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synchronize The Federal Reserve B a n k of St. L o u i s 1 999 A n n u a l Report C a u s e to o c c u r at t h e s a m e t i m e or r a t e of s p e e d THE F EDERAL RESERVE RANK OF ST. LOUIS The F e d e r a l R e s e r v e R a n k of St. Lo ui s is one o f 12 r e g i o n a l R e s e r v e R a n k s , w h i c h t o g e t h e r w i t h t he R o a r d o f G o v e r n o r s , ma ke up t he n a t i o n ’ s c e n t r a l b a n k . The F e d c a r r i e s out U. S. m o n e t a r y p o l i c y , r e g u l a t e s c e r t a i n d e p o s i t o r y i n s t i t u t i o n s , p r o v i d e s w h o l e s a l e - p r i c e d s e r v i c e s to b a n k s and a c t s as f i s c a l a g e n t f o r t he U. S. T r e a s u r y . The St. L o u i s Fed s e r v e s the Ei g h t h F e d e r a l R e s e r v e D i s t r i c t , w h i c h i n c l u d e s al l o f A r k a n s a s , e a s t e r n M i s s o u r i , s o u t h e r n I n d i a n a , s o u t h e r n I l l i n o i s , w e s t e r n K e n t u c k y , w e s t e r n T e n n e s s e e and n o r t h e r n M i s s i s s i p p i . R r a n c h o f f i c e s are l o c a t e d in Li t t l e R o c k , L o u i s v i l l e and M e m p h i s . T he front cover of this year's annual report s u g ges ts an am bitio us goal: better synchron ize the Federal Reserve and the financial markets. to Just as trapeze artists display a mastery of timing and co m m u n ica t io n to achieve an outstand in g acrobatic feat, the Fed and financial markets could use similar skills to achieve an o u t sta nd in g e c o n o m ic feat. W h a t w ou ld such a feat require? Ideally, that the Fed and the financial markets receive the same information at the same time and interpret it the same way. The first part is easy. For all practical purposes, the markets and the Fed do receive the same data at the same time. Deve lo pin g a c o m m o n interpretation, t h o u g h , is not so easy. The impa ct of such a synch ron izatio n w ould be significant. The print, broadcast and electronic media speculatio n that occurs before each mee ting of the Federal Open Market C o m m i t t e e ( F O M C ) w o u ld become less intense. The media w o u ld concentrate on interpreting the data, rather than on interpreting the Fed. The decreased news co ve rage w ou ld , however, be the least im portan t c o n s e q u e n c e of a syn ch ron iz e d financial system. Most important w o u ld be the impact that closer s y n ch ron iza tio n w o u ld have on businesses and households. The markets and the Fed w o u ld both co ncentra te on the difficult task of u n d e rsta n din g the flo w of information, with all its inherent uncertainties and am biguitie s. Because of the difficulty of this task, the Fed's and the markets' interpretations w ou ld not alw ays be correct, but they w o u ld be close to one another. Businesses and household s, therefore, w o u ld not make mistakes because of their m is u n d ers ta n d in g of the Fed's intentions and interpretations. In this report, we'll first take stock of the inefficiencies that arise in the present day w hen the Fed and the markets are operating on different w a v e le n g th s . We'll then co nsid er w h a t w e at the St. Louis Fed believe can be done to bring ab o ut greater s ynchrom city with financial markets. Finally, we'll look at some of the steps that are already under w a y to improve synchronicity. P R E S I D E N T ’ S M E S S A G E Th is report was ad apted from two spe ech es d e liv e re d by W illiam Poole: " Syn ch in g, Not S in kin g , the M arkets" and "C o m m u n ica tin g the S ta n ce of M onetary Policy." The o p in io n s ex p re sse d here are not n e ce ssa rily those o f the Federal R eserve System . T H his year's annual report highlights the need for greater synchronicity between the Federal Reserve and financial markets. By greater synchronicity, I mean a greater understanding of each other's expectations, interpretations and actions. The Fed has long had a large staff devoted to deepening its understanding of how markets are likely to respond to monetary policy actions, or lack thereof. Over time, the Fed has also increasingly recognized how important it is that the markets understand how monetary policy is conducted. After all, for the Fed to understand the market, the Fed must also understand the market's expectations about monetary policy. Clearly, both the market and the Fed have a prob lem if the market's expectations do not match the Fed's intentions. All the attention to the stance of monetary policy is perfectly understandable: There's an awful lot of money at stake in today's financial marketplace. There is, therefore, an intense— and completely proper— public interest in correctly understanding the monetary policy making process. And since the ones who know the most are the ones most directly involved in this process, S U S A N policy-makers like myself often find people hanging on our w i l l i a m S. E L L I O T T , p o o l e , C H A I R M A N , p r e s i d e n t a n d AND c e o every word. We policy-makers are the ones responsible for providing as much information as we can. In fact, what is at stake is more a matter of knowledge than of information. The public needs to understand how and why policy is made, and not just the specifics of particular policy actions. While I'm all for the increased communication that greater synchronicity demands, there are limits to what FOMC members can say. Political accountability and economic efficiency require that the FOMC disclose as much as possible without damaging the integrity of the decision-making process upon which sound policy depends. If, for example, FOMC meetings were broadcast live on C-SPAN, the entire nature of the policy deliberations would be changed. Some critically important issues could not be discussed freely and openly, and others would not be raised at all. While the FOMC's delib erations can't be found on cable TV, they are available to the public in transcript form, with a lag of about five years. The goal for us at the Fed is, I believe, to strike a balance— to communicate as much as we are able as clearly as we can without sacrificing the candor and completeness that policy-making discussions require. A daunting task, to be sure, but one that's worthy of our best attempt. This report is dedicated to that goal. OUR CURRENT, Different views IMPERFECT and different SYSTEM interpretations the biggest are obstacles W ' hen the Fed and the markets are out of synch, policy act ions taken by the F e d D I F F E R E N T I NFORMATION The reality is that the markets and the Fed do eral Open Market C o m m i t t e e can ge ner at e large not have exactly the same i nf ormati on. market responses. inf ormati onal dif ferences are minor, they do exist. These market responses reflect While errors in expectat ions of policy moves, which can In individual markets, the participants themselves lead to resource mi sal l ocat ion by i ndi vi dual s and often have more c ompl et e and timely i nformati on w H H busi nesses alike. But while c han ge s in policy direction are not necessarily u nd es i ra b le — policy o u g h t to c h a n g e if it has drifted off co ur s e— large fl uctuations j in market prices f o l lo wi n g policy actions i ndicate that the markets and the Fed are not o pe ra ti ng on the same page. A lack of s y n chroni ci ty can be due to one of three factors: either the market and the Fed are op er ating on the basis of different i n f o r mation, they have different views about w ha t the i nformati on means, or they have diff erent views about the policy objectives. than the Federal Reserve does. The Fed attempts to c omp ens at e for its ma rk et - by -m ar ke t d i s a d v a n tage by carefully a na ly z in g statistical i nformati on and by co ll ecti ng as much anecdotal informati on about markets as possible t hr ough its cont act s with business and labor leaders, fi nancial analysts and many others. When it comes to agg rega te information, however, the Federal Reserve likely has some i nf ormati onal a dv an ta g e over market participants. The Federal Reserve is one of the l argest and most skillful data collection and processing orga ni zat ion s in the world. While everyone receives the raw d at a— such as the e mpl oyment report— at about the same time, the Fed's army of economists is no doubt able to extract additional i nformation from the available data. What is the i mpl ic ati on of the Fed's i nf orma ti ona l a d v a nt a g e on b ig - pi c tu r e data? The Fed will some- INSIDE AN FOMC MEETING T h e f o c a l p o i n t o f e v e r y F O M C m e e t i n g is t h e f i n a l v o t e o n t h e i n t e n d e d f e d e r a l f u n d s r at e t a r g e t , w h i c h o c c u r s at t h e m e e t i n g ' s e n d . To r e a c h t h i s d e c i s i o n , c o m m i t t e e m e m b e r s hear staf f b r ie f i n g s , e x a m in e data that have arrive d since the last m e e tin g and de lib e rate a b o u t the a p p ro p r ia te m o n etary policy stance. Before every FOMC meeting, Board staff and Reserve Bank staff brief the governors and Bank presidents on economic news since the last meeting. These briefings differ among Reserve Banks, depending on each bank's traditions and each bank president's background. Every briefing, however, includes a discussion of what the incoming news implies for the mone tary policy stance. The Board staff prepares and circulates regular briefings and, before each FOMC meeting, the Greenbook and the Bluebook. The Greenbook contains the economic forecast for the next year or two; the Bluebook includes a summary of open market operations and financial market developments, as well as a discussion of policy options. FOMC meetings usually begin at 9 a.m. on a Tuesday morning with presentations to the committee from the inter national and open market desks at the New York Fed. After a discussion period, Board staff members present the key elements in the Green book forecast. Committee members then offer their views about the state of the economy and whether they think the incoming news has shifted their opinions about the appropriate monetary policy stance. Of course, FOMC members may have different interpretations of the incoming data flow and the appropriate policy responses. In fact, the policy implications of a particular event are rarely perfectly clear. Although economic theory provides tremendous guidance, it does not provide calculations out to the second decimal place. action is unclear. Indeed, sometimes even the appropriate direction of policy Nevertheless, it is insightful to think about policy as if there is some correct policy response to each new piece of information that comes along, and that the aim of the central bank is to dial in that response in a timely fashion. After this first discussion round, a staff member who helped prepare the Bluebook provides a briefing on f inan cial markets, the monetary aggregates and policy options. policy stance in a second go-around. Committee members then state their views about the The committee often discusses at length what to say publicly about the probable, or possible, future policy direction. The aim is always to determine the most constructive thing to say to make policy more effective and not to confuse— even inadvertently— the markets. the key decision: the fed funds rate target. Finally, a vote is taken on times act or not act on the basis of this a d v a n tage, taki ng the markets by surprise. Under normal circumstances— meaning that there are no special factors upsetting financial markets— the committee faces four types of si t Such cases probably explain many routine, relatively small, market reactions to FOMC policy actions. uations, reflecting different combinations of i nfl a tion and economic outcomes. Suppose that both inflation and output have come in above expecta The bottom line on i nformati on about the e c o n omy is that differences in the market's and the tions and are projected to continue that way over the short term. In such a situation, no one will be calling for a lower fed funds rate target. But Fed's i nformati on sets do exist, but they are a minor issue. even in this case, members will differ in their projections and the certainty with which they are held, so typically there will be some sentiment for D I F F E RE NT VIEWS ABOUT WHAT raising the target and some for awaiting further THE I NFORMATION MEANS developments. The case in which both inflation An ot he r way the markets and the Fed can and real growth have come in below expectations is parallel: No one will want to raise the target. The discussion will revolve around whether to lower the fed funds rate target at the meeting, or wait for further information. The difficult be out of step is in how they interpret the same informati on. For example, suppose that the Fed t hi nks econ omi c condi ti ons are s o f t e n cases are those in which inflation comes in above ing and that lower interest rates are a p p r o expectations, while output comes in below, or priate. vice versa. time, it is usually because economists have mis judged the economy's underlying growth poten tial. Believing that only modest stimulus is If such situations go on for a long In the 1 990s, for example, inflation has, required, the Fed lowers the intended, or tar get, federal f unds rate by one-quar ter of a percentage point. The market, however, might on average, come in expectations, while conc lude that the cut is the first of several. the real economy Based on this belief, the market bids longer- has surprised almost everyone on the upside. term rates, i ncludi ng the mo rt ga g e rate, down by, say, half of a per cent age point. The Fed f inds that the stimul us to econ omi c activity is greater than i ntended, and, in a f ew months, it reverses the original rate cut. Longer-term i nter tive time frames. C o nf u si o n may arise, however, est rates rise, and the market is tho rou gh ly c o n because the Fed does not have a speci fic inflation fused about the Fed's intentions. objective. A g ai n , purely hypothetically, assume the market The objective is that i nflation should be low and steady, but market part icipant s are interprets the Fed's initial cut in the intended fed left guessi ng as to exactly what level or range the f unds rate as temporary. In this case, longer-term Fed regards as a ccept able at a given point in time. The Fed discovers that When it comes to e co n om ic gr ow th , however, rates move little, if at all. it has not provided e nough stimulus to the e conomy the Fed is unable to set a speci fic o bj ect i ve — say, and, in a few months, cuts the federal f unds rate 3 percent. agai n. output near its potential. Longer-term interest rates eventually fall, but valuabl e months have been lost. In both examples, the lack of synchronicity Here, the Fed can only attempt to keep The growth of potential is determined by labor force growth and productivity growth, both of which are beyond the Fed's control. between the markets and the Fed has resulted in Because potential gr owth is not a Fed target, it ineffi cienci es that adversely affect the economy. is probably not wise for the Fed to e mp ha si z e a specific numerical esti mate of potential growth. D I F F E R E N T VIEWS ABOUT Indeed, different pol ic y-ma ker s have different POLICY OBJECTIVES estimates of potential gr owth. A final way the markets and the Fed can be out of Nevertheless, Fed officials have helped to s t rengt hen publ ic u n de r synch is in the different views they have about the s tandi ng of these important issues by of feri ng prevailing policy objectives. analyses of e mp loymen t and product ivi ty growth. one of three areas: This conf usi on occurs in in the Fed's objectives for i nf l a Uncertainty about which of the Fed's objectives— tion, in its objectives for economi c growth or in its inflation or economic g r o w t h — is most important at percepti ons of the interplay between the two. any given time adds to the co nf u si o n a bout policy When it comes to infl ation, the Fed has the objectives. For example, if ou tpu t gr ows more rap ability to choose an objective from a wide range of idly than e xp ec te d — as we' ve seen during the last options, i n c lu d i ng alternative indexes and a l t e r n a four years— the public cannot be sure whether the Fed will raise the fed funds target to prevent inflation or whether the Fed will raise its forecast of the growth in Gross Domestic Product (GDP). In 1999, the Fed both a c k n o w l e d g e d the increase in labor productivity g r o w t h — s u g ge s ti n g that perhaps the FOMC's out put objective had been raised— and raised the fed f unds rate target. T ■ he gai ns to the In any of the three cases, the lack of clarity about policy objecti ves can lead to inef fi ciency e c on omy of a s us t a i ned and a lack of synchronicity. Our current system, then, is ch arac te ri zed by Fed poli cy to f os t er l ow incomplete sy n ch r on iz at io n of the Fed and the markets. The i nc omp le te nes s reflects, to a small degree, diff erences in i nformati on. i nf l at i on are mani fest . Different interpretations of i nf orma ti on and different views on policy objecti ves are more i mportant. The task r e ma i ni ng The next section of this report descri bes the St. Louis Fed's proposal for ad dres si ng both of is for the Fed to make these reasons for i nc omp le te s yn ch ron iz at io n. its i nf l at i on obj e ct i ve more precise. O ne important step the Fed could take in pro index. moting greater synchronicity between itself provide a benchmark that would help put the cur An explicit multi-year objective would and the markets is to clarify its long-term policy rent policy situation in a longer-term perspective. objective. Al th ou gh there has been a growing c o n This is quite unlike the current situation in which sensus that price stability— a low and steady inflation each FOMC member has an individual view about rate— is the primary goal of monetary policy, the the operational definition of price stability. There objective remains rather vaguely defined. is no overall objective that has been adopted to The Fed also— as much as possible given the price stability represent the consensus view. goal— acts to stabilize the empl oyment and output members may define price stability as 0 percent levels. While these goals may appear to be c onf l i ct inflation, based on the GDP chain price index, ing at a particular moment in time, experience and some may define it is as 2 percent inflation in the developments in macroeconomi c theory have taught Consumer Price Index (CPI), and still others may us that the trade-off between empl oyment and infla not have a precisely defined view. tion is temporary at best. bers are likely to differ in their assessments about Indeed, attempts to lower unemployment by al lowi ng inflation to rise have For example, some Also, mem the probability of rising inflation or a recession. Individual members form their own views of the objectives and the current state of the economy research at the Federal Reserve Bank when deciding how to vote at FOMC meetings. of St. Louis shows that, even if there were a short- The nature of the committee process means that run trade-off between inflation and output, the the FOMC's objectives— as a body— are not clearly adoption of an operational goal for long-term price defined. stability would e nhance the FOMC's ability to st abi the committee can lead to subtle changes in the lize these measures. actual monetary policy objectives. What do we mean by an opera ti on al goal for long-term price stability? We mean choosi ng a spe cific number or a narrow range for a particular price Furthermore, changes in the makeup of To see why clarification of the long-term o b j e c tive is important for bri ngi ng about improved s yn chronicity, consider the information problem that THE FED FUNDS FUTURES MARKET: S Y N C H E D WITH THE FOMC? No one, i n c l u d i n g the Fed, knows what ma r k e t i n t e r e s t r at es wi l l be. i n h e r e n t u n c e r t a i n t y , ma r k e t s have e me r g e d . In the f a c e of such One of t hes e is the f e d e r a l f u n d s f u t u r e s mar k e t . Federal funds futures are contracts traded on the Chicago Board of Trade. The dollar amounts traded are large— the trading unit is $5 million. All contracts mature on the last business day of a future month. The price at which a contract trades depends on market participants' expectations of the daily average federal funds rate in the matu rity month. The higher the funds rate at maturity, the lower the final value of the contract. Before maturity, the contract price fluctuates as market THE MARKET FAILS TO ANTI CIPATE POLI CY ACTI ONS participants receive new information. Purchased contracts can only be closed out prior to maturity by selling an off setting contract of equal trading units and maturity at the prevailing market price of the contract, and vice versa. > _ The market rate for fed funds Q J Q . * -> futures incorporates market partici C 0 1 u 1 0 ) Q _ pants' estimate of future FOMC policy decisions. At each FOMC meeting, the committee issues a directive, which specifies a target for the federal funds rate, to the New York Fed's open mar ket desk. The "Desk" then conducts open market operations— buys and 5.75 5.50 September 1994 Federal Funds Futures Rate 5.25 * 0 2 5.00 0 ) 4.75 0 1 the actual federal funds rate in close lished by the FOMC. The Desk is gen erally quite skilled at minimizing the C 0 1 u sells government securities— to keep proximity to the target rate estab V i_ CL Aug. 16, 1994 FOMC Meeting differences between the actual federal 4.50 funds rate and the target specified by C L FOMC Intended Federal Funds Rate 4.25 4.00 the FOMC. In fact, on a monthly aver age basis, the actual fed funds rate is very close to the target set by the 3.75 FOMC. Thus, the price at which fed NOTE: The data cover the period 30 days before to 30 days after the date of the FOMC meeting. SOURCE: Future Yields, The Wall Street Journal; Intended Federal Funds Rate, Board of Governors eral funds futures trade reflects mar ket participants' best guess as to what the FOMC will do with the federal funds rate target in future months. the market would have to solve when the policy objective is explicit and policy is " p e r fect." Policy would be perfect if the markets Market participants sometimes anticipate the and the Fed had a common understanding of FOMC's action on the fed funds target correctly, and sometimes not. An example of the latter occurred in July 1 992. three things: the interpretation of new information and the ing, the FOMC announced that it reduced the f ed eral funds rate target from 3.75 percent to 3.25 percent. the monetary policy objectives, At its July 1, 1 992, meet policy actions required to achieve the ob je c Before the meeting, the August funds tives in light of the new information. rate futures contract traded somewhat below the old target level of 3.75 percent. As the top In these circumstances, securities prices, for example, chart shows, when the change in the target was would respond to the new information itself announced, the yield on the July futures contract and not to the Fed's policy decisions. quickly dropped down near the new target level. In this case, it appears that the change in the fed Each policy decision would be an implication of funds target was not widely anticipated, taking the new information. market participants by surprise. At other times, however, the market is deadon in its anticipation of FOMC actions. the state of the economy is inherently u npr e In August dictable and, therefore, naturally takes the 1994, for example, market participants appeared to anticipate the FOMC decision well in advance of the committee's meeting. markets by surprise. At the Aug. 1 6, 1994, Some surprises would be larger; most would be small. meeting, the FOMC announced that it increased But, ideally, Fed policy actions would not be surprises at all; the fed funds rate target from 4.25 to 4.75 per cent. New information on Before the meeting, the September funds given the new information, the market would rate futures contract traded slightly below the new target level of 4.75 percent. know what policy action to expect. As the bottom chart shows, when the change in the target was Even if perfect policy existed, we would still announced, the yield on the September futures contract changed only slightly. have much disagreement about how the world In this case, it appears that the change in the target was widely works. anticipated as early as mid-July, and market par Markets would not know for sure how a given piece of news would affect the short-run ticipants were not surprised by the FOMC's action. path of inflation, or whether it would trigger If the Fed and the markets were better synchro nized, we'd see participants in the fed funds futures a change in the Fed's policy stance. Opinions market make successful predictions like this more about these short-run matters would differ, but often than not. I I markets would kn ow the long-term price objective, condi ti ons would normally require an increase in and the objective would not ch an ge because of that the fed f unds rate target. news, or the Fed's short-term reaction to it. FOMC did not raise the fed f u nd s rate target in 1996, the interest rate on one -yea r Treasury bills Now suppose that the price stability objective is vaguely stated, as it is now. But even t ho u gh the rose a full per cent age point in the first half of the Market participants do not kn ow whet her price stability means 3 per year. A l t h o u g h the strong e c on o mi c gr owt h has cent i nflation in the CPI, as we experi enced from conti nued into 20 00, the 1996 increase in inflation 1991 to 1996, 2 percent inflation as we have seen proved to be only temporary. If the price stability objective were more specific over the last three years, or 0 percent i nf l at io n — after a l low in g for measurement errors in price and credible, the Fed wou ld also not have to raise i ndexes— as representatives of this bank have rec the fed funds rate target as much to l ower i nfl a ommended. tion expectations. Wi th ou t a precise l ong-term objective, Wh at the Fed wou ld have to markets not only have to f igure out how incoming do with the t arget to achi eve its infl ation o b j e c - y informati on affects the short-run infl ation path and tive depends both on how st ron gl y people believe the probability of future FOMC policy acti ons, they the Fed is commi tt ed to price stabil ity and on what also must decide how all of this will affect the sort of e con om ic d is tu rb an ce s occur. long-t er m objective. disturbances, such as d r ou g ht s and oil price shocks, If people believe the Fed is commi tted to price E conomi c will cause t emporary f l u c tu a ti o ns in price indexes. stability, market interest rates would do much of Pol icy-makers ca nn ot prevent such f l uc tu at io ns , nor the st ab il i za ti on work. should they wa nt to. If the public truly believes Wh at they shoul d do is pre that the Fed wou ld do whatev er is necessary to vent these t emporary events from c h a n g i n g people's achieve its l on g- ru n objective in response to a longer-term i nflation e xp ec tat io ns . pot ent ial ly i nf lat iona ry shock, the Fed may not have cian whose first responsi bil ity is to do no harm, to do a n yt hi n g or, at least, not anythi ng quickly. the FOMC shoul d avoid d e s ta b il iz i ng the economy D uri ng 1996, for exampl e, news about e co n om ic by al l owi ng erratic c ha n g e s in expected inflation. p er f or ma n ce and i nfl ation exceeded market part ic i A l t h o u g h the Fed does not have direct control over pants' e xp ec tat io ns . m o n th - t o- m on t h c h a n g e s in the i nfl ation rate, it Such a c h an ge in e co n om ic A Like the physi could help stabilize and s yn ch ron ize the process by choosing a l ong-run infl ation target. A central bank that has credi bi lity in m a i n t a i n ing long-term price stabil ity also has more f l e x i bility in dealing with short-term problems, such as financial crises and recessions. Cred ibi l it y is an asset that pays high divi dends. When the Fed— responding to f i nan ci al d is rupti ons f o l l o w ing the crisis in the Russian bond m a rk et — l o w L ike the physi ci an wh o s e fi rst r e s pon s i b i l i t y ered the fed f u nd s t ar ge t in the fall of 1998, the markets' exp ec ta ti ons of co nt i nu e d low i nflation remained rock solid. In a not her era, the Fed is to do no harm, the might not have lowered the fed fu n ds target in such a situation for fear that many might have FOMC s houl d avoi d interpreted the action as an indi cat ion that the Fed was s of te ni ng its resolve to control i nflation. d e s t a b i l i z i n g the Low inflation and high credi bi lity e nh an ce the Fed's range of opt ion s in t a ki ng policy acti ons e c o n o my by a l l o w i n g in the face of unusual ci rc umst an ce s. The gains to the e c on o my of a sust ai ned Fed policy to foster low inf lat ion are manifest. The erratic c h a n g e s in task remaining is for the Fed to make its i nflation objective more precise. e x pec t ed i nf l at i on. ' ithout clear objecti ves, the task of g e t W tion about the economy that surprises markets will ting the markets and the Fed in synch is typically surprise the FOMC, as well. ferent considerations have to be f ol ded into policy the markets on the same page with the Fed. decisions. too, does the FOMC's release of information. enormously difficult, especial ly since so many d i f The track record of FOMC actions also helps put For exampl e, at any given time, there So, Since might be six i mpor tant c o ns i de r at io n s that point February 1994, the FOMC has announced changes toward policy easing and four that point t oward in the fed funds target the same day that the d ec i policy tig hte ni ng. sions were made. The FOMC must w ei gh c o m p e t Six or seven weeks later— a few ing considerations, a cc o un t for data i nac curac ies days after the next scheduled meeti ng— the FOMC and determine w he th er markets have already then releases the minutes of the previous meeting. responded to the f low of i nf or mat ion , ma ki ng a These minutes reveal the topics discussed, s u m ma Fed response unnecessary. rize views about the state of the economy and describe the reasons for dissenting votes. That said, the markets and the Fed have made The min great progress in recent years toward synchronicity. utes are t horough, which provides an important Market participants i nc re as in gl y possess a deep vehicle for keeping the markets and the public unde rs ta nd in g of monet ary policy. H wel l-inf or med about Fed thi nki ng. In fact, T hr ough congressi onal testimony, speeches, much of the time, the Fed and the markets articles in Fed publ ications and other ways, Fed are in close a g r ee m en t ab ou t wha t policy officials make every effort to keep the public acti ons are required to keep the econ| M m \ \» omy on a steady course. informed. Fed policy- about Fed vagueness, the i nformation flow is, in makers and market part ic ip an ts also m V fact, substantial. use simil ar theori es and data to Much of this v agueness is i nher ent in the difficulties of deal ing with imperfect form their shor t-t erm expectations. A lt ho u gh it is c ommonpl ace to joke i nformati on. So, i n c o m in g i n f o r m a A The accuracy of Fed e conomi c fore- P O LICY FAILURES: WHEN THE FED AND THE MARKETS WERE NOT IN SYNCH The r i se of i n f l a t i o n in the p o s t - Wo r l d War II pe r i od is one of the mos t d r a m a t i c e x a m p l e s of mo n e t a r y p o l i c y f a i l u r e in U.S. hi st or y. P o l i c y - m a k e r s a l l o w e d i n f l a t i o n to a c c e l e r a t e to such a hi gh r at e t hat pol l s of U.S. v o t e r s s howe d i n f l a t i o n to be the No. 1 p r o b l e m in t he c ount r y. T h r o u g h o u t the 1 9 6 0 s and 1 970s , Fed p o l i c y - m a k e r s and ot her g o v e r n m e n t l e a d e r s s a i d t hey wer e f i g h t i n g i n f l a t i o n , yet i n f l a t i o n g r e w h i g h e r wi t h each b u s i n e s s c yc l e. MAJOR P OL I C Y C O R R E C T I O N S C O N F U S E M A R K E T S '60s low and positive real rates '80s high real rates '70s negative real rates October 19 79 M Policy Chan g e f 1 2 k. 0 1 CL / 1 I ■> * c 0) u 1 — V Q . ' A jf— l i t " ! l ^ 1960 \t\ / 7 A x 1 ^ \ J \ ^ \ / V A \ 1 | \y l, 1 1 1 f 1 1 I r K 1 i t 1 i 1 i 1 * J V 1 1 1 A\ ! ,Si1 1, jr i i i! i i i1 i i1 1 l 'i1 l IsT I # I i I iI iT—i— 1 K \ \ .7 V Actual Real Rate of Return -------- 1956 if * X \1 ir 1964 1968 \ 7 1972 Expected Real Rate of Return 1976 1980 1984 1988 1992 1996 NOTES: The chart shows real interest rates from 1956 to 1999. The actual real rate of return is the yield on the one-year Treasury bill in January, minus the CPI inflation for that year. The expected real rate of return is the same T-bill yield, minus the expected inflation as reported in the University of Michigan's Surveys of Consumers for that year. SOURCE: U.S. Treasury, Bureau of Labor Statistics; University of Michigan, Surveys of Consumers During the 1960s, there was a long-term rise in both inflation and market interest rates: Inflation rose from under 2 percent to about 5 percent, while the one-year Treasury bill rate rose from about 3 percent to 8 percent. The accompanying chart shows the expected real rate of return and the actual real rate of return on an invest ment in a one-year Treasury bill. inflation. Such "real" interest rates are a measure of market interest rates, adjusted for When the expected real rate of return is greater than the actual real rate of return, borrowers benef i t at the expense of lenders, and vice versa. As the chart shows, real interest rates during the '60s were rather low, but generally positive. In August 1971, the U.S. government adopted a comprehensive package of wage and price controls in an attempt to stem the rising tide of inflation. The markets no doubt expected the Fed to go along with the program. however, allowed rapid money growth to continue. The Fed, casts, for example, is limited by the same lack of knowl ed ge in the discipline of economics that affects everyone else's forecasts. While the price controls caused a temporary lull in the reported inflation rate, by 1973, severe In the Fed, and certainly in this Reserve Bank, shortages in many markets brought both an end to interest in disclosure issues is high. While these most controls and a rapid acceleration of inflation. As the chart shows, real interest rates actually became negative for much of the 1 970s. issues are not simple, Fed officials are thinking People actively about disclosure issues and are fully clearly did not expect inflation to be this high. In both 1977 and 1 978, those who invested in aware of their importance in helping to bring Treasury securities lost money after adjusting for inflation. Those who borrowed money when inter about greater synchronization with the markets. est rates were low— as in the ' 6 0 s — and repaid What would we expect to see if disclosure their loans with inflated dollars made out like bandits. Lenders took the hit. Clearly, the mar and market understanding were so complete ket and the Fed were not in synch; market partici that the Federal Reserve and the markets pants did not know the Fed was going to allow inflation to rise above 13 percent in 1979. were synchronized? The price level would be On Oct. 6, 1 979, the Fed announced the b egin ning of a new resolve to reduce inflation. market did not believe it. stable, and the unemployment rate and real But the Interest rates remained GDP growth rate would be relatively stable. very high despite the sharp fall in inf lat ion— from We would certainly not expect, however, the about 13 percent in 1979 to about 4 percent in 1983. Because financial markets were skeptical federal f unds rate to remain forever constant that the Fed really would keep inflation low, real at an unch an ge d level. interest rates remained high, compared with his torical averages, until the early 1 990s. Investors would have to be higher sometimes and lower who loaned money in 1980 did very well because inflation did not erode the value of their principal as they had expected it would. The fed f unds rate sometimes to be consistent with the policy Those who bor objectives. rowed money in 1 980 were dismayed to find very high real debt burdens. How would the Fed decide when and by how much to c ha ng e the federal f unds Overall, everyone lost during the period from rate target? the '60s through the '80s. The gains made during one decade were generally offset by the losses in Federal Reserve staff and FOMC members are cont inual ly exa mi ni ng the f low of another, and vice versa. And the lack of Fed syn i ncoming i nf ormati on on the state of the econ- chronicity with the markets was partially responsible. I I omy and w o rk i n g to decide which policy actions Everyone should understand that interest rates may be necessary to keep the economy on the will not be perfectly stable if the Fed is successful desired track. in achi evi ng its goal of low and stable inflation. Af ter processing the information, the FOMC would take the appropriate policy action Market interest rates have fl uc tu a te d substantially at its next meeti ng. in recent years, despite the fact that inflation has The market, sharing the Fed's analysis, woul d not be surprised by the policy ch an ge d little. As e c on omi c news arrives, the Fed decision, whatever it might be. must process the i nf ormati on and make the appro priate adjust ment s to the federal f unds rate target. WHEN IT S OK TO BE A FOLLOWER In recent history, it often seems that the Fed is merely ratifying market expectations. Some The better the market u nde rs t an ds how and why the Fed reaches its decisions, the better it will be able to respond to new i nf ormati on in the same observers cite this " f o l l o w i n g " behavior as evi dence way the Fed responds to the i nf ormati on . that the Fed is not exercising proper leadership. result will be a smoother, and more efficient, On the contrary, the market sh o u ld be able to pre t ransmissi on of monet ary policy c h a n g e s to the dict what the Fed is going to do; the St. Louis Bank economy' s product, labor and capi tal markets. believes this synchronicity is what the Fed should be striving for. If monetary policy is to be fully The Suppose markets do, in fact, acc ura te ly forecast decisions at FOMC meeti ngs. Is that an indication s uccessf ul, markets must understand the Fed's goals that the Fed is simply f o l l o w i n g markets and not and the procedures used to achieve them. exercising its proper l eadership role? When Obviously, monetary policy has been successful for an extended this is not the case. period, it should di sappear from the headlines. FOMC act ions indi cates Fed succ es s both in design A l t h o u g h the market has ga in ed confi den ce in the ing policies that achi eve social ly a c c ep t ab le goals Fed to keep infl ation low and steady, we believe and in c o m m u n i c a t i n g those g o al s to the public. more can be done: The ideal env iron men t is one in w hi ch the Fed The Fed should be more explicit a b ou t its inf lat ion objective. Market succ es s in anticipating and the markets are perfectl y sy n ch r on iz e d. We at the St. Louis Fed are convi nced that conti nued progress in achi evi ng greater synchronicity will make a major cont ri but ion to ending the s c ou rg es of i nflation and i n fl a tion uncertainty, of unstabl e booms and damaging busts. he better the market u nd e r s t a nd s how and wh y the Fed reaches its dec i s i ons , the better it will be able to r espond to new i nf or ma t i on in the same w a y the Fed r es ponds to the i nf or ma t i on. S T . L O U I S B O A R D OP D I R E C T O R S M I C H A E L A. A L E X A N D E R Chairman and President First National Bank Mount Vernon, Illinois C H A R L E S W. M U E L L E R D e p u ty Chairman, Federal Reserve Bank o f St. L o u i s Chairman, Ameren St. President and Corp. Louis, Mi ssouri T H O M A S H. J A C O B S E N Chairman Firstar of t h e Corp. Milwaukee, BERT Board Wisconsin GREENWALT Partner Greenwalt Hazen, Co. Arkansas R O B E R T L. J O H N S O N Chairman and Chief Executive Officer Johnson Bryce Memphi s, Tennessee Inc. CEO G A Y L E P. W. J A C K S O N Managing Lange, Global Mullen & Bohn Financial St. Director LLC Solutions Louis, Mi s s our i L U N S F O R D W. B R I D G E S President and Executive Metropolitan Chief Officer National Little Rock, Bank Arkansas J O S E P H E. G L I E S S N E R J R. Executive New Directions Director Housing Louisville, Corp. Kentucky S U S A N S. E L L I O T T Chairman, Federal Reserve B a n k o f St. L o u i s Chairman and Executive Systems Officer Service Enterprises St. Louis, Chief Inc. Mi ssouri L I T T L E B O A R D O F R O S S M. W H I P P L E Chairman Summit Bank Arkadelphia, Arkansas R A Y M O N D E. S K E L T O N Chief Executive Mercantile Bank of A r k a n s a s Little Rock, Officer N. A. Arkansas E V E R E T T T U C K E R I II Moses Nosari Real Estate Little Rock, Tucker Arkansas ROCK D I R E C T O R S DIANA T. H U E T E R Chairman, Federal Reserve Bank of St. L o u i s , L i t t l e R o c k B r a n c h President and Executive Hueter Chief Officer & Associates Little Inc. Rock, Ar k a ns as L A W R E N C E A. D A V I S J R. Chancel l or University of A r k a n s a s at Pi ne Pine Bluff, Bluff Arkansas V I C K M. C R A W L E Y Plant Baxter Manager Healthcare Mountain Ho me , Corp. Arkansas A. R O G E R S Y A R N E L L II Pr es i dent Yarnell Ice Cream Co. Inc. Searcy, Arkansas L O U I S V I L L E B O A R D O F D I R E C T O R S E D W I N K. P A G E Vi ce President, External AP T e c h n o g l a s s Elizabethtown, Affairs Co. Kentucky DEBBIE SCOPPECHIO Chairman Chief and Executive Creative Officer Alliance Louisville, Inc. Kentucky J. S T E P H E N B A R G E R Chairman, Federal Reserve Bank of St . L o u i s , L o u i s v i l l e B r a n c h Executive S e c r e t a r y - Tr e a s u r e r Kentucky District State Council Carpenters, Frankfort, of AFL-CIO Kentucky ROGER RE YN OLD S President Chief Executive Reynolds Off i cer Coatings Louisville, and LLC Kentucky L A R R Y E. D U N I G A N Chairman Chief Holiday Executive Offi cer Management Evansville, and Corp. Indiana ORSON OLIVER Pr es i dent Mid-America of Bank Louisville Louisville, Kentucky F R A N K J. N I C H O L S Chairman, President Community and Financial Services Benton, CEO Inc. Kentucky ME MP H I S B O A R D OF D I R E C T O R S WAL TER L. MOR RI S JR. Pr esi dent H&M Lumber West Helena, Co. Inc. Arkansas MI KE P. S T U R D I V A N T JR. Chairman, Federal Reserve Bank of St. L o u i s , M e m p h i s B r a n c h Partner Due We s t Glendora, Mississippi E. C. N E E L L Y III Chief Executive First American Iuk a , Mississippi Officer National Bank G R E G O R Y M. D U C K E T T Senior Vice President Corporate Baptist Health and Counsel Memorial Care Memphis, Corp. Tennessee J A ME S A. E N G L A N D Chairman, President Decatur and County Decaturville, CEO Bank Tennessee J OHN C. K E L L E Y JR. President, Business Financial Services First Tennessee Memphis, Bank Tennessee C A R O L G. C R A WL E Y Senior Memphis Vice President Area Chamber of Memphis, Commerce Tennessee 30 \ i We w o u l d l i k e t o e x p r e s s o u r d e e p e s t g r a t i t u d e t o t h o s e m em b ers of the Eighth D istrict boards of d irectors who retired at t h e e n d o f 1 9 9 9 . go o u t t o : Our a p p r e c i a t i o n and b e s t w i s h e s W. D. G l o v e r a n d V e o P e o p l e s J r . , o f t h e St. L o u i s b o a r d , J a n e t M. J o n e s and M a r k S i m m o n s of the L ittle R o c k b o a r d , and K a t i e S. W i n c h e s t e r o f t h e M e m p h i s b o a r d . THE FEDERAL RESERVE BANK FINANCIAL For the years ended December OF ST. LOUIS STATEMENTS 31, 1999 and 1998 MAR C H 3, 2 0 0 0 TO THE B O A R D OF D I R E C T O R S : The management of the Federal Reserve Bank of St. Louis (the "Bank") is responsible for the prepara tion 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 Bank 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 Bank 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 Bank believes that the Bank 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 St. Louis William Poole, President and Chief Executive Officer By: W. LeGrande Rives, First Vice President and Chief Operating Officer REPORT OF INDEPENDENT ACCOUNTANTS TO THE B O A R D OF D I R E C T O R S OF T H E F E D E R A L R E S E R V E B A N K OF ST. L O U I S We have examined management's assertion that the Federal Reserve Bank of St. Louis ("FRB St. Louis") 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 finan cial 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 St. Louis 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. March 3, 2000 St. Louis, Missouri r ep o r t of i n d e p e n d e n t a c c o u n t a n t s TO THE B O A R D OF G O V E R N O R S OF T H E F E D E R A L R E S E R V E S Y S T E M AND THE B O A R D OF D I R E C T O R S OF T H E F E D E R A L R E S E R V E B A N K OF ST. L O U I S : We have audited the accompanying statements of condition of The Federal Reserve Bank of St. Louis (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 manage ment. 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, evi dence 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 over all 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 princi ples, 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 finan cial 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. March 3, 2000 St. Louis, Missouri FEDERAL RESERVE STATEMENTS BANK OF S T . LOUIS OF C O N D I T I O N (in mi llion s) As of December 3 1, 1999 1998 ASSETS $ 337 175 10 471 37 1 5,918 327 160 5,176 55 16 $ 358 340 19 516 7 1 6,048 462 1 52 “ 51 11 $ Gold certificates Special drawing rights certificates 22,682 $ 17,964 $ 21,575 $ 14,701 Coin Items in process of collection Loans to depository institutions U S. government and federal agency securities, net Investments denominated in foreign currencies Accrued interest receivable Interdistrict settlement account Bank premises and equipment, net Other assets Total assets LIABILITIES AND CAPITAL Liabilities: Federal Reserve notes outstanding, net Deposits: Depository institutions Other deposits Deferred credit items Surplus transfer due U.S. Treasury Interdistrict settlement account Accrued benefit cost Other liabilities Total liabilities 692 4 398 31 1,841 48 7 440 1 272 19 51 8 $ 22,366 $ 17,722 Capital: Capital paid-in Surplus 158 1 58 121 121 Total capital 316 242 Total l iabilities and capital $ 22,682 The accompanying notes are an integral part of these financial statements. $ 17,964 BANK OF ST. LOUIS STATEMENTS OF INCOME fed eral r e s e r v e (in m i l l i o n s ) For the years ended December 31, 1999 1999 Interest i n c om e: Interest on U.S. g o v e r n m e n t an d f e d e r a l a g e n c y securi ti es $ 917 5 2 $ 967 10 1 $ 924 $ 978 Interest on f o r e i g n c u r r e n c i e s Interest on l o a n s to d e p o s i t o r y i n s t i t u t i o n s Total interest income Other operating income (loss): Income from services Reimbursable services to government agencies Foreign currency gains (losses), net U.S. government securities gains (losses), net Other income Total other operati ng income 42 19 (10) 41 17 44 1 - (1) 1 $ Operating expenses: Salaries and other benefits Occupancy expense Equipment expense Assessments by Board of Governors Other expenses 51 $ 103 65 6 7 19 44 70 7 8 19 44 Total operati ng expenses $ 148 $ 141 Net income prior to distribution $ 827 $ 940 $ 9 37 781 S 7 Distribution of net income: Dividends paid to member banks Transferred to (from) surplus Payments to U.S. Treasury as interest on Federal Reserve notes Payments to U.S. Treasury as required by statute Total distributi on “ $ The accompanying notes are an integral part of these financial statements. (1) 266 668 827 $ 940 FEDERAL RESERVE BANK OF ST. LOUIS STATEMENTS OF CHANGES IN CAPITAL for the years ended December 31, 1999 and December 31, 1998 (in millions) Capital Paid-in Balance at January 1, 1998 (2.5 million shares) Net income transferred from surplus S Net change in capital stock redeemed (0.1 million shares) Balance at December 31, 1998 (2.4 million shares) Net income transferred to surplus $ 121 122 (1) $ $ 121 249 (1) (6) $ 242 - 37 37 $ 37 - 37 158 The accom panying notes are an integral part of these financial statements. $ (6) Net change in capital stock issued (0.8 million shares) Balance at December 31, 1999 (3.2 million shares) 127 - Total Capital Surplus $ 158 $ 316 FEDERAL RESERVE BANK OF ST. LOUIS NOTES TO FINANCIAL STATEMENTS 1. ORGANIZATION: The Federal Reserve Bank of St. Louis ("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 char tered by the federal government and possess a unique set of governmental, corporate, and central bank char acteristics. 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. Structure: The Bank and its branches in Little Rock, Louisville and Memphis serve the Eighth Federal Reserve District, which includes Arkansas, portions of Illinois, Indiana, Kentucky, Mississippi, Missouri and Tennessee. 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 o f 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 designat ed 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 mem ber 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. 2. OPERATIONS AND SER V ICE S: 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; pro viding short-term 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 adm inistering 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 FEDERAL RESERVE BANK OF ST. LOUIS NOTES TO FINANCIAL STATEMENTS authorized by the FOMC to hold balances of and to execute spot and forward foreign exchange and securi ties 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. 3. SIG NIFICAN T ACCOUNTING PO LICIES: 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 devel oped specialized accounting principles and practices that it believes are appropriate for the significantly dif ferent 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 apply accounting policies and practices that are consistent with the Financial A ccounting Manual. The financial statements have been prepared in accordance with the Financial A ccounting Manual. Differences exist between the accounting principles and practices of the System and generally accepted accounting principles in the United States ("G A A P "). 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 A ccounting 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. 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 equiv alent 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 reac quire the gold certificates at any time and the Reserve Banks must deliver them to the U.S. Treasury. At FEDERAL RESERVE BANK OF ST. LOUIS NOTES TO FINANCIAL STATEMENTS such time, the U.S. Treasury's account is charged and the Reserve Banks' gold certificate accounts are low ered. 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 D raw ing Rights Certifica tes Special drawing rights ("S D R s ") are issued by the International Monetary Fund ("Fund") to its members in proportion to each m em bers 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 U.S. 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 D e p o s ito ry In stitu tio n s The Depository Institutions Deregulation and Monetary Control Act of 1980 provides that all depository insti tutions 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 evalu ated 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 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. U.S. G o vern m en t a n d Federa l A g e n c y Securities and Investm ents Denominated in Foreign C u rrencie s 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 th FRBNY to execute operations in foreign markets for major currencies in order to counter disorderly condi FEDERAL RESERVE BANK OF ST. LOUIS NOTES TO FINANCIAL STATEMENTS tions 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 sale-purchase 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. gov ernment 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 cur rencies, 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 forward 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 maxi mum 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 pur chases 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. FEDERAL RESERVE BANK OF ST. LOUIS NOTES TO FINANCIAL STATEMENTS 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 securi ties 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. U.S. government and federal agency securities and investments denominated in foreign currencies com prising the SOMA are recorded at cost, on a settlement-date basis, and adjusted for amortization of premi ums 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 cur rencies," 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 report ed as "U.S. government securities gains (losses), 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 unre alized gains and losses on investments denominated in foreign currencies are reported as "Foreign currency gains (losses), 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 denomi nated 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 arrange ments are allocated to the FRBNY and not to other Reserve Banks. e. Bank Prem ises and Equ ipm en t 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. In te rd istrict S e ttle m e n t A cco u n t At the close of business each day, all Reserve Banks and branches assemble the payments due to or from other Reserve Banks and branches as a result of transactions involving accounts residing in other Districts FEDERAL RESERVE BANK OF ST. LOUIS NOTES TO FINANCIAL STATEMENTS that occurred during the day’s operations. Such transactions may include funds settlement, check clearing and automated clearinghouse (" A C H " ) 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 spe cific 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. gov ernment 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 addi tional 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 U.S. government. The "Federal Reserve notes outstanding, net" account represents Federal Reserve notes reduced by cash held in the vaults of the Bank of $4,869 million, and $2,589 million at December 31, 1999 and 1 998, 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 cap ital 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 o f stock subscribed by it. /. S u rp lu s The Board of Governors requires Reserve Banks to maintain a surplus equal to the amount of capital paidin 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 FEDERAL RESERVE BANK OF ST. LOUIS NOTES TO FINANCIAL STATEMENTS 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 addi tional 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 expenses." 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 FED ER AL AGEN CY SECU RITIES: 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 3 .2 8 9 % and 3 .5 1 4 % at December 31, 1999 and 1998, respectively. FEDERAL RESERVE BANK OF ST. LOUIS NOTES TO FINANCIAL STATEMENTS The Bank's allocated share of securities held in the SOMA at December 31, that were bought outright, were as follows (in millions): 1999 Par value: Federal agency U.S. government: Bills Notes Bonds 6 $ 1998 $ 12 5,806 7,186 2,730 1 5,728 299 (109) Total par value Unamortized premiums Unaccreted discounts Total allocated to Bank 6,845 6,603 2,441 1 5,901 259 (112) 15,918 $ $ 16,048 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): Par value Maturities of Securities Held 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 Total U.S. Government Securities Federal Agency Obligations 1 52 3,024 4,601 4,084 1,681 2,180 15,722 Total 1 52 3,025 4,602 4,084 1,685 2,180 $ 15,728 At December 31, 1999, and 1998, matched sale-purchase transactions involving U.S. government secu rities with par values of $39,182 million and $20,927 million, respectively, were outstanding, of which $1,289 million and $735 million were allocated to the Bank. Matched sale-purchase transactions are generally overnight arrangements. FEDERAL RESERVE BANK OF ST. LOUIS NOTES TO FINANCIAL STATEMENTS 5. INVESTM ENTS 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 agree ments 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 2.02 8% and 2 .3 3 3 % 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): 1998 1999 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 Accr ued i nterest Total $ $ 244 - 88 - 51 - 7 16 180 1 $ 55 145 2 327 $ 462 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. FEDERAL RESERVE BANK OF ST. LOUIS NOTES TO FINANCIAL STATEMENTS The maturities of investments denominated in foreign currencies that were allocated to the Bank at December 31, 1999, were as follows (in millions): Maturities of Investments Denominated in Foreign Currencies Within 1 year Over 1 year to 5 years Over 5 years to 10 years Total $ ^06 ^ $ 327 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): 1999 Bank premises and equipment: Land Buildings Building machinery and equipment Construction in progress Furniture and equipment $ $ $ 55 3 31 12 1 44 91 (40) 101 (46) Accumulated depreciation Bank premises and equipment, net 4 34 12 1 50 1998 $ 51 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 4 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 $1 million for the years ended December 31, 1999 and 1998, respectively. Certain of the Bank's leases have options to renew. 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 outstand ing under such agreement at December 31, 1999 or 1998. FEDERAL RESERVE BANK OF ST. LOUIS NOTES TO FINANCIAL STATEMENTS 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: Retirem ent Plans: The Bank currently offers two defined benefit retirement plans to its employees, based on length of ser vice 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 employ ers. 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 $2 million for the years ended December 31, 1999 and 1998, respectively, and are reported as a component of "Salaries and other be nefits." 9. POSTRETIREMENT BENEFITS OTHER THAN PENSIONS AND POSTEMPLOYMENT BENEFITS: P ostretirem ent B en efits o ther 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): 1999 Accumulated postretirement benefit obligation at January 1 Service cost-benefits earned during the period Interest cost of accumulated benefit obligation Actuarial (gain) Contributions by plan participants Benefits paid Accumulated postretirement benefit obl igati on at December 31 1993 $ 43.8 1.0 2.6 (3.9) 0.1 (1.7) $ 38.6 0.9 2.6 3.0 0.2 (1.5) $ 41.9 $ 43.8 FEDERAL RESERVE BANK OF ST. LOUIS NOTES TO FINANCIAL STATEMENTS 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): 1999 Fair value of plan assets at January 1 Contributions by the employer Contributions by plan participants Benefits paid Fair value of plan assets at December 31 Unfunded postretirement benefit obligation Unrecognized prior service cost Unrecognized net actuarial gain Accrued postretirement benefit cost $ $ 1998 1.5 0.1 (1.6) $ - $ 1.3 0.2 (1.5) $ 41.9 0.8 4.1 $ 43.8 0.9 0.1 $ 46.8 $ 44.8 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 .2 5 % , respectively. For measurement purposes, an 8 .7 5 % 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 .5 0 % 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 Increase Effect on aggregate of service and interest cost components of net periodic postretirement benefit cost Effect on accumulated postretirement benefit obligation 1 Percentage Point Decrease 0.9 0.7 8.4 8.5 FEDERAL RESERVE BANK OF ST. LOUIS NOTES TO FINANCIAL STATEMENTS The follow ing is a summary of the components of net periodic postretirement benefit cost for the years ended December 31 (in millions): 1999 Service cost-benefits earned during the period Interest cost of accumulated benefit obligation Amortization of prior service cost Recognized net actuarial loss Net periodic postretirement benefit cost 1998 $ 1 . 0 2.6 $ 0.8 2.6 $ $ 3.4 3.6 Net periodic postretirement benefit cost is reported as a component of "Salaries and other benefits." P o stem ploym ent B enefits: 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 $4 million and $3 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 $1 million, for each year. ADVISORY COUNCILS FINANCIAL SERVICES ADVISORY & BANK OFFICERS GROUP MEMBERS FEDERAL ADVISORY COUNCIL MEMBER Camden Fine President Midwest Independent Bank Jefferson City, Missouri Katie S. Winchester President, Chief Executive Officer and Director First Citizens National Bank Dyersburg, Tennessee Barbara McKenzie Executive Vice President and CFO Banterra Corp. El Dorado, Illinois BANK OFFICERS DISTRICT ADVISORY COUNCIL Paul Combs Vice President Baker Implement Co. Kennett, Missouri Robert A. Cunningham Valley Farms Bigbee Valley, Mississippi Joseph H. Spalding Lebanon, Kentucky Gerald W. Clapp Jr. President/Owner Clapp Oldsmobile Clarksville, Indiana William D. Crawley President Southern Sales & Service Memphis, Tennessee Chris Krehmeyer Beyond Housing St. Louis, Missouri Ann Ross Association of Retail Paper Stores St. Louis, Missouri ST. LOUIS OFFICE Phil Porter President Arvest Bank Operations Inc. Lowell, Arkansas Judy R. Loving Chairman The Bank of Yellville Yellville, Arkansas Reynie Rutledge Chairman First Security Bank Searcy, Arkansas Carolyn Betsy Hudson Senior Vice President Bank of Benton Benton, Kentucky Don Hughes President FCB Services Farmers Capital Bank Corp. Frankfort, Kentucky James Clayton President Planters Bank and Trust Co. Indianola, Mississippi Rowe M. Belcher Jr. Executive Vice President Trust One Bank Germantown, Tennessee William Poole President and Chief Executive Officer W. LeGrande Rives First Vice President and Chief Operating Officer Karl W. Ashman Senior Vice President Henry H. Bourgaux Senior Vice President Joan P. Cronin Senior Vice President Mary H. Karr Senior Vice President, General Counsel and Secretary Robert H. Rasche Senior Vice President and Director of Research Richard G. Anderson Vice President John P. Baumgartner Vice President John W. Block Jr. Vice President Timothy A. Bosch Vice President Marilyn K. Corona Vice President Cletus C. Coughlin Vice President William T. Gavin Vice President R. Alton Gilbert Vice President N. Lynn Greenwood Vice President Jean M. Lovati Vice President Elizabeth A. Hayes Robert E. Kellar Jr. Assistant Vice President Operations Officer Michael J. Mueller Edward A. Hopkins Vice President Assistant Vice President W. Scott McBride Assistant Counsel Kim D. Nelson Patricia A. Marshall Vice President Assistant Vice President, Assistant Counsel and Assistant Secretary Paul M. Nunnally Vice President Michael D. Renfro General Auditor David A. Sapenaro Vice President Steven N. Silvey Vice President William Sneed Vice President Randall C. Sumner Vice President and Assistant Secretary Daniel L. Thornton Vice President Jerome J. McGunnigle Assistant Vice President John P. Merker Assistant Vice President Frances E. Sibley Assistant Vice President Harold E. Slingerland Assistant Vice President Leisa J. Spalding Assistant Vice President and Assistant General Auditor Robert James Taylor Assistant Vice President David C. Wheelock Kathleen O'Neill Paese Operations Officer Patricia S. Pollard Research Officer Todd J. Purdy Accounting Officer Mark D. Vaughan Supervisory Officer Jeffrey L. Wann Chief Technology Officer LITTLE ROCK BRANCH Robert A. Hopkins Vice President & Branch Manager Thomas R. Callaway Assistant Vice President Assistant Vice President William D. Little Operations Officer Carl K. Anderson Supervisory Officer LOUISVILLE BRANCH Assistant Vice President Barkley Bailey Supervisory Officer Thomas A. Boone Vice President & Branch Manager Timothy C. Brown Assistant Vice President Bernard E. Berns Jr. Public Affairs Officer Vice President James B. Bullard Assistant Vice President Assistant Counsel Thomas 0. Short Assistant Vice President Assistant Vice President Susan K. Curry Operations Officer Gerard V. Mattingly Operations Officer Judith A. Courtney Assistant Vice President Supervisory Officer MEMPHIS BRANCH Jeffrey M. Dale Assistant Vice President Michael J. Dueker Research Officer Vice President & Branch Manager Hillary B. Debenport Assistant Vice President Gary J. Juelich Supervisory Officer John W. Mitchell Assistant Vice President Andrea S. Eddy Assistant Vice President Visweswara R. Kaza Operations Officer John G. Holmes Assistant Vice President Dennis W. Blase Assistant Vice President Daniel P. Brennan Martin J. Coleman Diane B. Camerlo Michael Wayne DeClue Ronald L. Byrne Martha Perine Beard SUMMARY OF OPERATIONS S u m m a r y o f Ke y O p e r a t i o n S t a t i s t i c s f o r S e r v i c e s P r o v i d e d to D e p o s i t o r y I n s t i t u t i o n s a n d t he T r e a s u r y Number of Items Dollar Amount (Thousands) (Millions) 1999 1998 1999 1998 22,894 26 ,5 4 9 $ 22,100 $ 23,166 22 5 , 8 5 3 212,691 29,1 18 28 , 4 6 9 1,062,774 99 7, 2 62 537,430 51 1,055 1 5 5 ,87 7 148, 700 279,070 268,435 C ur r en cy Processed 1 , 0 07 , 59 3 957,650 13,921 12,540 Funds Transfers 4,791,747 5 , 0 35 , 46 3,524,052 3,444,509 595 826 2,656 923 13 7 , 6 4 4 16 4, 870 851,898 381,857 55 ,9 1 5 9 8 ,5 4 6 282 504 3,051 3, 3 08 1 1 Government Checks Processed Postal Money Orders Processed C o mm e rc i al C h e c k s Processed A C H Commerci al Items Originated Loans to Depository Institutions Transfer of G o ve r nm en t Securities Food C o u p o n s Destroyed Treasury C o u p o n s Processed THE FEDERAL RESERVE BANK OF ST. LOUIS 411 Locust Street Saint Louis, Missouri 63102 314.444.8444 LITTLE ROCK BRANCH 325 West Capitol Avenue Little Rock, Arkansas 72201 501.324.8300 LO U ISV ILLE BRANCH 410 South Fifth Street Louisville, Kentucky 40202 502.568.9200 MEMPHIS BRANCH 200 North Main Street Memphis, Tennessee 38102 901.523.7171 THIS REPORT IS ALSO AVAILABLE ON THE INTERNET AT WWW.STLS.FRB.ORG.