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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 http://fraser.stlouisfed.org/ Federal Reserve 13Bank of St. Louis 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