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Federal Reserve Bank
of Richmond
19 9 9
A N N U A L R E P OR T
THE ROLE OF A REGIONAL BANK
IN A SYSTEM
OF CENTRAL BANKS
Mission
As a regional Reserve Bank, we work within the
Federal Reserve System to foster the stability,
integrity, and efficiency of the nation’s monetary,
financial, and payments systems. In doing so,
we inspire trust and confidence in the U.S. financial system.
Vision
We want to be a standard of excellence within
the Federal Reserve System and continuously
improve our service to our customers and
the public. Because success depends on each
of us, we are striving to create a workplace
where we all live our Bank’s values and can
reach our full potential.
Table of Contents
1
A Message from the President and First Vice President
2
The Role of a Regional Bank in a System of Central Banks
by Marvin Goodfriend
16
Year in Review
A Message from the President and First Vice President
It is our pleasure to present the Bank’s 1999 Annual Report. The final year of the millennium saw
continued extraordinary growth in both the national and District economies, while inflation
remained well contained. Stimulated by rising productivity growth and the expectation it created
of higher future income, domestic demand grew strongly and the foreign trade deficit expanded
further.These events led the Federal Reserve to tighten monetary policy on three occasions during
the second half of the year. Continued rapid consolidation in the banking industry challenged the
Fed to enhance its capacity to supervise and regulate very large, far-flung banking organizations
efficiently. Meanwhile, the Fed, like all financial institutions, ran hard to stay abreast of advances in
information technology in order to provide better service to the public.
The “Year in Review” section highlights the Bank’s contributions to System efforts in this
environment to support the financial system and foster stable economic growth. Our staff worked
diligently and successfully to help ensure that the century date rollover occurred with no disruptions
in internal systems or services to the Bank’s customers.We are exceedingly proud of the contributions
of our employees to this achievement and grateful to them for their extra effort.
Equally important was the high level of teamwork and dedication that went into reformulating the Bank’s strategic plan. Staff members throughout the District joined forces across
functions to develop a plan that speaks directly to all of us about the Bank’s mission and future
vision. With broad-based internal support for the plan and its initiatives, the Bank will be better
positioned to serve its customers and the public in the years to come.
As we enter a new era, a key international monetary development has been the recent establishment of the European Central Bank whose constituent national central banks will now play
roles somewhat analogous to those of the regional Reserve Banks of the Federal Reserve System.
Reserve Banks perform crucial functions in the conduct of monetary policy. Our regional presence facilitates surveillance of current economic and financial conditions. We assist in communicating the System’s policy strategies and decisions to local and regional audiences. And healthy
competition among the Reserve Banks in producing policy-related research stimulates innovative
thinking on policy issues and critical scrutiny of particular policy proposals. In this year’s feature
article, Marvin Goodfriend, senior vice president and policy advisor, discusses how the national
central banks in the Eurosystem might perform these same functions.
We thank all of our customers, employees, and other stakeholders for their support in 1999,
and we look forward to working with and serving you in the years ahead.
J. Alfred Broaddus, Jr.
Walter A. Varvel
PRESIDENT
FIRST VICE PRESIDENT
THE ROLE OF A REGIONAL BANK
IN A SYSTEM
OF CENTRAL BANKS
MARVIN GOODFRIEND
INTRODUCTION
Marvin Goodfriend is senior vice
president and policy advisor at the
Federal Reserve Bank of Richmond.
This article is reprinted as it
appeared in the Carnegie-Rochester
Conference Series on Public Policy,
volume 51, number 1, with permission from Elsevier Science. It
benefited from presentations at
the European Central Bank, the
Federal Reserve Board, the Bank
of Finland, and the Bank of Italy,
IGIER, Paolo Baffi conference on
“Monetary Policy of the ESCB:
Strategic and Implementation Issues.” Ignazio Angeloni, Al Broaddus,
Bennett McCallum, and Mark
Wynne provided helpful comments.
The views expressed are the
author’s and not necessarily those
of the Federal Reserve System.
and businesses. Monetary policy encourages
economic growth and stabilizes employment
over the business cycle by anchoring inflation
and inflation expectations. Bank supervision
and regulation aims to promote confidence in
the banking system.
The need to influence expectations and
promote confidence puts a premium on credibility, a commitment to goals, and a central
bank’s perceived independence and competence to achieve its objectives. Thus, a central
bank must create in the public’s mind an
understanding of the methods by which its
objectives can be sustained. This formidable
problem has to be overcome in spite of the
fact that a central bank operates in the background, with obscure methods and procedures.
The second and third difficulties arise
because central bankers must understand markets. Dynamic markets introduce evermore
efficient productive technologies and create
new goods and services to better satisfy consumer wants. Economic dynamism complicates the measurement of macroeconomic
conditions. A central bank seeks to under-
A modern central bank seeks to maintain a
financial environment within which competitive markets support the efficient use of productive resources.The overarching principle is
that a central bank should provide the necessary monetary and financial stability in a way
that leaves the maximum freedom of action to
private markets. In keeping with this principle,
monetary policy is implemented by indirect
means, with an interest rate policy instrument
rather than with direct credit controls. In the
banking sphere every effort is made to minimize as far as possible the regulatory burden
associated with financial oversight.
The principle that markets should be
given free reign wherever possible creates
three difficulties of understanding that a central bank must overcome in order to carry out
its policies effectively. The presumption that
monetary and banking policies are best when
they are as unobtrusive as possible creates the
first difficulty. Inevitably, central banks seem
shadowy and distant from the public’s point of
view. Yet, to work well, central bank policies
need to shape the expectations of households
2
stand the latest market developments in order
to implement monetary and banking policies
appropriately. Policy actions are inevitably
benchmarked against historical correlations in
data. Yet a central bank must be prepared to
question its interpretation of data in light of
anecdotal and other information that suggests
behavior different from historical averages.
The third difficulty of understanding is
in the area of economic analysis. Because
policies influence economic activity indirectly,
central bankers must use economic analysis to
think about how their policies are transmitted
to the economy. Some sort of quantitative
theoretical model must be used to think about
how markets respond to monetary and banking policies, and how monetary and banking
policies ought to react to the economy.
The role of regional banks in a system
of central banks is about creating understanding in the three senses described above. For
example, decentralization enhances credibility
because the diffusion of power makes it more
difficult for outside pressures to be brought to
bear on a central bank.The regional presence
helps a central bank to get its policy message
out and to gather anecdotal and specialized
information on regional economies. Information gathering and dissemination are particularly important for central banks such as the
Eurosystem and the Federal Reserve System,
whose currency areas span large and populous
regions. For this reason, the Central Bank of
the Russian Federation and the Peoples Bank
of China might profitably restructure themselves as a system of regional central banks.1
A regional presence also benefits a central bank with responsibilities for bank supervision and regulation, and the power to extend
emergency credit assistance to troubled financial institutions. Specialized knowledge of local
economies, industries, and businesses is of use
to bank examiners and helpful in determining
whether a troubled bank deserves emergency
credit assistance. Likewise, central banks that
play a role in the provision of payments services run far-flung operations through their
regional offices.
Last but not least, the diversification of
research within a system of central banks
brings a variety of analytical perspectives to
policy deliberations that is invaluable in our
increasingly complex economy. Moreover, a
system of regional banks led by the center
institution harnesses competitive forces to
encourage innovative thinking within the
central bank.
The first half of this paper, which
includes Sections 1 though 4, highlights the
role played by the Reserve Banks in the Federal Reserve System. The remainder of the
paper, Sections 5 through 8, offers some
observations on the new Eurosystem based on
the experience of the Federal Reserve System.There is a short concluding section.
Having spent 20 years as an economist
at the Federal Reserve Bank of Richmond, I
welcome the opportunity to clarify my thinking on these matters. I hope that my discussion of the Federal Reserve System helps the
European national banks and the European
Central Bank to think about their respective
roles in the Eurosystem. Early in the century
the Federal Reserve System looked to European central banks for guidance in designing
its institutional structure and operating procedures. The Federal Reserve will be pleased if
it can now return the favor.
3
general market information. All receive news
and data instantaneously from everywhere.
Reserve Bank presidents, in turn, contribute
to policy discussions with speeches and articles transmitted instantaneously around the
world by wire services and by the Internet.
Reserve Bank officials are familiar
with both their regional private sector world
and the world of the Federal Reserve Board.
Reserve Banks help bridge the two worlds.
Responsibilities and pressures at the Board
create a culture very different from the private sector.The Board staff relies on aggregate data and abstract concepts to think about
the whole economy.Thinking at the Board
reflects consensus beliefs and attitudes, and
is cautious in adopting and even considering
new ideas. Because the Board has ultimate
responsibility for much that is done in the
System, it has little trouble attracting hardworking, dedicated, and highly skilled
employees.Yet because of the responsibility,
the pressure, the need for consensus, and
the need to focus on abstractions and aggregates, the Board staff can be distant from the
private sector.This is a manifestation of the
remoteness described in the introduction
that plagues central bankers.
With important exceptions there is less
ultimate responsibility for System matters at
Reserve Banks. On the other hand, there is
opportunity for distinguishing one’s Reserve
Bank from the others.This is a manifestation
of the competitive innovation, described
in the introduction, that a system of central
banks promotes.
One of the Federal Reserve Board’s
most important duties is to manage relations
with Congress.The Board also handles international relationships and deals directly with
large financial institutions and national interest groups. Board members testify and give
speeches frequently.While these are critically
important responsibilities, such communications are nevertheless rather abstract and
remote.
THE FEDERAL RESERVE BANK
PERSPECTIVE
The improvement over time in communication, information, and transportation technologies has enhanced the role of Reserve
Banks in the Federal Reserve System.The
United States has seen a deconcentration of
metropolitan employment that appears to be
the result of urban congestion and technologies that make it increasingly possible to
locate businesses away from traditional urban
centers.2 The tendency is toward an equalization of regional economic activity.3 Think of
the growth of California, Florida, and Texas,
and the tremendous growth in the South
and Southwest. Atlanta, Georgia has become
a major commercial center; Charlotte, North
Carolina is a major banking center; Seattle is
the home of aircraft and software production.
The growing dispersion of economic
activity increases the value of local information that Reserve Bank presidents bring to
the Federal Open Market Committee.The
presence of Reserve Banks in the midst of
the various regional economies makes possible
a deeper understanding of these than can be
acquired from Washington. Personal contacts
built up over time create trusting relationships
that facilitate the timely acquisition of information about local businesses and markets.
Personal contacts are particularly valuable
in periods of financial stress when it is especially difficult to know what is happening
in certain sectors. Reserve Banks tend to
specialize in knowledge concerning industries concentrated in their respective districts.
For instance, the New York Fed follows
financial markets generally, the Chicago Fed
follows commodity markets and heavy manufacturing, the Dallas Fed follows oil production and developments in Mexico, etc.
Thanks to the progress in information
and communication technology, Reserve
Banks are no longer at an information disadvantage relative to the Federal Reserve
Board or the New York Fed with respect to
4
Because of its regional presence and
focus, the staff at Reserve Banks is more
engaged with the rank and file public. Much
of what Reserve Banks do involves direct
relations with people in the private sector.
For instance, Reserve Bank officials manage
relations with their Boards of Directors
made up of private citizens. Officials speak
to local groups about Federal Reserve policies and current economic conditions. Staff
members supervise and examine banks, collect data on banking and regional business
conditions, provide financial services, promote
economic education, and help facilitate community development.The staff at Reserve
Banks understands core policy, regulatory,
and operational issues and knows how to
explain these to its constituencies. In short,
Reserve Banks keep the central bank from
becoming disembodied, isolated, and out
of touch.
a discussion and vote on the intended federal
funds rate. Normally, an FOMC meeting
lasts four to five hours, but twice a year the
Committee meets for two days to set annual
target ranges for the monetary aggregates
and to consider longer-run procedural and
strategic issues.
Even though all Reserve Bank presidents but the New York Fed president vote
on a rotating basis, all 19 members of the
Committee participate on equal terms at
every meeting.The time for discussion
among the members is, accordingly, limited.
More often than not, Committee members
influence each other incrementally by revisiting issues as time passes, rather than by
exchanging views at any particular meeting.
Economic conditions usually do not call for
a change in the intended federal funds rate.
The Committee uses such occasions to prepare itself for possible future policy actions.
Such “down time” affords ample opportunity
to consider strategic and procedural questions. All in all, there is time for Committee
members to educate and influence each
other, and to reach consensus. But, again,
much of the back and forth among Committee members takes place over time. In this
regard, the verbatim written transcript that
is prepared and circulated after each FOMC
meeting (but released with a five-year lag) is
of great help in enabling members to review
each other’s statements in detail.
The deliberative process works reasonably well in practice.The repeated interaction
creates a mutual understanding that enables
a variety of geographical and professional
perspectives (academic economist, banker,
business economist, businessman, financial
market professional, government administrator, lawyer, and regulator) to be brought to
bear in making policy decisions.
Two related pitfalls have the potential
to weaken the FOMC. First, the bonding
that takes place as a consequence of repeated
meetings can cause Committee members to
FEDERAL OPEN MARKET
COMMITTEE MEETINGS4
The Federal Open Market Committee
(FOMC) meets every six weeks on average
at the Federal Reserve Board in Washington.
The meetings are attended by the seven governors of the Federal Reserve System, the
12 Reserve Bank presidents, and research
directors and other staff members from the
Reserve Banks and the Board.The Chairman of the Board of Governors sets the
agenda, leads the discussions, shapes the policy decisions, and develops the consensus to
support the Committee’s policy actions.
The meetings routinely include a
report from the open market desk at the
Federal Reserve Bank of New York, a briefing by the Board staff on current economic
and financial conditions in the United States
and abroad, a couple of “go arounds” in
which the governors and presidents present
their views on the economy and policy, and
5
begin to think alike. As a result, the FOMC
could be blindsided by a risk or side effect
of a policy stance that it had not taken into
account.To some extent, that risk is diminished by the external community of “Fed
watchers” offering professional advice on
monetary policy.
The sheer size of the FOMC reduces
the likelihood that Committee members will
think alike. One of the great strengths of
policy made by representatives from a system
of regional central banks is the diversity and
number of points of view brought to the
table. But the size of the FOMC actually
creates the second potential pitfall: a free
rider problem. Recognizing that their influence in the Committee may be small, members may be inclined to free-ride on the
preparations of others more interested,
expert, or responsible for monetary policy,
such as the Chairman and the Board staff.
The free rider problem is dangerous
because it has the potential to make the
effective size of the FOMC much smaller
than the full Committee. Even worse, free
riding is hard to detect because free riders
can continue to participate with thoughtfulsounding statements.Widespread free riding
would weaken the Committee in much the
same way as the tendency to think alike.
ulation, financial services, foreign exchange
operations, relations with Congress and the
Treasury, and public relations).The Chairman is the only member of the FOMC fully
aware of all the potential interconnections in
what the Federal Reserve does. Consequently, no major decision can be taken without
the Chairman’s assent for fear of not having
all the facts. For all these reasons it is difficult
to challenge the Chairman’s leadership.
By the same token, a good Chairman
is aware of the risks of excessively centralizing power in his hands. For the reasons
discussed above he must encourage diverse
points of view in the FOMC. Central
bankers worry about a variety of risks to the
economy and the Chairman must encourage
Committee members to bring their concerns to the table.The Chairman must help
prioritize the concerns and suggest a course
of action to achieve the central bank’s goals.
Finally, the Chairman must mobilize the
Committee to action. All in all, the Chairman must use his preeminence to make the
most of the diversity in the FOMC while
preserving the decisiveness needed to make
monetary policy.
Reserve Bank Presidents
at the FOMC
Broadly speaking, Reserve Bank presidents
contribute to FOMC meetings in two
important ways.They make regular reports
on their respective regional economies, and
they provide their own analysis of the
national economy and the policy options.
Regional information compiled by
Reserve Banks for the FOMC in the Beige
Book is of great importance.5 But information in the Beige Book can be stale by the
time of an FOMC meeting. Presidents bring
more timely information to the meeting,
including confidential information from personal or other sources not included in the
Beige Book. Anecdotal information brought
The Chairman of the
Federal Reserve Board
Even though the Chairman has only one
vote in the FOMC, he is preeminent for a
number of reasons.The Chairman and the
other Board members are appointed by the
President of the United States, and the
Chairman is named by the President to lead
the Federal Reserve System.The Chairman
has command of the large staff at the Federal
Reserve Board. Most importantly, only he is
involved in every key central bank operation
(monetary policy, bank supervision and reg-
6
to the FOMC can signal changing sentiment
before it becomes evident in aggregate data.
Mutually supportive signals from various
regions may help to identify or confirm a
change in trend or a turning point in the
aggregate data. It is particularly important
that a central bank recognize and react
promptly to turning points in inflation and
employment trends.
Besides the Chairman, the Board staff
presents the most influential economic
analysis at FOMC meetings.The staff ’s analysis is primarily presented in two briefing
documents with which Committee members’
views are invariably compared.The Greenbook summarizes national and international
economic conditions and presents a forecast;
the Bluebook lays out the policy alternatives.
Although the briefing books are comprehensive, the analysis of individual members provides essential perspective. Governors
and presidents alike contribute substantively
to the interpretation of current economic
conditions and the analysis of alternative
policy options. Many important possibilities
such as the risk of an inflation or deflation
scare or the chance of a crisis of confidence
in financial markets are particularly difficult
to assess and take account of in econometric
models.The state of consumer and business
confidence is also difficult to assess formally.
Such issues are addressed in the statements
of Committee members themselves.
Economic analysis is a great equalizer
among members of the FOMC. An argument based on economic reasoning that can
be challenged and debated in the language
of economics is ultimately more influential
than an intuitive assertion about the economy
or policy, no matter who expresses it and
how strongly it is held.
ECONOMIC RESEARCH AT
FEDERAL RESERVE BANKS
Reserve Bank research departments are
staffed with an average of 15 or so research
economists (except for the New York Fed,
which has more than twice as many). Economists graduate from top schools where they
acquire the latest analytical skills and an
appreciation of how to think about macroeconomics, monetary policy, and banking
policy. For the most part, there is a belief in
the power and practical value of economic
theory and empirical work, and a drive to
use economics to make good policy.
Reserve Banks are able to attract and
retain good economists because they offer
a unique combination of opportunities.
Above all, there is the opportunity to prepare
the bank president for FOMC meetings. In
their role as policy advisors, Reserve Bank
economists acquire an intimate empirical
understanding of the macroeconomy and a
broad understanding of policy issues. Economists produce policy essays for the Bank’s
Economic Review and may be encouraged to
publish articles in professional economics
journals.The best of these essays may influence the way that the Federal Reserve, other
central banks, and academic economists
think about policy. It is possible for a Reserve
Bank economist to become increasingly
effective as a policy advisor while acquiring
a research reputation in the economics profession at large.
Reserve Bank research departments
need not specialize.The expression of alternative points of view is an important
strength of a system of central banks. Nevertheless, Reserve Bank research departments
often develop a specialization. A Reserve
Bank president may encourage research of
one type or another; or a particularly skillful
economist may happen to make a department strong in a particular sort of research.
7
A Bank may also exploit a feature of its
regional economy or its operational responsibilities to develop a research advantage.
Differences of opinion among Federal
Reserve economists are discussed at regular
System research meetings. From time to time,
there are differences of opinion involving
essays in a Reserve Bank Economic Review.
Reserve Banks send review articles to the
Board for a prepublication review. Ordinarily
essays benefit from comments by the Board
staff. On occasion, the Board staff may recommend against publication because an article is thought to be technically flawed or
because the article takes a position regarded
as inconsistent with System policy. Conflicts
arise because the Board staff prepares speeches and testimony for the Chairman and
other Board members in which the Federal
Reserve explains current policies to Congress and others. Policy essays published by
a Reserve Bank that implicitly or explicitly
question current policies may be a nuisance
or worse from the perspective of the Board.
Obviously, Reserve Bank economists
could be prevented from publishing essays
critical of current policy. But that would deny
the public the work of economists most
knowledgeable about central banking. It
would leave the field wide open to others
less familiar with the subject. Besides, policy
essays reveal a healthy open debate within
the Federal Reserve System. In keeping with
the mission of a central bank to worry about
the economy and policy, it is helpful to have
policy questioned by enterprising economists at the Reserve Banks. Furthermore, the
best essays facilitate policy advances by suggesting alternatives.
Ultimately, a Reserve Bank has both
the incentive and the ability to discipline
the output of its economists.The Reserve
Bank itself has the most to lose by publishing a poor essay in its Review. Reserve Bank
research is regularly presented at Federal
Reserve System committees and at academic
conferences and seminars. Research directors
have ample opportunity to judge the professional reception of a particular piece of
research prior to publishing it in the Bank’s
Review.
PUBLIC INFORMATION
The modern era of monetary policy at the
Federal Reserve began when Chairman Paul
Volcker took responsibility publicly for inflation in the early 1980s, and subsequently
brought it down.This was a watershed event
because before that Federal Reserve officials
and much of the public, too, generally
blamed inflation on a variety of causes
beyond the central bank’s control. Since
then, the public has come to understand that
Federal Reserve monetary policy determines
the trend rate of inflation over any substantial span of time.
The acceptance of the responsibility
for low inflation by the Federal Reserve
greatly elevated the importance of public
information and communication in the policy
process. Previously, the Federal Reserve preferred to operate in the background and
out of the limelight.The public thought that
important economic policy decisions were
made elsewhere, and the Fed felt relatively
little need to communicate with the public
about its policy intentions. All that changed
after the disinflation initiated by Chairman
Volcker, for two reasons. First, the Fed thrust
itself into the limelight with inflation-fighting
policy actions that raised interest rates and
weakened economic activity in order to
bring down inflation. Second, the Fed realized that bringing down inflation and maintaining price stability would be easier if the
Fed had credibility for low inflation.Thus,
the public became more interested in what
the Fed was doing, and Fed officials came
to see communication with the public as a
tool useful for building credibility.
8
Markets know that the Chairman, and
only the Chairman, speaks for the whole
FOMC, and the Chairman’s rhetoric is
understood to represent the current consensus thinking of the FOMC on policy.The
Chairman makes use of his numerous
appearances before Congress and elsewhere
to update or elaborate upon the current
thinking of the FOMC. Moreover, the FOMC
announces any change in its intended federal
funds rate immediately after any meeting in
which the rate is changed. Minutes of each
FOMC meeting, released shortly after the
following meeting, give a fairly comprehensive idea of the concerns and inclinations of
Committee members, though without individual attribution. Included with the minutes
is the policy directive from the FOMC to
the open market desk.The directive contains
“symmetry language” that indicates any
inclination on the part of the Committee as
a whole to be more concerned with the risk
of inflation or recession over the next few
weeks.The minutes also contain the voting
record and any statements of dissent
expressed by members of the FOMC.
The public does not seem to mistake
the personal views of individual members for
information about the FOMC as a whole.
Transparency of a Committee member’s
views, rather than secrecy, seems more likely
to build understanding and credibility for the
Federal Reserve over time. Not to air differences among Committee members would
deprive markets of useful information, and it
would put the public at a permanent disadvantage in understanding monetary policy.
It is worth emphasizing that the Federal Reserve’s most effective voice is that
of its Chairman.The great respect accorded
the Fed Chairman is largely due to his own
analytical ability and experience, and the
informational and analytical support of the
capable Board staff. A good measure of credit
is no doubt due to recent monetary policy
successes. But an important source of the
Chairman’s personal credibility probably
The Fed has two primary public information objectives with respect to monetary
policy.6 A consensus has emerged among
monetary economists and central bankers
that some sort of explicit mandate for low
inflation is beneficial.Yet, Congress has not
mandated in a clear way that the Fed place
a priority on low inflation. Consequently,
Fed officials bear the burden of responsibility
for educating the public about the benefits
of low inflation. Second, the guiding tactical
principle of monetary policy is to preempt
inflation, or deflation for that matter. A welltimed preemptive increase in the intended
federal funds rate is nothing to be feared. For
instance, the 1994 monetary tightening was
almost certainly necessary to keep inflation
from ending the business expansion. If the
Fed is to successfully maintain price stability,
it must create an understanding of the need
for policy to be preemptive; and the Fed
must build a consensus for specific preemptive policy actions when they are needed.
The regional presence of the Reserve
Banks is a great advantage in getting the
Fed’s message out to the public.The participation of Reserve Bank presidents in the
FOMC puts them in great demand as speakers in their districts. Economists and other
staff members at the Reserve Banks also
carry the Fed’s message to the public. Reserve
Banks produce a variety of literature aimed
at educating the public about the Federal
Reserve.There are extensive economic education programs through which the staff at
Reserve Banks explains monetary policy to
schoolteachers and college professors.
Sometimes market participants complain that speeches by members of the FOMC
complicate the business of understanding the
Fed’s current thinking. As mentioned above,
the great strength of the Federal Reserve
System is that it brings a number of different
points of view to the FOMC.There is no
reason why the public should not hear these
diverse views.
9
comes from the fact that he represents the
views of the diverse members of the FOMC.
If the public were to believe that the Chairman was acting alone, the public would be
more inclined to worry that the Chairman
could be co-opted, i.e., that he might take
policy actions for political rather than economic reasons.The Chairman’s credibility and
influence would suffer accordingly. Even here,
the regional nature of the Federal Reserve
System plays an important role.The Federal
Reserve Chairman needs the FOMC as
much as the Committee needs its Chairman.
THE EUROSYSTEM7
The Eurosystem shares the basic structure of
the Federal Reserve System.The Eurosystem
consists of the European Central Bank (ECB)
headquartered in Frankfurt am Main, more
or less the equivalent of the Federal Reserve
Board, and 11 national central banks (NCBs),
which are like the 12 Federal Reserve Banks.
Monetary policy in the Eurosystem is made
by the Governing Council (the equivalent of
the FOMC).The Governing Council includes
six members of an Executive Board housed at
the ECB (the rough equivalent of the sevenmember Board of Governors of the Federal
Reserve System) and the governors of the
11 national central banks.The President of
the ECB chairs the Governing Council,
playing a role similar to the Chairman of the
Board of Governors.
Power in the Eurosystem is more
decentralized than in the Federal Reserve
System. First of all, the governors of the
NCBs all vote on policy matters in the Governing Council on each occasion.The seven
members of the Board of Governors and
the New York Fed president vote all the
time in the FOMC, but the other 11 Reserve
Bank presidents have only four votes on
10
a rotating basis. As is the case in the FOMC,
policy decisions in the Governing Council
require a simple majority vote.
Secondly, the Board of Governors
exercises more power in the Federal Reserve
System than the ECB does in the Eurosystem.
For instance, the Board of Governors exercises general supervision over the Reserve
Banks: the Board approves Reserve Bank
budgets, approves the appointment
of Reserve Bank presidents, and appoints
three of nine directors at each Reserve
Bank, including the chairman. In contrast,
the Maastricht Treaty gives the NCB governors control over the terms and conditions
of employment of the staff at the ECB.
The NCBs are financially independent of
both the ECB and their respective national
governments. Decentralized control, the socalled principle of subsidiarity, is enshrined
in the preamble of the Maastricht Treaty.
Even the ECB itself is more decentralized than the Board of Governors. For
instance, the Economic and Research Directorates, which employ the bulk of the ECB’s
professional economists, do not report to
the President of the ECB but to another
member of the Executive Board.The fact
that there is no Chief Executive of Europe
to give his assent to the President of the
ECB and other Executive Board members,
as in the United States, probably makes
for a weaker ECB within the Eurosystem.
The NCB governors are appointed by their
respective national governments, without
approval of the Executive Board.
On the objectives for monetary policy,
the Maastricht Treaty states unambiguously
that the primary objective of the Eurosystem
shall be to maintain price stability. Although
the treaty obliges the Eurosystem to support
the general economic policies of the European Union, that support is to be without
prejudice to the objective of price stability.
Accordingly, the Eurosystem mandate is considerably more definite than the objectives
given in the Federal Reserve Act.
The Maastricht Treaty safeguards the
independence of the Eurosystem.The
Eurosystem charter is an international treaty
that cannot be revoked without unanimous
consent of the signatories. Moreover, the
treaty itself actually tells the Eurosystem not
to take instructions from other institutions
in the European Union.The greatest threat
to the Eurosystem’s independence and the
pursuit of price stability could come from
the ambiguity in the treaty on exchange rate
policy, which is to be established by the
European Council. It is not completely clear
how a conflict between exchange rate and
price stability objectives would be settled.
On transparency, the Maastricht Treaty
mandates that the ECB publish quarterly and
annual reports. Executive Board members
have signaled their willingness to testify regularly before the European Parliament.The
ECB intends to keep the public informed of
its policy actions and thinking through press
conferences, speeches, and other regular publications.The President of the ECB holds a
press conference to discuss monetary policy
immediately after one of the two Governing
Council meetings held each month. Notably,
the treaty specifies that the proceedings of
the meetings shall be confidential, but that
the Governing Council may decide to make
the outcome of its deliberations public.
For now, the Eurosystem does not
coordinate and centralize bank supervision
and regulation, or emergency credit provision. NCBs carry on in these areas according
to their respective national policies.This,
of course, differs from Federal Reserve practice, where the Board exercises control
over emergency credit assistance and over
the supervision and regulation of banks.
DECENTRALIZATION
IN THE EARLY FEDERAL RESERVE:
Implications for the Eurosystem
The decentralized Governing Council
described above is reminiscent of the early
Open Market Committee of the Federal
Reserve System. Established informally in
1922 with five of the 12 Reserve Banks represented, the Committee’s membership was
broadened to include all 12 banks in 1930.
The FOMC took its modern form with the
Banking Act of 1935, which gave the seven
members of the Federal Reserve Board a
vote in open market policy for the first time,
and reduced the Reserve Bank votes to five.
As is well known from the account by
Milton Friedman and Anna Schwartz, the
decentralized structure of the Open Market
Committee in the 1920s depended for its
decisiveness on the leadership of Benjamin
Strong, Governor of the Federal Reserve
Bank of New York.8 Governor Strong’s powers of persuasion, personal courage, and good
judgment gave coherence and purpose to
Federal Reserve policy. After Governor
Strong died in October 1928, the Open
Market Committee became unworkable.
Without Strong’s leadership the decentralized
Open Market Committee made for drift
and indecisiveness in Federal Reserve policy.
The Governing Council of the
Eurosystem appears to be susceptible to the
same indecisiveness as was the early Open
Market Committee. A closer look, however,
shows why this is not likely to be the case.
First, the objectives of Federal Reserve
monetary policy in the early years were ambiguous.The United States was on a gold standard, and the Fed was committed to defend
the dollar price of gold.Yet for much of the
1920s Governor Strong sterilized gold flows
and instead tried to stabilize the price level.9
In large part, Strong’s personal discretion
11
substituted for the lack of an agreed objective.The Eurosystem’s price stability mandate
should go a long way toward preserving the
decisiveness of the Governing Council.
Second, it will take some time for the
Eurosystem to develop and become familiar
with euro-area data. But on the whole, much
better macroeconomic data exist today than
were available to the early Fed.This, too,
should make the Governing Council more
decisive than the early Open Market Committee.
Third, today’s central banks can draw
on the considerable theoretical and practical
knowledge that economists have accumulated
since the early years of the Fed. Central
bankers have accumulated a good deal of
practical knowledge themselves. The early Fed
had little experience in managing monetary
policy and very little in the way of analytical skills at its disposal to help guide policy.
Fourth, professional central bank
watchers today provide external advice and
discipline.10 This, too, should act against policy
indecision. Fifth, the Fed did not yet have
the tradition of making the Chairman of
the Board of Governors the Chairman of the
FOMC. In effect, the Fed then lacked an
institutional leader designated by the President of the United States.This was a great
weakness in a decentralized structure such as
the Open Market Committee.The President
of the ECB is the designated leader. He
is appointed by the European Council and
confirmed by the European Parliament. In
any case, it should be pointed out that centralization of power in the FOMC such as
occurred with the Banking Act of 1935 did
not guarantee good monetary policy, as the
Great Inflation from the late 1960s to the
early 1980s showed.
To sum up, the analogy with the early
Fed is far from conclusive.With the help of
the support systems described above, the
Governing Council should be able to strike
a reasonable balance between decentralization and decisiveness.
12
SUBSIDIARITY AND
ECB STAFFING
One problematic issue facing the Eurosystem
is the nature of the control that the NCBs
will exercise over the staffing budget of the
ECB according to the principle of subsidiarity.This is critical because, as the discussion of
the Federal Reserve System makes clear, the
Eurosystem cannot function effectively without a sufficiently strong ECB.The ECB must
perform certain tasks. For instance, the ECB
must represent the Eurosystem in its external
relationships. Presumably, only the President
of the ECB can speak for the Governing
Council. Also, the ECB is the natural home
for economists following the euro-area economy as a whole.The ECB is a natural repository for euro-area data, and its economists
will assume primary responsibility (though by
no means an exclusive one) for following and
interpreting these data for the Eurosystem.
In addition, the ECB needs a staff with
analytical capabilities sufficient to support
the President in his role as leader of the
Eurosystem. Among other things, the ECB’s
staff, working with the staff at the NCBs,
must devise an analytical framework that can
help the President of the ECB guide the
members of the Governing Council in their
monetary policy deliberations.
The funding of the ECB staff must
be authorized by the NCB governors.Yet
the NCBs lack the experience to judge the
ECB’s priorities and needs.The problem is
two-fold. First, NCBs know relatively little
about managing independent monetary policy.
Second, NCBs have little experience as
regional banks in a system of central banks.
The division of labor between the NCBs
and the ECB will have to be worked out
gradually over time.
One hopes that the NCBs will agree
to build up staff at the ECB fast enough to
provide the leadership that the Eurosystem
needs.The analogy with the Fed system makes
clear that critical responsibilities should be
borne by the ECB. NCBs have responsibilities and comparative advantages of their own
that they should exploit for the benefit of
the Eurosystem.11
NATIONAL CENTRAL BANKS
AND THE CREDIBILITY
OF THE EUROSYSTEM
The Eurosystem will establish full credibility
for low inflation over time by satisfying three
conditions. First, the Eurosystem must manage monetary policy competently. Second,
the NCB governors and Executive Board
members on the Governing Council must
learn to work together.Third, the Eurosystem
must build on its price stability mandate to
broaden the public’s support for price stability and the preemptive policy actions necessary to sustain it.The NCBs play a central
role in seeing that these three conditions are
satisfied.
Competence
It seems fair to say that the Eurosystem’s
expertise in maintaining price stability
derives in large part from the Bundesbank,
which has had a long and successful track
record in managing independent monetary
policy.12 Other NCBs have less experience
because for the most part they have chosen
to fix their exchange rates to the Deutsche
Mark.The Eurosystem adopted many of
the Bundesbank’s operational procedures to
facilitate the transfer of the Bundesbank’s
monetary policy credibility to the Governing
Council.
One significant difference between
the Eurosystem and its fixed exchange rate
system predecessor led by the Bundesbank is
that monetary policy will now take account
of euro-area aggregate data. Since those
data are only recently being created, little is
known about their historical behavior or
their relationship to euro-area monetary policy. Until the Eurosystem becomes more
familiar with the new area-wide aggregates,
the Governing Council needs to rely on
anecdotal regional information and the intimate knowledge that NCBs possess of their
own country’s data.
Finally, the NCBs have relatively large
research departments compared to the ECB
and extensive operational experience in
financial and banking markets.The competence of the Eurosystem will depend on the
ability of the ECB to draw on the talents
of staff at the NCBs, as need be, for the good
of the system as a whole.
Working Relationships
on the Governing Council
Despite the safeguards in the Maastricht
Treaty, the independence of the Eurosystem
is at risk because the regional members of
the Governing Council represent countries.
Members could be influenced by their governments.Votes on the Governing Council
could be traded for those on other governing
bodies of the European Union. As mentioned
above, the ambiguity on exchange rate policy opens the door to political interference
in monetary policy. Politically motivated disputes could greatly complicate the business
of the Governing Council. Such conflicts
could cause indecisiveness, inconsistent policy actions, and a loss of credibility.
FOMC experience suggests a number
of additional measures to prevent the politicization of the Governing Council. First,
a macroeconomic framework should be
developed to guide policy deliberations.The
framework should be rich enough to encompass a wide variety of views and sufficiently
coherent to provide the basis for prioritizing
concerns and building a consensus for policy
actions.The Governing Council should utilize economic arguments disciplined by the
13
price stability objective to smoke out and
defuse political rhetoric. Economic reasoning
is, to repeat, a great equalizer.
Second, the ECB President’s role in
the Governing Council should be strengthened so that he can guide the debate within
the agreed upon framework.The ECB
President should act against free riding by
encouraging members of the Governing
Council to prepare thoroughly and to participate actively. The effectiveness of members
would be enormously enhanced if each were
allowed to bring an economist advisor to the
meetings. A verbatim transcript of the meetings should be produced, if only for internal
use, to facilitate the give and take that must
occur over time.
Third, the macroeconomic framework
should be explained to the public in some
detail so that Eurosystem watchers can more
readily exercise professional discipline on the
internal debate.13 Minutes without individual
attribution, published shortly after each Governing Council meeting would help focus
Eurosystem watchers on issues of concern
to policymakers. Over the long run, greater
transparency can serve as a powerful safeguard against political interference.
Admittedly, the FOMC never had the
potential for internal international disputes
that exists in the Governing Council. However, FOMC experience suggests that the
above-mentioned practices would facilitate
the development of productive professional
working relationships in the Council.
Broadening Public Support
for the Eurosystem
The Bundesbank has an admirable monetary
policy record in large part because it always
had the full support of the German public
for its price stability objective.That support
was there because the Bundesbank was associated in the public’s mind with the postwar
economic miracle that began in the late
14
1940s at the time that the Deutsche Mark
and the Bundesbank were created.
The European public has little natural
affinity for the new Eurosystem. As was the
case for the Federal Reserve System, the
Eurosystem will have to earn the public’s
confidence. If anything, public relations will
be more difficult for the Eurosystem than
they have been for the Federal Reserve System
because the euro area is made up of 11 different countries whose citizens speak many
different languages.The Eurosystem should
make extensive use of the regional presence
of its NCBs to broaden the understanding
of its mission and methods, much as the Fed
uses the Reserve Banks.
The Eurosystem has one big advantage
over the Fed in explaining itself to the public. In contrast to the Fed, whose mandate
only exists in the Federal Reserve Act and is
ambiguous at that, the Eurosystem’s price
stability mandate is unambiguous and part of
one of the founding documents of the European Union.
SUMMARY
The main message of this paper is that
regional (national) banks play an especially
important role in central banks whose currency areas span a continent, such as the
Eurosystem and the Federal Reserve System.
A regional presence facilitates the acquisition of specialized information on the economy and positions the staff to reach out to
the public with an explanation of the central
bank’s policy objectives and practices. Presidents (governors) of regional central banks
bring analytical diversity to the monetary
policy committee. Above all, a system of
central banks promotes a healthy competition that stimulates innovative thinking on
operational, regulatory, research, and policy
questions.
Federal Reserve experience teaches
that a decentralized system needs a strong
center. Staff at the center needs to be large
enough to support a strong Chairman (President) of the system.The Chairman must be
strong enough to encourage diverse views in
the policy committee and to build a consensus for decisive and timely policy actions.
The Chairman should exploit diversity and
promote decisiveness.
The key to success in the Eurosystem,
in addition to the above-mentioned points,
is to establish good working relationships
on the Governing Council.To facilitate this,
the staff at the center should take the lead
in developing a macroeconomic framework
within which diverse policy views can be
expressed and debated productively. Personal
advisors should accompany members to the
policy meetings.Verbatim transcripts should
be prepared for internal use to facilitate an
exchange of views over time. Minutes without individual attribution should be published to present opposing views clearly, to
focus central bank watchers, and to guard
against the potential for politically motivated
policy mistakes.
The Eurosystem and the Federal
Reserve System will succeed in the long run
by broadening the public’s understanding
and support for low inflation and the preemptive policy procedures to maintain price
stability.The way to do that is to involve the
Reserve Bank presidents (national central
bank governors) and their advisors fully in
the policymaking process, and to utilize the
system’s regional presence to take the central
bank’s monetary policy message to the public.
ENDNOTES
1. In late 1998, the Peoples Bank of China announced its intention to establish nine provincial branches.
2. See, for example, Chatterjee and Carlino (1998).
3. Barro and Sala-í-Martin (1992) present evidence of convergence within the United States.
4. See Meyer (1998).
5. See Balke and Petersen (1998).
6. See Goodfriend (1997).
7. European Union (1995) contains the Maastricht Treaty, which,
in turn, contains the language governing the structure, administration, and objectives of the Eurosystem.Wynne (1999) summarizes the documentation authorizing the establishment of the
Eurosystem.
8. See Friedman and Schwartz (1963).
9. See Hetzel (1985).
10. See, for example, Begg et al. (1998).
11. See, for instance, Liebscher (1998).
12. See Deutsche Bundesbank (1999).
13. See Issing (1998).
REFERENCES
Balke, Nathan, and D’Ann Petersen. “How Well Does the Beige
Book Reflect Economic Activity?,” Federal Reserve Bank of Dallas Working Paper 98-02, June 1998.
Barro, Robert, and Xavier Sala-í-Martin. “Convergence,” Journal
of Political Economy, vol. 100 (April 1992), pp. 223-51.
Begg, David et al. “The ECB: Safe at Any Speed?” London: Center for Economic Policy Research, October 1998.
Chatterjee, Satyajit, and Gerald Carlino. “Aggregate Employment
Growth and the Deconcentration of Metropolitan Employment,”
Federal Reserve Bank of Philadelphia Working Paper 98-6,
March 1998.
Deutsche Bundesbank. Fifty Years of the Deutsche Mark: Central
Bank and the Currency in Germany Since 1948. London: Oxford
University Press, 1999.
European Union: Selected Instruments taken from the Treaties, Book 1,
Volume 1. Luxembourg: Office for Official Publications of the
European Communities, 1995.
Friedman, Milton, and Anna Schwartz. A Monetary History of
the United States, 1867-1960. Princeton: Princeton University
Press, 1963.
Goodfriend, Marvin. “Monetary Policy Comes of Age: A 20th
Century Odyssey,” Federal Reserve Bank of Richmond Economic
Quarterly, vol. 83 (Winter 1997), pp. 1-22.
Hetzel, Robert.“The Rules versus Discretion Debate over Monetary Policy in the 1920s,” Federal Reserve Bank of Richmond
Economic Review, vol. 71 (November/December 1985), pp. 3-14.
Issing, Otmar. “Monetary Policy in EMU.” Speech delivered at
the 1998 Annual Meeting of the International Monetary Fund
and the World Bank Group in Washington, D.C., October 1998.
Liebscher, Klaus. “The Role of a National Central Bank within
the ESCB as Illustrated by the OeNB.” Vienna: Austrian National
Bank, May 1998.
Meyer, Laurence. “Come with Me to the FOMC,” Federal
Reserve Bank of Minneapolis The Region, vol. 12 (June 1998),
pp. 6-15.
Wynne, Mark.“The European System of Central Banks,” Federal
Reserve Bank of Dallas Economic Review, (First Quarter 1999),
pp. 2-14.
15
DECEMBER 31, 1999
Year in Review
FEDERAL RESERVE BANK
OF RICHMOND
Both the national and Fifth
District economies continued
to grow robustly in 1999,
with sizable gains in employment and production.
With rising current income, and higher expected future income driven by
increased productivity growth, domestic U.S. demand for goods and services
was exceptionally strong throughout
most of the year — indeed, so strong
that many economists concluded that
greater monetary restraint was needed
to sustain the expansion over time.
In response, the Fed raised the federal
funds rate one-quarter percentage
point on three occasions in the second
half of the year.Two of these increases
were accompanied by quarter point
increases in the discount rate.The
impacts of these policy actions were
still being assessed in early 2000.
Far easier to ascertain was the success of the Bank’s preparation for a
smooth transition to the year 2000.
The Bank completed the century date
rollover with no service disruptions to
internal operations or external customers. Preparing for the successful
transition required the dedication and
commitment of staff in every area of
the Bank.The financial services areas
made extensive operating and contingency preparations and worked closely
with customers to ensure readiness.
Customer Support staff played a key
role in testing, monitoring, and communicating with Fifth District financial
institutions. Staff in the Reserve
Accounts and Loans areas assisted
depository institutions in preparing to
use the discount window as a contingency source of funds. Banking
Supervision ensured that supervised
institutions successfully completed
their preparations for the transition.
Federal Reserve efforts to inform the
public about the banking system’s
readiness for the rollover helped reduce
anxiety in the period leading up to
the event. Bank staff provided information about the industry’s preparations through 247 speeches and panel
presentations that reached an estimated
11,000 individuals.Videos and print
and broadcast media interviews, including radio and television appearances,
reached even broader audiences.
Bank management and staff also
took steps in 1999 to ensure continued success in the dynamic economy
envisioned for the 21st century. Most
importantly, a new strategic plan was
completed that better aligns the Bank’s
mission, vision, and longer-term
goals to the new challenges presented
by the rapidly changing banking and
financial system.The plan was developed with substantial input from customers and employees and includes
new strategies and initiatives to improve
performance in all areas of the Bank.
Mr. Broaddus and Mr.Varvel introduced the plan in a series of meetings
throughout the District to ensure that
all staff members understood the contribution of their individual job assignments to the Bank’s overall strategy.
16
Economic Research and
Public Outreach
The Bank continued to produce economic research relevant to the Federal
Reserve’s monetary and banking
policies, the Fifth District economy,
and the payments system. Research
staff supplied timely analyses of current policy issues and advised the
Bank president in his preparation for
the Federal Open Market Committee
meetings.They also provided senior
management with comprehensive
analytical support in meeting banking
and payments system responsibilities.
The Bank conveyed information
about the Fifth District, the national
economy, and Federal Reserve monetary policy through its public outreach.
In 1999, over 200,000 copies of
16 Bank publications were distributed.
The Bank’s business magazine, Region
Focus, increased circulation and garnered four more awards for journalistic
merit, bringing the total number of
awards to 10 since it was first published in 1997.The Economic Quarterly
continued to receive positive feedback
from respected economists and institutions at home and abroad, and the
Bank’s Web site provided expanded
access to Bank publications, the president’s speeches, and regional economic
information.
Several economic education programs provided further opportunities
for information-sharing.The Bank
joined forces with the E. Angus Powell
Endowment for Economic Education
to host a national teachers’ conference
attended by 100 teachers from 28 states.
The Bank also sponsored its first Districtwide Fed Challenge competition
for high school students and cosponsored an innovative graduate course for
economics teachers of deaf and hardof-hearing students with Gallaudet
University in Washington, D.C.
The Community Affairs Office
supported the Federal Reserve System’s efforts to encourage community
reinvestment in several ways.These
included a joint initiative with the
Board of Governors’ Community
Affairs staff to promote better small
business access to capital and credit in
the District of Columbia’s lower
income neighborhoods.
of contact for all financial institutions
with more than $1 billion in assets.
In order to improve supervisory coordination, the Bank participated in joint,
targeted reviews of the three largest
banking organizations in the District
with the Comptroller of the Currency
and conducted joint meetings with
senior management of these organizations. Coordination of examinations
and inspections with regulators of
other District banks improved in 1999;
30 state member bank examinations
were conducted jointly with state
regulators.
Financial Services and
Other Operations
Banking Supervision
The overall condition of banking
organizations in the Fifth District
remained strong in 1999. At year-end,
the Bank supervised 230 bank holding
companies that controlled total assets
of approximately $1.1 trillion —
the second highest total in the Federal
Reserve System. Additionally, both
the number of state member banks
and the total assets of these banks were
among the highest in the System.
While merger activity decreased the
number of state member banks by 23,
five new state member banks opened,
and three existing banks converted
to state member status for a total of
128 banks with $94 billion in assets.
The Bank implemented a comprehensive strategy involving specialized
teams of examiners to supervise large,
complex banking organizations headquartered in the District and assigned
senior examiners as central points
The financial services areas provided
high quality, customer-focused services
to depository institutions and the
U.S.Treasury during 1999 and further
improved most service-level effectiveness and quality measures.The Bank
realized a financial services cost recovery rate of 103.9 percent for the year
and met nearly all key service quality
targets.
During 1999 the Bank participated
in the first Federal Reserve System
survey to measure customer satisfaction. In addition, it conducted a Fifth
District quality survey for the Accounting, Automated Clearinghouse, Business Development, and Funds Transfer
services.The results of both surveys
indicated a high level of satisfaction
with these services. Additionally, the
District led efforts to enlist large credit unions as savings bond agents and
17
trained their staffs in savings bond
marketing.The financial services areas
also took steps to utilize new technology to improve services. Check
Processing introduced high-speed commercial check imaging systems in
three District offices and increased the
number of customers using check
imaging services by 19. Bank staff also
introduced new technology to process
savings bond applications more efficiently and converted additional offline
customers to electronic connections.
Staff at the Charlotte Office successfully met the challenges associated
with serving as the key Federal
Reserve account management office
for four of the nation’s largest banking
organizations.The rapid expansion of
these institutions added significantly
to that office’s account management
responsibilities during the year.
The Bank also provided extensive
support to the U.S.Treasury and other
government agencies in 1999. A Bank
officer continued to serve as the System’s liaison to the Treasury; he coordinated a number of joint Treasury
and Federal Reserve initiatives during
the year and provided consultative
support. Also, Bank staff worked closely with the Treasury to improve the
efficiency of government payment
and collection systems.The Currency
Technology Office worked actively
with the Bureau of Engraving and
Printing on the design for the new
$5 and $10 notes.
As a new century begins, and in
keeping with its mission and vision,
the Bank will continue to foster
the stability, integrity, and efficiency
of the nation’s monetary, financial,
and payments systems.
FEDERAL RESERVE BANK
OF RICHMOND
December 31, 1999
To the Board of Directors:
The management of the Federal Reserve Bank of Richmond (FRB Richmond) is
responsible for the preparation and fair presentation of the Statement of Financial
Condition, Statement of Income, and Statement of Changes in Capital as of
December 31, 1999 (the “Financial Statements”). The Financial Statements have
been prepared in conformity with the accounting principles, policies, and practices
established by the Board of Governors of the Federal Reserve System and as set
forth in the Financial Accounting Manual for the Federal Reserve Banks, and as
such, include amounts, some of which are based on judgments and estimates of
management.
The management of the FRB Richmond is responsible for maintaining an effective process of internal controls over financial reporting including the safeguarding
of assets as they relate to the Financial Statements. Such internal controls are
designed to provide reasonable assurance to management and to the Board of
Directors regarding the preparation of reliable Financial Statements.This process of
internal controls contains self-monitoring mechanisms, including, but not limited
to, divisions of responsibility and a code of conduct. Once identified, any material
deficiencies in the process of internal controls are reported to management, and
appropriate corrective measures are implemented.
Even an effective process of internal controls, no matter how well designed, has
inherent limitations, including the possibility of human error, and therefore can
provide only reasonable assurance with respect to the preparation of reliable financial statements.
The management of the FRB Richmond assessed its process of internal controls
over financial reporting including the safeguarding of assets reflected in the Financial Statements, based upon the criteria established in the “Internal Control —
Integrated Framework” issued by the Committee of Sponsoring Organizations of
the Treadway Commission (COSO). Based on this assessment, the management of
the FRB Richmond believes that the FRB Richmond maintained an effective
process of internal controls over financial reporting including the safeguarding of
assets as they relate to the Financial Statements.
Federal Reserve Bank of Richmond
J. Alfred Broaddus, Jr.
Walter A.Varvel
PRESIDENT
FIRST VICE PRESIDENT
1
FEDERAL RESERVE BANK
OF RICHMOND
Report of Independent Accountants
To the Board of Directors of the Federal Reserve Bank of Richmond:
We have examined management’s assertion that the Federal Reserve Bank of
Richmond (“FRB Richmond”) maintained effective internal control over financial
reporting and the safeguarding of assets as they relate to the Financial Statements
as of December 31, 1999, included in the accompanying Management’s Assertion.
Our examination was made in accordance with standards established by the American Institute of Certified Public Accountants, and accordingly, included obtaining
an understanding of the internal control over financial reporting, testing, and evaluating the design and operating effectiveness of the internal control, and such other
procedures as we considered necessary in the circumstances. We believe that our
examination provides a reasonable basis for our opinion.
Because of inherent limitations in any internal control, misstatements due to error
or fraud may occur and not be detected. Also, projections of any evaluation of the
internal control over financial reporting to future periods are subject to the risk
that the internal control may become inadequate because of changes in conditions,
or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management’s assertion that the FRB Richmond maintained
effective internal control over financial reporting and over the safeguarding of
assets as they relate to the Financial Statements as of December 31, 1999, is fairly
stated, in all material respects, based upon criteria described in “Internal Control –
Integrated Framework” issued by the Committee of Sponsoring Organizations of
the Treadway Commission.
Richmond,Virginia
March 3, 2000
2
FEDERAL RESERVE BANK
OF RICHMOND
Report of Independent Accountants
To the Board of Governors of the Federal Reserve System and the
Board of Directors of the Federal Reserve Bank of Richmond:
We have audited the accompanying statements of condition of the Federal Reserve
Bank of Richmond (the “Bank”) as of December 31, 1999 and 1998, and the related statements of income and changes in capital for the years then ended. These
financial statements are the responsibility of the Bank’s management. Our responsibility is to express an opinion on the financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States.Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also
includes assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.We
believe that our audits provide a reasonable basis for our opinion.
As discussed in Note 3, the financial statements were prepared in conformity
with the accounting principles, policies, and practices established by the Board of
Governors of the Federal Reserve System.These principles, policies, and practices,
which were designed to meet the specialized accounting and reporting needs of
the Federal Reserve System, are set forth in the “Financial Accounting Manual for
Federal Reserve Banks” and constitute a comprehensive basis of accounting other
than accounting principles generally accepted in the United States.
In our opinion, the financial statements referred to above present fairly, in all
material respects, the financial position of the Bank as of December 31, 1999 and
1998, and results of its operations for the years then ended, on the basis of accounting described in Note 3.
Richmond,Virginia
March 3, 2000
3
FEDERAL RESERVE BANK
OF RICHMOND
STATEMENTS
OF CONDITION
(IN MILLIONS)
AS OF DECEMBER 31, 1 9 9 9
1998
Assets
Gold certificates
$
Special drawing rights certificates
834
516
Coin
Items in process of collection
Loans to depository institutions
U.S. government and federal agency securities, net
Investments denominated in foreign currencies
$
807
792
38
53
493
624
12
—
36,404
35,974
3,356
3,066
Accrued interest receivable
366
340
Interdistrict settlement account
646
4,985
Bank premises and equipment, net
201
201
90
85
$42,956
$46,927
$36,876
$41,577
Other assets
Total assets
Liabilities and Capital
Liabilities:
Federal Reserve notes outstanding, net
Deposits:
Depository institutions
1,957
1,898
Other deposits
48
54
Deferred credit items
566
676
Surplus transfer due U.S. Treasury
31
157
Accrued benefit cost
70
64
Other liabilities
26
25
39,574
44,451
Capital paid-in
1,691
1,238
Surplus
1,691
1,238
3,382
2,476
$42,956
$46,927
Total liabilities
Capital:
Total capital
Total liabilities and capital
The accompanying notes are an integral part of these financial statements.
4
FEDERAL RESERVE BANK
OF RICHMOND
STATEMENTS
OF INCOME
(IN MILLIONS)
FOR THE YEARS ENDED DECEMBER 31, 1 9 9 9
1998
Interest Income
Interest on U.S. government and
federal agency securities
$2,085
$2,212
45
65
1
—
2,131
2,277
Income from services
66
65
Reimbursable services to government agencies
31
31
(105)
290
(2)
3
5
4
(5)
393
Interest on foreign currencies
Interest on loans to depository institutions
Total interest income
Other Operating Income (Loss)
Foreign currency (losses) gains, net
U.S. government securities (losses) gains, net
Other income
Total other operating income (loss)
Operating Expenses
170
157
Occupancy expense
Salaries and other benefits
23
24
Equipment expense
74
84
Assessments by Board of Governors
85
57
(48)
(60)
304
262
$1,822
$2,408
$
$
Other credits
Total operating expenses
Net income prior to distribution
Distribution of Net Income
Dividends paid to member banks
Transferred to surplus
Payments to U.S. Treasury as interest on
Federal Reserve notes
Payments to U.S. Treasury as required by statute
Total distribution
The accompanying notes are an integral part of these financial statements.
5
86
61
453
420
1,283
733
—
1,194
$1,822
$2,408
FEDERAL RESERVE BANK
OF RICHMOND
STATEMENTS OF
CHANGES IN CAPITAL
FOR THE YEARS ENDED DECEMBER 31, 1999
AND DECEMBER 31, 1998
Capital
(IN MILLIONS)
Paid-in
Surplus
Capital
Total
$ 833
$ 818
$1,651
—
420
420
405
—
405
$1,238
$1,238
$2,476
—
453
453
453
—
453
$1,691
$1,691
$3,382
Balance at January 1, 1998
(16.7 million shares)
Net income transferred to surplus
Net change in capital stock issued
(8.0 million shares)
Balance at December 31, 1998
(24.7 million shares)
Net income transferred to surplus
Net change in capital stock issued
(9.1 million shares)
Balance at December 31, 1999
(33.8 million shares)
The accompanying notes are an integral part of these financial statements.
6
FEDERAL RESERVE BANK
OF RICHMOND
NOTES TO
FINANCIAL STATEMENTS
1. Organization
2. Operations and Services
The Federal Reserve Bank of Richmond (“Bank”) is
part of the Federal Reserve System (“System”)
created by Congress under the Federal Reserve
Act of 1913 (“Federal Reserve Act”) which established the central bank of the United States. The
System consists of the Board of Governors of the
Federal Reserve System (“Board of Governors”)
and twelve Federal Reserve Banks (“Reserve
Banks”). The Reserve Banks are chartered by the
federal government and possess a unique set of
governmental, corporate, and central bank characteristics. Other major elements of the System are
the Federal Open Market Committee (“FOMC”)
and the Federal Advisory Council. The FOMC is
composed of members of the Board of Governors,
the president of the Federal Reserve Bank of New
York (“FRBNY”) and, on a rotating basis, four other
Reserve Bank presidents.
The System performs a variety of services and
operations. Functions include: formulating and
conducting monetary policy; participating actively
in the payments mechanism, including large-dollar
transfers of funds, automated clearinghouse operations and check processing; distribution of coin
and currency; fiscal agency functions for the U.S.
Treasury and certain federal agencies; serving as
the federal government’s bank; providing shortterm loans to depository institutions; serving the
consumer and the community by providing educational materials and information regarding consumer laws; supervising bank holding companies,
and state member banks; and administering other
regulations of the Board of Governors. The Board
of Governors’ operating costs are funded through
assessments on the Reserve Banks.
The FOMC establishes policy regarding open
market operations, oversees these operations, and
issues authorizations and directives to the FRBNY
for its execution of transactions. Authorized transaction types include direct purchase and sale of
securities, matched sale-purchase transactions,
the purchase of securities under agreements to
resell, and the lending of U.S. government securities. Additionally, the FRBNY is authorized by the
FOMC to hold balances of and to execute spot and
forward foreign exchange and securities contracts
in fourteen foreign currencies, maintain reciprocal
currency arrangements (“F/X swaps”) with various
central banks, and “warehouse” foreign currencies
for the U.S. Treasury and Exchange Stabilization
Fund (“ESF”) through the Reserve Banks.
Structure
The Bank and its branches in Richmond, Virginia;
Baltimore, Maryland; and Charlotte, North Carolina,
serve the Fifth Federal Reserve District, which
includes Maryland, North Carolina, South Carolina,
Virginia, the District of Columbia, and a portion of
West Virginia. In accordance with the Federal
Reserve Act, supervision and control of the Bank is
exercised by a board of directors. Banks that are
members of the System include all national banks
and any state chartered bank that applies and is
approved for membership in the System.
Board of Directors
The Federal Reserve Act specifies the composition
of the board of directors for each of the Reserve
Banks. Each board is composed of nine members
serving three-year terms: three directors, including
those designated as Chairman and Deputy Chairman, are appointed by the Board of Governors, and
six directors are elected by member banks. Of the
six elected by member banks, three represent the
public and three represent member banks. Member
banks are divided into three classes according to
size. Member banks in each class elect one director
representing member banks and one representing
the public. In any election of directors, each member
bank receives one vote, regardless of the number
of shares of Reserve Bank stock it holds.
3. Significant Accounting Policies
Accounting principles for entities with the unique
powers and responsibilities of the nation’s central
bank have not been formulated by the Financial
Accounting Standards Board. The Board of Governors has developed specialized accounting principles and practices that it believes are appropriate
for the significantly different nature and function of
a central bank as compared to the private sector.
These accounting principles and practices are documented in the “Financial Accounting Manual for
Federal Reserve Banks” (“Financial Accounting
Manual”), which is issued by the Board of Governors. All Reserve Banks are required to adopt and
7
apply accounting policies and practices that are
consistent with the Financial Accounting Manual.
The financial statements have been prepared in
accordance with the Financial Accounting Manual.
Differences exist between the accounting principles and practices of the System and generally
accepted accounting principles in the United
States (“GAAP”). The primary differences are the
presentation of all security holdings at amortized
cost, rather than at the fair value presentation
requirements of GAAP, and the accounting for
matched sale-purchase transactions as separate
sales and purchases, rather than secured borrowings with pledged collateral, as is required by
GAAP. In addition, the Bank has elected not to
present a Statement of Cash Flows or a Statement
of Comprehensive Income. The Statement of Cash
Flows has not been included as the liquidity and
cash position of the Bank are not of primary concern to the users of these financial statements.
The Statement of Comprehensive Income, which
comprises net income plus or minus certain adjustments, such as the fair value adjustment for securities, has not been included because as stated
above the securities are recorded at amortized cost
and there are no other adjustments in the determination of Comprehensive Income applicable to the
Bank. Other information regarding the Bank’s activities is provided in, or may be derived from, the
Statements of Condition, Income, and Changes in
Capital. Therefore, a Statement of Cash Flows or a
Statement of Comprehensive Income would not
provide any additional useful information. There are
no other significant differences between the policies outlined in the Financial Accounting Manual
and GAAP.
The preparation of the financial statements in
conformity with the Financial Accounting Manual
requires management to make certain estimates
and assumptions that affect the reported amounts
of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of
income and expenses during the reporting period.
Actual results could differ from those estimates.
Unique accounts and significant accounting policies
are explained below.
deliver them to the U.S. Treasury. At such time,
the U.S. Treasury’s account is charged and the
Reserve Banks’ gold certificate accounts are lowered. The value of gold for purposes of backing the
gold certificates is set by law at $42 2/9 a fine troy
ounce. The Board of Governors allocates the gold
certificates among Reserve Banks once a year
based upon Federal Reserve notes outstanding in
each District at the end of the preceding year.
b. Special Drawing Rights Certificates
Special drawing rights (“SDRs”) are issued by the
International Monetary Fund (“Fund”) to its members in proportion to each member’s quota in the
Fund at the time of issuance. SDRs serve as a supplement to international monetary reserves and
may be transferred from one national monetary
authority to another. Under the law providing for
United States participation in the SDR system, the
Secretary of the U.S. Treasury is authorized to
issue SDR certificates, somewhat like gold certificates, to the Reserve Banks. At such time, equivalent amounts in dollars are credited to the account
established for the U.S. Treasury, and the Reserve
Banks’ SDR certificate accounts are increased. The
Reserve Banks are required to purchase SDRs, at
the direction of the U.S. Treasury, for the purpose
of financing SDR certificate acquisitions or for
financing exchange stabilization operations. The
Board of Governors allocates each SDR transaction
among Reserve Banks based upon Federal
Reserve notes outstanding in each District at the
end of the preceding year.
c. Loans to Depository Institutions
The Depository Institutions Deregulation and
Monetary Control Act of 1980 provides that all
depository institutions that maintain reservable
transaction accounts or nonpersonal time deposits,
as defined in Regulation D issued by the Board of
Governors, have borrowing privileges at the discretion of the Reserve Banks. Borrowers execute
certain lending agreements and deposit sufficient
collateral before credit is extended. Loans are evaluated for collectibility, and currently all are considered collectible and fully collateralized. If any loans
were deemed to be uncollectible, an appropriate
reserve would be established. Interest is recorded
on the accrual basis and is charged at the applicable
discount rate established at least every fourteen
days by the Board of Directors of the Reserve
Banks, subject to review by the Board of Governors.
However, Reserve Banks retain the option to
impose a surcharge above the basic rate in certain
circumstances.
The Board of Governors established a Special
Liquidity Facility (SLF) to make discount window
credit readily available to depository institutions in
sound financial condition around the century date
change (October 1, 1999, to April 7, 2000) in order
a. Gold Certificates
The Secretary of the Treasury is authorized to issue
gold certificates to the Reserve Banks to monetize
gold held by the U.S. Treasury. Payment for the
gold certificates by the Reserve Banks is made by
crediting equivalent amounts in dollars into the
account established for the U.S. Treasury. These
gold certificates held by the Reserve Banks are
required to be backed by the gold of the U.S. Treasury. The U.S. Treasury may reacquire the gold certificates at any time and the Reserve Banks must
8
to meet unusual liquidity demands and to allow
institutions to confidently commit to supplying
loans to other institutions and businesses during
this period. Under the SLF, collateral requirements
are unchanged from normal discount window
activity and loans are made at a rate of 150 basis
points above FOMC’s target federal funds rate.
ward contracts generally limited to the second leg
of a swap/warehousing transaction.
The FRBNY, on behalf of the Reserve Banks,
maintains renewable, short-term F/X swap
arrangements with authorized foreign central
banks. The parties agree to exchange their currencies up to a pre-arranged maximum amount and for
an agreed upon period of time (up to twelve
months), at an agreed upon interest rate. These
arrangements give the FOMC temporary access to
foreign currencies that it may need for intervention
operations to support the dollar and give the partner
foreign central bank temporary access to dollars it
may need to support its own currency. Drawings
under the F/X swap arrangements can be initiated
by either the FRBNY or the partner foreign central
bank, and must be agreed to by the drawee. The
F/X swaps are structured so that the party initiating
the transaction (the drawer) bears the exchange
rate risk upon maturity. The FRBNY will generally
invest the foreign currency received under an F/X
swap in interest-bearing instruments.
Warehousing is an arrangement under which
the FOMC agrees to exchange, at the request of
the Treasury, U.S. dollars for foreign currencies
held by the Treasury or ESF over a limited period of
time. The purpose of the warehousing facility is to
supplement the U.S. dollar resources of the Treasury and ESF for financing purchases of foreign
currencies and related international operations.
In connection with its foreign currency activities, the FRBNY, on behalf of the Reserve Banks,
may enter into contracts which contain varying
degrees of off-balance sheet market risk, because
they represent contractual commitments involving
future settlement, and counter-party credit risk.
The FRBNY controls credit risk by obtaining credit
approvals, establishing transaction limits, and performing daily monitoring procedures.
While the application of current market prices
to the securities currently held in the SOMA portfolio and investments denominated in foreign currencies may result in values substantially above or
below their carrying values, these unrealized
changes in value would have no direct effect on
the quantity of reserves available to the banking
system or on the prospects for future Reserve
Bank earnings or capital. Both the domestic and
foreign components of the SOMA portfolio from
time to time involve transactions that can result in
gains or losses when holdings are sold prior to
maturity. However, decisions regarding the securities and foreign currencies transactions, including
their purchase and sale, are motivated by monetary
policy objectives rather than profit. Accordingly,
earnings and any gains or losses resulting from the
sale of such currencies and securities are incidental to the open market operations and do not motivate its activities or policy decisions.
d. U.S. Government and Federal Agency
Securities and Investments
Denominated in Foreign Currencies
The FOMC has designated the FRBNY to execute
open market transactions on its behalf and to hold
the resulting securities in the portfolio known as
the System Open Market Account (“SOMA”). In
addition to authorizing and directing operations in
the domestic securities market, the FOMC authorizes and directs the FRBNY to execute operations
in foreign markets for major currencies in order to
counter disorderly conditions in exchange markets
or other needs specified by the FOMC in carrying
out the System’s central bank responsibilities.
Purchases of securities under agreements to
resell and matched sale-purchase transactions are
accounted for as separate sale and purchase transactions. Purchases under agreements to resell are
transactions in which the FRBNY purchases a
security and sells it back at the rate specified at the
commencement of the transaction. Matched salepurchase transactions are transactions in which the
FRBNY sells a security and buys it back at the rate
specified at the commencement of the transaction.
Effective April 26, 1999 FRBNY was given
the sole authorization by the FOMC to lend U.S.
government securities held in the SOMA to U.S.
government securities dealers and to banks participating in U.S. government securities clearing
arrangements, in order to facilitate the effective
functioning of the domestic securities market.
These securities-lending transactions are fully collateralized by other U.S. government securities.
FOMC policy requires FRBNY to take possession
of collateral in amounts in excess of the market
values of the securities loaned. The market values
of the collateral and the securities loaned are monitored by FRBNY on a daily basis, with additional
collateral obtained as necessary. The securities
loaned continue to be accounted for in the SOMA.
Prior to April 26, 1999 all Reserve Banks were
authorized to engage in such lending activity.
Foreign exchange contracts are contractual
agreements between two parties to exchange
specified currencies, at a specified price, on a
specified date. Spot foreign contracts normally settle two days after the trade date, whereas the settlement date on forward contracts is negotiated
between the contracting parties, but will extend
beyond two days from the trade date. The FRBNY
generally enters into spot contracts, with any for9
U.S. government and federal agency securities
and investments denominated in foreign currencies comprising the SOMA are recorded at cost, on
a settlement-date basis, and adjusted for amortization of premiums or accretion of discounts on a
straight-line basis. Interest income is accrued on a
straight-line basis and is reported as “Interest on
U.S. government and federal agency securities” or
“Interest on foreign currencies,” as appropriate.
Income earned on securities lending transactions
is reported as a component of “Other income.”
Gains and losses resulting from sales of securities
are determined by specific issues based on average cost. Gains and losses on the sales of U.S.
government and federal agency securities are
reported as “U.S. government securities (losses)
gains, net.” Foreign currency denominated assets
are revalued monthly at current market exchange
rates in order to report these assets in U.S. dollars.
Realized and unrealized gains and losses on investments denominated in foreign currencies are
reported as “Foreign currency (losses) gains, net.”
Foreign currencies held through F/X swaps, when
initiated by the counter party, and warehousing
arrangements are revalued monthly, with the unrealized gain or loss reported by the FRBNY as a
component of “Other assets” or “Other liabilities,” as appropriate.
Balances of U.S. government and federal agencies securities bought outright, investments
denominated in foreign currency, interest income,
amortization of premiums and discounts on securities bought outright, gains and losses on sales of
securities, and realized and unrealized gains and
losses on investments denominated in foreign currencies, excluding those held under an F/X swap
arrangement, are allocated to each Reserve Bank.
Effective April 26, 1999 income from securities
lending transactions undertaken by FRBNY was
also allocated to each Reserve Bank. Securities
purchased under agreements to resell and unrealized gains and losses on the revaluation of foreign
currency holdings under F/X swaps and warehousing arrangements are allocated to FRBNY and not
to other Reserve Banks.
e. Bank Premises and Equipment
Bank premises and equipment are stated at cost less
accumulated depreciation. Depreciation is calculated
on a straight-line basis over estimated useful lives
of assets ranging from 2 to 50 years. New assets,
major alterations, renovations and improvements are
capitalized at cost as additions to the asset
accounts. Maintenance, repairs and minor replacements are charged to operations in the year incurred.
f. Interdistrict Settlement Account
At the close of business each day, all Reserve
Banks and branches assemble the payments due
10
to or from other Reserve Banks and branches as a
result of transactions involving accounts residing in
other Districts that occurred during the day’s operations. Such transactions may include funds settlement, check clearing and automated clearinghouse
(“ACH”) operations, and allocations of shared
expenses. The cumulative net amount due to or
from other Reserve Banks is reported as the
“Interdistrict settlement account.”
g. Federal Reserve Notes
Federal Reserve notes are the circulating currency
of the United States. These notes are issued
through the various Federal Reserve agents to the
Reserve Banks upon deposit with such Agents of
certain classes of collateral security, typically U.S.
government securities. These notes are identified
as issued to a specific Reserve Bank. The Federal
Reserve Act provides that the collateral security
tendered by the Reserve Bank to the Federal
Reserve Agent must be equal to the sum of
the notes applied for by such Reserve Bank. In
accordance with the Federal Reserve Act, gold certificates, special drawing rights certificates, U.S.
government and agency securities, loans, and
investments denominated in foreign currencies are
pledged as collateral for net Federal Reserve notes
outstanding. The collateral value is equal to the
book value of the collateral tendered, with the
exception of securities, whose collateral value is
equal to the par value of the securities tendered.
The Board of Governors may, at any time, call upon
a Reserve Bank for additional security to adequately collateralize the Federal Reserve notes. The
Reserve Banks have entered into an agreement
which provides for certain assets of the Reserve
Banks to be jointly pledged as collateral for the
Federal Reserve notes of all Reserve Banks in
order to satisfy their obligation of providing sufficient
collateral for outstanding Federal Reserve notes.
In the event that this collateral is insufficient, the
Federal Reserve Act provides that Federal Reserve
notes become a first and paramount lien on all the
assets of the Reserve Banks. Finally, as obligations
of the United States, Federal Reserve notes are
backed by the full faith and credit of the United
States government.
The “Federal Reserve notes outstanding, net”
account represents Federal Reserve notes
reduced by cash held in the vaults of the Bank of
$17,884 million and $9,343 million at December 31, 1999 and 1998, respectively.
h. Capital Paid-in
The Federal Reserve Act requires that each member bank subscribe to the capital stock of the
Reserve Bank in an amount equal to 6% of the capital and surplus of the member bank. As a member
bank’s capital and surplus changes, its holdings of
the Reserve Bank’s stock must be adjusted. Member banks are those state-chartered banks that apply and
are approved for membership in the System and all national banks. Currently, only one-half of the subscription is paid-in and the remainder is subject to call. These shares are nonvoting with a par value of $100. They
may not be transferred or hypothecated. By law, each member bank is entitled to receive an annual dividend
of 6% on the paid-in capital stock. This cumulative dividend is paid semiannually. A member bank is liable for
Reserve Bank liabilities up to twice the par value of stock subscribed by it.
i. Surplus
The Board of Governors requires Reserve Banks to maintain a surplus equal to the amount of capital paid-in as
of December 31. This amount is intended to provide additional capital and reduce the possibility that the
Reserve Banks would be required to call on member banks for additional capital. Reserve Banks are required
by the Board of Governors to transfer to the U.S. Treasury excess earnings, after providing for the costs of operations, payment of dividends, and reservation of an amount necessary to equate surplus with capital paid-in.
The Omnibus Budget Reconciliation Act of 1993 (Public Law 103-66, Section 3002) codified the existing
Board surplus policies as statutory surplus transfers, rather than as payments of interest on Federal Reserve
notes, for federal government fiscal years 1998 and 1997 (which ended on September 30, 1998 and 1997,
respectively). In addition, the legislation directed the Reserve Banks to transfer to the U.S. Treasury additional
surplus funds of $107 million and $106 million during fiscal years 1998 and 1997, respectively. Reserve Banks
were not permitted to replenish surplus for these amounts during this time. Payments to the U.S. Treasury
made after September 30, 1998, represent payment of interest on Federal Reserve notes outstanding.
The Consolidated Appropriations Act of 1999 (Public Law 106-113, Section 302) directed the Reserve
Banks to transfer to the U.S. Treasury additional surplus funds of $3,752 million during the Federal Government’s 2000 fiscal year. The Reserve Banks will make this payment prior to September 30, 2000.
In the event of losses, payments to the U.S. Treasury are suspended until such losses are recovered
through subsequent earnings. Weekly payments to the U.S. Treasury may vary significantly.
j. Income and Cost Related to Treasury Services
The Bank is required by the Federal Reserve Act to serve as fiscal agent and depository of the United States.
By statute, the Department of the Treasury is permitted, but not required, to pay for these services. The
costs of providing fiscal agency and depository services to the Treasury Department that have been billed
but not paid are immaterial and included in “Other credits.”
k. Taxes
The Reserve Banks are exempt from federal, state, and local taxes, except for taxes on real property, which
are reported as a component of “Occupancy expense.”
4. U.S. Government and Federal Agency Securities
Securities bought outright and held under agreements to resell are held in the SOMA at the FRBNY. An undivided interest in SOMA activity, with the exception of securities held under agreements to resell and the
related premiums, discounts and income, is allocated to each Reserve Bank on a percentage basis derived
from an annual settlement of interdistrict clearings. The settlement, performed in April of each year, equalizes Reserve Bank gold certificate holdings to Federal Reserve notes outstanding. The Bank’s allocated share
of SOMA balances was approximately 7.523% and 7.877% at December 31, 1999 and 1998, respectively.
The Bank’s allocated share of securities held in the SOMA at December 31, that were bought outright,
were as follows (in millions):
19 9 9
Par value:
Federal agency
U.S. government:
Bills
Notes
Bonds
Total par value
Unamortized premiums
Unaccreted discounts
Total allocated to Bank
$
14
13,279
16,435
6,243
35,971
684
(251)
$36,404
11
19 9 8
$
27
15,343
14,801
5,473
35,644
582
(252)
$35,974
Total SOMA securities bought outright were $483,902 million and $456,667 million at December 31, 1999
and 1998, respectively.
The maturities of U.S. government and federal agency securities bought outright, which were allocated
to the Bank at December 31, 1999, were as follows (in millions):
P A R
Maturities of Securities Held
U.S. Government
Securities
V A L U E
Federal Agency
Obligations
Total
Within 15 days
16 days to 90 days
91 days to 1 year
Over 1 year to 5 years
Over 5 years to 10 years
Over 10 years
$
348
6,916
10,522
9,341
3,845
4,985
$—
2
2
1
9
—
$
348
6,918
10,524
9,342
3,854
4,985
Total
$35,957
$14
$35,971
At December 31, 1999, and 1998, matched sale-purchase transactions involving U.S. government securities
with par values of $39,182 million and $20,927 million, respectively, were outstanding, of which $2,948 million and $1,648 million were allocated to the Bank. Matched sale-purchase transactions are generally
overnight arrangements.
5. Investments Denominated in Foreign Currencies
The FRBNY, on behalf of the Reserve Banks, holds foreign currency deposits with foreign central banks and
the Bank for International Settlements and invests in foreign government debt instruments. Foreign government debt instruments held include both securities bought outright and securities held under agreements to
resell. These investments are guaranteed as to principal and interest by the foreign governments.
Each Reserve Bank is allocated a share of foreign-currency-denominated assets, the related interest
income, and realized and unrealized foreign currency gains and losses, with the exception of unrealized gains
and losses on F/X swaps and warehousing transactions. This allocation is based on the ratio of each Reserve
Bank’s capital and surplus to aggregate capital and surplus at the preceding December 31. The Bank’s allocated share of investments denominated in foreign currencies was approximately 20.792% and 15.499% at
December 31, 1999 and 1998, respectively.
The Bank’s allocated share of investments denominated in foreign currencies, valued at current exchange
rates at December 31, were as follows (in millions):
German Marks:
Foreign currency deposits
Government debt instruments
including agreements to resell
European Union Euro:
Foreign currency deposits
Government debt instruments
including agreements to resell
Japanese Yen:
Foreign currency deposits
Government debt instruments
including agreements to resell
Accrued interest
19 9 9
19 9 8
—
$1,620
—
368
901
—
528
—
67
103
1,850
10
960
15
$3,356
$3,066
$
Total
Total investments denominated in foreign currencies were $16,140 million and $19,769 million at December
31, 1999 and 1998, respectively. The 1998 balance includes $15 million in unearned interest collected on certain foreign currency holdings that is allocated solely to the FRBNY.
12
The maturities of investments denominated in foreign currencies which were allocated to the Bank at
December 31, 1999, were as follows (in millions):
MATURITIES
OF
INVESTMENTS
DENOMINATED
IN
Within 1 year
Over 1 year to 5 years
Over 5 years to 10 years
$ 3,134
103
119
Total
$3,356
FOREIGN
CURRENCIES
At December 31, 1999 and 1998, there were no open foreign exchange contracts or outstanding F/X swaps.
At December 31, 1999 and 1998, the warehousing facility was $5,000 million with nothing outstanding.
6. Bank Premises and Equipment
A summary of bank premises and equipment at December 31 is as follows (in millions):
19 9 9
19 9 8
Accumulated depreciation
$ 16
116
35
3
234
404
(203)
$ 16
115
32
3
288
454
(253)
Bank premises and equipment, net
$201
$201
Bank premises and equipment:
Land
Buildings
Building machinery and equipment
Construction in progress
Furniture and equipment
Depreciation expense was $35 million and $44 million for the years ended December 31, 1999 and 1998,
respectively.
Bank premises and equipment at December 31 include the following amounts for leases that have been
capitalized (in millions):
19 9 9
19 9 8
Bank premises and equipment
Accumulated depreciation
$33
(19)
$86
(77)
Capitalized leases, net
$14
$ 9
The Bank leases unused space to outside tenants. Those leases have terms ranging from 1 to 2 years. Rental
income from such leases was $1.4 million for each of the years ended December 31, 1999 and 1998. Future
minimum lease payments under agreements in existence at December 31, 1999, were (in millions):
2000
2001
$1.1
0.9
$2.0
7. Commitments and Contingencies
At December 31, 1999, the Bank was obligated under noncancelable leases for premises and equipment
with terms ranging from 1 to approximately 5 years. These leases provide for increased rentals based upon
increases in real estate taxes, operating costs or selected price indices.
Rental expense under operating leases for certain operating facilities, warehouses, and data processing
and office equipment (including taxes, insurance and maintenance when included in rent), net of sublease
rentals, was $36 million and $37 million for the years ended December 31, 1999 and 1998, respectively. Certain of the Bank’s leases have options to renew.
13
Future minimum rental payments under noncancelable operating leases and capital leases, net of sublease rentals, with terms of one year or more, at December 31, 1999, were (in thousands):
O P E R A T I N G
C A P I T A L
$1,119
847
455
236
138
$1,158
692
344
55
—
$2,795
2,249
2000
2001
2002
2003
2004
Amount representing interest
Present value of net minimum lease payment
(123)
$2,126
At December 31, 1999, there were no other commitments and long-term obligations in excess of one year.
Under the Insurance Agreement of the Federal Reserve Banks dated as of March 2, 1999, each of the
Reserve Banks has agreed to bear, on a per incident basis, a pro rata share of losses in excess of 1% of the
capital paid-in of the claiming Reserve Bank, up to 50% of the total capital paid-in of all Reserve Banks. Losses are borne in the ratio that a Reserve Bank’s capital paid-in bears to the total capital paid-in of all Reserve
Banks at the beginning of the calendar year in which the loss is shared. No claims were outstanding under
such agreement at December 31, 1999 or 1998.
The Bank is involved in certain legal actions and claims arising in the ordinary course of business.
Although it is difficult to predict the ultimate outcome of these actions, in management’s opinion, based on
discussions with counsel, the aforementioned litigation and claims will be resolved without material adverse
effect on the financial position or results of operations of the Bank.
8. Retirement and Thrift Plans
Retirement Plans
The Bank currently offers two defined benefit retirement plans to its employees, based on length of service
and level of compensation. Substantially all of the Bank’s employees participate in the Retirement Plan for
Employees of the Federal Reserve System (“System Plan”) and the Benefit Equalization Retirement Plan
(“BEP”). The System Plan is a multi-employer plan with contributions fully funded by participating employers. No separate accounting is maintained of assets contributed by the participating employers. The Bank’s
projected benefit obligation and net pension costs for the BEP at December 31, 1999 and 1998, and for the
years then ended, are not material.
Thrift plan
Employees of the Bank may also participate in the defined contribution Thrift Plan for Employees of the Federal Reserve System (“Thrift Plan”). The Bank’s Thrift Plan contributions totaled $5 million and $3 million for
the years ended December 31, 1999 and 1998, respectively, and are reported as a component of “Salaries
and other benefits.”
9. Postretirement Benefits Other Than Pensions and Postemployment Benefits
Postretirement benefits other than pensions
In addition to the Bank’s retirement plans, employees who have met certain age and length of service
requirements are eligible for both medical benefits and life insurance coverage during retirement.
The Bank funds benefits payable under the medical and life insurance plans as due and, accordingly, has
no plan assets. Net postretirement benefit cost is actuarially determined using a January 1 measurement date.
Following is a reconciliation of beginning and ending balances of the benefit obligation (in millions):
19 9 9
19 9 8
Accumulated postretirement benefit obligation at January 1
Service cost-benefits earned during the period
Interest cost of accumulated benefit obligation
Actuarial (gain)/loss
Contributions by plan participants
Benefits paid
$ 67.2
2.1
4.0
(7.5)
0.3
(2.3)
$ 54.1
1.8
3.9
9.3
0.3
(2.2)
Accumulated postretirement benefit obligation at December 31
$ 63.8
$ 67.2
Following is a reconciliation of the beginning and ending balance of the plan assets, the unfunded postretirement benefit obligation, and the accrued postretirement benefit cost (in millions):
19 9 9
19 9 8
Fair value of plan assets at January 1
Actual return on plan assets
Contributions by the employer
Contributions by plan participants
Benefits paid
$
—
—
2.0
0.3
(2.3)
$
—
—
1.9
0.3
(2.2)
Fair value of plan assets at December 31
$
—
$
—
Unfunded postretirement benefit obligation
Unrecognized prior service cost
Unrecognized net actuarial (loss)
$ 63.8
0.7
(5.0)
$ 67.2
0.7
(12.7)
Accrued postretirement benefit cost
$ 59.5
$ 55.2
Accrued postretirement benefit cost is reported as a component of “Accrued benefit cost.”
The weighted-average assumption used in developing the postretirement benefit obligation as of December 31, 1999 and 1998 was 7.5% and 6.25%, respectively.
For measurement purposes, an 8.75% annual rate of increase in the cost of covered health care benefits
was assumed for 2000. Ultimately, the health care cost trend rate is expected to decrease gradually to 5.50%
by 2006, and remain at that level thereafter.
Assumed health care cost trend rates have a significant effect on the amounts reported for health care
plans. A one percentage point change in assumed health care cost trend rates would have the following
effects for the year ended December 31, 1999 (in millions):
1 PERCENTAGE
POINT
Effect on aggregate of service and interest cost
components of net periodic postretirement benefit cost
Effect on accumulated postretirement benefit obligation
INCREASE
$ 1.5
11.3
1 PERCENTAGE
POINT
DECREASE
$(1.1)
(9.3)
The following is a summary of the components of net periodic postretirement benefit cost for the years
ended December 31 (in millions):
19 9 9
19 9 8
Service cost-benefits earned during the period
Interest cost of accumulated benefit obligation
Recognized net actuarial loss
$2.1
4.0
0.2
$1.8
3.9
—
Net periodic postretirement benefit cost
$6.3
$5.7
Net periodic postretirement benefit cost is reported as a component of “Salaries and other benefits.”
Postemployment benefits
The Bank offers benefits to former or inactive employees. Postemployment benefit costs are actuarially
determined and include the cost of medical and dental insurance, survivor income, and disability benefits.
Costs were projected using the same discount rate and health care trend rates as were used for projecting
postretirement costs. The accrued postemployment benefit costs recognized by the Bank at December 31,
1999 and 1998, were $10.1 million and $8.8 million, respectively. This cost is included as a component of
“Accrued benefit cost.” Net periodic postemployment benefit costs included in 1999 and 1998 operating
expenses were $2.0 million and $1.9 million, respectively.
15
FEDERAL RESERVE BANK
OF RICHMOND
SUMMARY OF OPERATIONS
DOLLAR
(UNAUDITED)
AMOUNT
1 9 9 9
1998
VOLUME
1 9 9 9
1998
Cash
Currency received and counted
39.3 Billion
30.9 Billion
3.3 Billion
2.5 Billion
6.8 Billion
7.0 Billion
638.9 Million
609.5 Million
55.0 Million
71.5 Million
1.3 Trillion
1.2 Trillion
1.7 Billion
1.6 Billion
574.9 Billion
494.2 Billion
837.8 Million
783.2 Million
45.7 Billion
62.2 Billion
30.6 Million
35.7 Million
Commercial
789.4 Billion
650.5 Billion
226.3 Million
178.0 Million
Government
368.1 Billion
347.3 Billion
3.7 Million
17.8 Million
18.7 Trillion
10.3 Million
9.9 Million
Currency destroyed
Coin bags received and counted
84.6 Thousand 124.5 Thousand
Noncash Payments
Commercial checks processed
Commercial checks,
packaged items handled
U.S. government checks processed
Automated Clearing House
transactions:
Fedwire funds transfers
18.9 Trillion
Loans to Depository Institutions
Discount window loans made
2.8 Billion
2.0 Billion
241.4 Billion
278.0 Billion
146
39
N/A
N/A
Securities Services
Safekeeping balance of book-entry
securities as of December 31
Fedwire securities transfers
16.5 Trillion
10.1 Trillion
855.5 Thousand 674.9 Thousand
Services to U.S. Treasury and Government Agencies
Issues, redemptions, and exchanges
of U.S. savings bonds
776.5 Million
760.2 Million
Federal tax deposits processed
236.9 Million
239.8 Million
Food stamps redeemed
513.8 Million
902.7 Million
N/A = not applicable
16
6.5 Million
9.2 Thousand
106.0 Million
8.8 Million
10.9 Thousand
176.1 Million
Editor: Elaine M. Mandaleris
Managing Editor: Alice Felmlee
Design: Communication Design, Inc.
Designer – Laura Petta
Feature Article Photography:
Euro currency – ©TSM/Firefly Productions, 1999
U.S. currency – Mark Mitchell Photography
Special thanks to Faye Ball and Rebecca Martin for
editorial and production assistance. Also, we are grateful
to Laura Fortunato, Nita Jones, and Lisa Oliva for
editorial comments, to Claudia MacSwain for providing
information on the Year in Review, and to Susan Saavedra
for providing support on the financial section.
For additional print copies, contact the Public Affairs
division, Federal Reserve Bank of Richmond, P.O. Box 27622,
Richmond, VA 23261.
@FedFRASER