n t addition to the outsta n d in g stock of
securities. The only w o rry fo r individual taxpayers
then is interest on the debt. But interest paym ents
sim p ly tra n sfe r pu rch a sin g po w e r fro m taxpayers to
bo n d h o ld e rs; they do not c h a n g e aggregate
d em and. Thus, if the d e b t is not expected to be
retired, aggregate spe n d in g will rise. This will push
prices higher.
This p oint has sig n ifica n ce fo r o u r c u rre n t p ro b ­
lems. Since fiscal 1960 the federal g o v e rn m e n t has
operated with a bu d g e t su rp lu s (unified basis) in
only one year, 1969. The su rp lu s a m o u n te d to a little
over $3 billion. However, the cu m u la tive sum of
deficits in the oth e r years since 1960 c o m e s to over
$ 3 5 0 billion. U n d e r c u rre n t b udget plans, there
is no p ro sp e ct of a su rp lu s until fiscal 1982. In view
of this, it is co n ce ivab le that m u c h of the increase in
federal d e b t in recent years has been viewed as
having a low probability of re tire m e n t and has thus
m ade a d ire c t c o n trib u tio n to the n a tio n ’s inflation
problem .

The Growth of Prices, Money, and Federal Debt
(A n n u a l Rates of C h a n ge o ve r 4-Y ear Intervals)

■ Prices (CPI)
ffl Money (M.)
B Federal debt
(Total interest-bearing federal public debt)

1970

1974

inflation rates have changed, they will not be acting in their
own best interests to ignore this when negotiating wage
contracts. A firm could lose money if it ignored a new
economic policy, because the policy affects the wages it
must pay its workers and the prices it can charge for its
products. Workers could price themselves out of their
jobs if they assume that inflation is going to be higher than
it turns out to be and bargain for high wage settlements.
On the other hand, if workers assume that inflation is
going to be lower than it turns out to be and bargain for
low wage settlements, they could find that their incomes,
when adjusted for inflation, are falling.
The data suggest that people are not naive about
permanent policy changes. In the United States from
1960 to 1978, as Figure 3 shows, there appears to be no
trade-off between inflation and unemployment. This is
consistent with the theory that people are not fooled for
long periods by changes in policy. Indeed, the relationship
between inflation and unemployment appears to be the
opposite of what many people have claimed. Higher
inflation tends to be associated with higher, not lower,
unemployment. Apparent trade-offs have existed only for
short periods of time, as might be expected if people
temporarily failed to perceive a shift in the course of
macroeconomic policy.
As shown in the figure, increases in inflation were
generally associated with a decline in unemployment

Figure 3. Inflation and Unemployment
%




1960-1978

lUniMiiploymont jr. a porcont < l the labor force)
>

during the first half of 1960. During the 1960s money
growth accelerated and a sizable budget deficit began to
emerge. After the many years of virtual price stability in
the 1950s, this shift in policy probably came as a surprise
to most market participants and helped to boost output
and lower unemployment. But after a short while, when
the basic policy change was presumably recognized,
wage demands began to adjust. Thus, in the late 1960s
and early 1970s when inflation rose, unemployment
generally rose.3
The correlation of inflation and unemployment over
the last two decades suggests that labor markets do, in
fact, react to basic changes in macroeconomic policies.
According to Figure 3, once a change in policy and the
resulting inflationary consequences are understood,
labor markets adjust. If history is any guide, this means
that if more stimulative policies are expected, then we
should get more inflation and more unemployment. Con­
versely, if tighter policies are expected, we should get less
of each. Gains can thus be made against inflation without
incurring the high costs of increased unemployment.

Needed: A Credible
Macroeconomic Policy
A policy of gradually slowing money growth and reducing
the federal budget deficit can lower and, ultimately, elim­
inate inflation in the United States. (See discussion on
page 7.) There are compelling political or psychological
reasons that the steps should be gradual. In the years
since World War II, macroeconomic policy has been
characterized by stop-and-go actions and by many sur­
prises. On the basis of this experience, many observers
doubt that government has the will to change and to
persist patiently in a sequence of announced, gradual
steps to achieve price stability. To these skeptics, as well
as others who may not fully understand the new policy
approach and its implications, the change in approach
will come as a surprise.
If it does surprise some people, then real costs will
arise, at least during the early steps of the new approach.
In fact, large changes could shock the economy and
cause a recession. A serious recession could lead, as in
the past, to the abandonment of attempts to bring inflation
under control. For this reason, it is essential that the initial
steps be small. Of course, if people for some reason
believed that the government was going to take the

3Part of the reason for this relationship is that average unemployment rates have
risen during the last two decades as the labor participation rates of women and teen
agers. who have traditionally experienced higher than average unemployment rates,
have risen. Also, the liberalization of income maintenance programs has tended to
raise average unemployment rates. The 1974 75 points are especially high because
they were influenced by the OPEC price hike and the dismantling of price controls.

6

m onetary and fiscal steps necessary to co n tro l inflation
and if they w ere not restricted by previous contracts, then
even the initial steps c o u ld be m ade large w ithout causing
a s h o ck o r a recession.
O nce the p ro g ra m of g radually slow ing g ro w th in
agg regate d e m a n d has begun and the g o ve rn m e n t has

u n a m b ig u o u s ly d e m o n stra te d its d e te rm in atio n to ca rry it
out, the costs of the p ro g ra m will decline. W hen the new
a p p ro a ch is well know n and u nderstood, then even large
steps will not lead to h ig h er u n e m p lo ym e n t. As su rp rises
g radually disappear, so will the high costs of fighting
inflation w ith m a c ro e c o n o m ic policies.

Inflation Can Be Eliminated
Without Creating High Unemployment
A g ra d u a list policy s ce n a rio is illustrated in the
a c c o m p a n y in g chart, w here U F represents the “ full
e m p lo y m e n t” u n e m p lo y m e n t rate. The eco n o m y is
initially at po in t P0, experiencing inflation equal to i0
and an u n e m p lo y m e n t rate equal to U F.
Then a sm all co n tra c tio n a ry change of policy
occu rs. W hen this first step is taken —m oney supply
gro w th is cu t o r the deficit is reduced o r b o th - th e
e c o n o m y m oves to the point Pv U ne m p lo ym e n t
rises because the p u b lic does not anticipate the
ch a n g e in policy. B ut after the policy change occurs,
at least so m e of the p u b lic are persuaded that
futu re a n n o u n c e m e n ts of tighter policy ou g h t to be
taken m o re seriously. O nce w o rke rs recognize and
act u pon the new policy steps, then inflation and
u n e m p lo y m e n t can be reduced sim ultaneously.


http://fraser.stlouisfed.org/
7
Federal Reserve Bank of St. Louis

A nticipated policy chan ges

W hen the second s t e p - a fu rth e r g radual tig h te n ­
ing of p o lic y - is a n n o u n ce d and then im plem ented,
w o rk e rs begin to low er th e ir d e m a n d s fo r w age in­
creases. W hen they do this, they are acting in their
ow n best interests. If they do not lo w e r th e ir w age
dem ands, they will m ake la b o r too expensive and
w o rk e rs will be laid off. The anticipated tightening of
policy thus low ers not only inflation but u n e m p lo y­
ment, since firm s can afford to hire m o re w o rk e rs
w hen w ages are rising less rapidly.
S ub se q u e n t steps to tighten policy result in
fu rth e r decreases in inflation and u n e m p lo y m e n t as
labor m a rke t participants adjust th e ir w age d e m a n d s
to reflect the low er rate of inflation. Few er and few er
w o rk e rs are now priced o u t of th e ir jobs. Eventually,
the p oint P4 is achieved. At this point, the e co n o m y
o nce again has full e m p lo y m e n t but at a m u c h low er
rate of inflation. Because an e ve r-g ro w in g share of
the la b o r m a rke t c o m e s to re cognize the co n se ­
q uences of the new policy, the c o st of significantly
low ering inflation is m o d e st and short-lived.
Alternatively, if la b o r m arkets do not adjust at all,
the se q u e n ce of policy steps d e scrib e d above will
p ro d u c e the series of points P1( Q t , Q 2, and Q 3. This
is the process that critics of tig h te r m a c ro e c o n o m ic
policies have in m ind w h e n they a rg u e that it is too
expensive to fight inflation with these policies.
H owever, all the evidence indicates that firm s and
w o rk e rs will re cognize the im p lica tio n s of a policy
ch a n g e fo r th e ir ow n m arkets. They will learn and
they will adjust. Even skeptics will find it in th e ir best
interests to m odify th e ir e c o n o m ic beh a vio r to re­
flect the ch anged en viro n m e n t. A d ju stm e n ts in w age
d e m a n d s will o ccu r, and the m istakes m ade by the
p ublic that can be attributed to a m isp e rce p tio n of
g o v e rn m e n t policy will b e co m e less and less im ­
portant. As a result, the later policy steps in the
sequence do not involve substantial u n e m p lo ym e n t,
since the steps are p ro p e rly anticipated by decision
m akers.




1978 Performance
N ineteen hu n d re d and seventy-eight was a year of
exe m plary operatin g p e rfo rm a n c e fo r the Federal
Reserve System in gen e ra l and the Federal Reserve
B ank of M inneapolis in particular. Ninth District 1978
ope rating expense of $28.1 m illion represents a 2 . 1%
re d u c tio n fro m 1977 levels —the first tim e in o u r history
that we have experienced an actual year-to-year expense
reduction. This decre a se in expenses was accom plished
in spite of a 7.3% increase in m easurable outputs (e.g.,
checks, c u rre n c y and coin, and securities processing),
expansion of su pervisio n and regulation activities, ex­
panded legislated responsibilities in the area of co n s u m e r
affairs, and general price level increases.


http://fraser.stlouisfed.org/
9
Federal Reserve Bank of St. Louis

The a c co m p a n yin g charts illustrate som e of the fac­
tors w hich co n trib u te d to this perform ance. As the charts
indicate, 1978 did not really represent an exception but
rather a co n tin u a tio n of favorable trends in expenses,
productivity and unit costs over the past five years. The
first tw o charts (ch a rts 1 and 2) deal with expense and
m easurable o u tp u t trends since 1973. O ver this tim e
period, total expenses in the Ninth D istrict increased by
an average of 6.8% per year w hile m easurable output
increased 6.0% per year. For the Federal Reserve System
as a whole, total expenses have increased on average by
8.6% per year w hile m easurable o u tp u t has increased
6.4% per year.

C hart 1

Percent

Total Expenses
Annual Percent Change

C hart 2

Total Operating Output
Annual Percent Change
Percent

Unit cost p erfo rm a n ce [c h a rt 3) has been even m ore
favorable. A pproxim ately 80% of System expenditures
are incurre d in areas w here there are m easurable o u t­
puts. Expense gro w th in these areas has been even less
than total expense grow th, averaging 5.4% per year for
the Ninth D istrict and 8.4% fo r the System. This, coupled
with the gro w th in output, has resulted in Ninth District
1978 w eighted average unit costs being 2.3% below
1973 levels for an average decline of 0.6% per year. A l­
tho u g h show ing a decline fo r 1978, average unit costs
for the System have increased at the rate of 1.9% per
year since 1973. Since the G N P price deflator has
increased at an average rate of 7.9% per year, real dollar




unit costs have decreased by a p p ro xim a te ly 33% fo r the
Ninth District and 25% fo r the System over the period
1973 th ro u g h 1978.
Increases in p ro d u ctivity (c h a rt 4) have been a p rim e
c o n trib u to r to unit co st p e rfo rm a n ce . O u tp u t per
m a n h o u r has increased 37.8% since 1974 fo r the
Federal Reserve Bank of M inneapolis and 41.5% for the
System. This co m p a re s w ith a p ro d u ctivity gain of 7.4%
over the sam e tim e period fo r the n o n -fa rm private
business sector. D ecreases in total e m p lo y m e n t in each
of the last fo u r years (c h a rt 5] have resulted in 1978
em p lo ym e n t levels falling below 1973 levels fo r both the
Ninth District and the System.

C hart 3

Unit Cost
Annual Percent Change

C hart 4

Output Per Manhour
(1 9 7 4 = 100)

*F rom E conom ic R eport o f the President. January, 1979, pp 226-227

C hart 5

Employment Annual Percent Change
Percent

10

Statement of Condition
[In T h o u s a n d s ]


11


D e c e m b e r 31

1978

1977

Assets
G old C ertificate A c c o u n t..............................................
Interdistrict Settlem ent F u n d ........................................
Special D rawing Rights Certificate A c c o u n t.............
C o in ....................................................................................
Loans to M em ber B a n k s ..............................................
Securities
Federal A gency O b lig a tio n s................................
U.S. G ove rn m e n t S e c u ritie s................................

$

2 31,177
(4 3 5 ,1 4 6 ]
2 8,000
11,182
10,250
1 89,477
2,627,263

$

225,007
12,659
25,000
9,109
900

Total S e cu ritie s........................................................

2,816,740

195,940
2,470,538
2,666,478

Cash Items in Process of C o lle c tio n ..........................
Prem ises and E q u ip m e n tLess D epreciation of $8,217 and $ 7 ,0 0 9 ........
O ther A s s e ts ....................................................................

802 ,0 6 0

572,661

3 0,992
101,654

30,468
47,206

Total Assets.........................................................

$3,5 9 6 ,9 0 9

$3,5 8 9 ,4 8 8

$1,8 5 4 ,8 1 0

$1,9 9 9 ,3 1 2
720,178
276,165
7,995
12,772

Total D e p o sits..........................................................

8 6 6,328
182,605
6,081
7,638
1,062,652

Deferred Availability Cash Ite m s .................................
O ther Lia b ilitie s................................................................

5 5 9,983
51,384

Total Liabilities.........................................................

3,528,829

4 8 2,400
29,206
3,528,028

3 4,040
3 4,040
68,080

30,730
30,730
61,460

$3,5 9 6 ,90 9

$3,5 8 9 ,4 8 8

Liabilities
Federal Reserve N o te s ..................................................
D eposits
M em ber Bank Reserve A c c o u n ts ......................
U.S. T re a s u ry -G e n e ra l A c c o u n t......................
F o re ig n ......................................................................
O ther D e p o s its ........................................................

1,017,110

Capital Accounts
Capital Paid In ..................................................................
S u rp lu s ..............................................................................
Total Capital A c c o u n ts ..........................................

Total Liabilities and Capital Accounts

Earnings and Expenses
(In T housands)

F o r the Year E nd e d D e c e m b e r 31

1978

1977

C urrent Earnings
Interest on Loans to M e m b e r B a n k s .......................................
Interest on U.S. G o ve rn m e n t Securities
and Federal A gency O b lig a tio n s ......................................
All O ther E a rn in g s ........................................................................
Total C u rre n t E a rn in g s ........................................................

$

2,3 7 9

$

521

2 0 0 ,2 4 3
............... 377
2 0 2 ,9 9 9

162,187
_______ 336
163,044

C urrent Expenses
Salaries and O ther B e n e fits ........................................................
Postage and E xp re ssa g e ............................................................
Telephone and T e le g ra p h ..........................................................
Printing and S u p p lie s ...................................................................
Real Estate T a x e s ..........................................................................
Furniture and O perating E q u ip m en t—
Rentals, Depreciation, M a in te n a n ce ................................
D epreciation —Bank P re m is e s ..................................................
U tilitie s..............................................................................................
O ther O perating E xpe n se s.........................................................
Federal Reserve C u rre n c y .........................................................

1 6,299
3 ,1 3 5
585
944
1,521

15,674
2,952
577
949
1,577

1,505
873
48 9
1,815
............... 99 2

1,679
1,567
461
1,745
______1,549

Total C u rre n t E x p e n se s......................................................

2 8 ,158

28,7 3 0

Less Expenses R eim bursed o r R e co ve re d ...........................
Net E x p e n se s.........................................................................

............1,942
2 6 ,2 1 6

______1,910
26,8 2 0

1 7 6 ,7 8 3
(1 8 ,2 5 2 )

136,224
(4 ,7 6 6 )

1,596
1,921
1 5 1,704
3 ,3 1 0

1,383
1,777
1 26,158
2,140

C urrent N et Earnings
Net Profit (o r L o s s ).......................................................................
Less:
A ssessm ent fo r Expenses of Board of G o v e rn o rs ..........
D ividends P a id ...........................................................................
Paym ents to U.S. T re a s u ry ....................................................
Transferred to S u rp lu s ........................................................

$

$

Surplus Account
Surplus, January 1 .......................................................................
Transferred to S u r p lu s - a s a b o v e ...........................................
Surplus, D e ce m b e r 3 1 ................................................................

$
3 0 ,7 3 0
............3 ,3 1 0
$
3 4 ,0 4 0

$
28,590
______2,140
$
3 0 ,730

Volume of Operations*
N um ber
F o r the Year E n d e d D e c e m b e r 31

1978

Loans to M em b e r B a n k s .........................
C u rre n cy Received and V e rifie d ...........
C oin Received and C o u n te d ..................
C hecks H andled, T o ta l.............................
C ollection Items H a n d le d ........................
Issues, R edem ptions, Exchanges
of U.S. G o v e rn m e n t Securities
Securities Held in S a fe k e e p in g ..............
Transfer of F u n d s ......................................

987
148
637
718
.3

m illion
m illion
m illion
m illion

9.2 million
5 2 3 ,7 7 2
1,001,192

1977
326
147
613
649
.3

m illion
m illion
m illion
m illion

8.9 m illion
478 ,7 2 0
898 ,1 7 6

D ollar A m o u n t
1978
1977
$ 1.4
1.3
87
26 3
2.2

billion
billion
m illion
billion
billion

81.1 billion
2.5 billion
941 billion

$591 m illion
1.2 billion
83 m illion
21 2 billion
2 billion
57.7 billion
2.1 billion
7 62 billion

‘ M inneapolis and Helena com bined.




12

Directors of the Federal Reserve Bank of Minneapolis

January 1979

Term expires December 31 of indicated year
Stephen F. Keating
Chairman and Federal Reserve Agent
William G. Phillips
Deputy Chairman
Class A - Elected by Member Banks--------------------------------------------------------------------------------------------------------------- —
Nels E T urnquist (1979)
President
National Bank of South Dakota
Sioux Falls, South Dakota

James H. Smaby (1980)
President
Commercial National Bank & Trust Company
Iron Mountain, Michigan

Donald L. Scothom (1981)
President
First State Bank
Stevensville, Montana

Class B - Elected by Member Banks-----Warren B. Jones (1979)
Secretary-Treasurer& General Manager
Two Dot Land & Livestock Company
Harlowton, Montana

Donald P. Helgeson (1980)
Vice President and Secretary
Jack Frost, Inc.
St. Cloud, Minnesota

Russell G. Cleary (1981)
Chairman and President
G. Heileman Brewing Co., Inc.
La Crosse, Wisconsin

Class C-Appointed by Board of Governors-------------------------------------------------------------------------------------------------------Sister Generose Gervais (1979)
Administrator
Saint Marys Hospital
Rochester, Minnesota

Stephen F. Keating (1980)
Vice Chairman
Honeywell, Inc.
Minneapolis, Minnesota

William G. Phillips (1981)
Chairman
International Multifoods
Minneapolis, Minnesota

Member of Federal Advisory Council
Richard H. Vaughan (1979)
President & CEO
Northwest Bancorporation
Minneapolis, Minnesota

Directors of the Helena Branch
Patricia P. Douglas, Chairman
Norris E. Hanford, Vice Chairman
Appointed by Board of Directors
Federal Reserve Bank of Minneapolis
Lynn D. Grobel (1979)
President
First National Bank
Glasgow, Montana

William B. Andrews (1980)
Chairman
Northwestern Bank of Helena
Helena, Montana

Appointed by Board of Governors----------------------------------------------------Norris E. Hanford (1979)
Wheat and Barley Operator
Fort Benton, Montana


13

Patricia P. Douglas (1980)
Vice President-Fiscal Affairs
University of Montana
Missoula, Montana

Jase O. Norsworthy (1980)
President
The NRG Company
Billings, Montana

Officers of the Federal Reserve Bank of Minneapolis

as o f J a n u a ry 1979

Mark H. Willes, President
T hom as E. Gainor, First Vice President
Leonard W. Fernelius, Senior Vice President
Roland D. G raham , S enior Vice President
John A. M acD onald, S enior Vice President
John D. Paulus, S enior Vice President
Melvin L. Burstein, Vice President
and General C ounsel
Lester G. Gable, Vice President
Gary P. Hanson, Vice President
B ruce J. H edblom , Vice President
D ouglas R. Hellweg, Vice President
H ow ard L. Knous, Vice President
and General A u d ito r
David R. M cD onald, Vice President
C larence W. Nelson, Vice President
R obert W. W orcester, Vice President
Sheldon L. Azine, Assistant Vice President
and Assistant C ounsel
Jam es U. B rooks, Assistant Vice President
Marilyn L. Brow n, Assistant Vice President
J o h n P. D anforth, Assistant Vice President
R ichard K. Einan, A ssistant Vice President
Phil C. G erber, Assistant Vice President
R ichard C. Heiber, A ssistant Vice President
W illiam B. Holm , A ssistant Vice President
Ronald E. Kaatz, A ssistant Vice President
Preston J. Miller, Assistant Vice President
Michael J. Pint, A ssistant Vice President
and Assistant S ecretary
Ruth A. Reister, A ssistant Vice President
and Secretary
C harles L. S hrom off, Assistant Vice President
C olleen K. Strand, Assistant Vice President
R ichard B. Thom as, Assistant Vice President
Joseph R. Vogel, C hief Exam iner

Officers of the Helena Branch
John D. Joh nson, Vice President
Ronald 0 . Hostad, A ssistant Vice President
Betty J. Lindstrom , A ssistant Vice President




14


Federal Reserve Bank of St. Louis, One Federal Reserve Bank Plaza, St. Louis, MO 63102