Full text of Economic Review (Federal Reserve Bank of Atlanta) : January 1984, Volume 69, Number 1

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norme
eview

ERAL RESERVE BANK OF ATLANTA

ANKS

JANUARY 1984

Will Interstate Banking Increase Competition?

EFICITS

Exploring the Link to Monetary Growth

ONSUMERS
AYMENTS
EFORM

The Do-It-Yourself Movement

In-Store ATMs Gather Steam

Deposit Insurance Proposals

JTERNATIONAL




Lender of Last Resort

President:
Robert P. Forrestal
Sr. V i c e P r e s i d e n t a n d
Director of R e s e a r c h :
D o n a l d L. K o c h
Vice President and
A s s o c i a t e Director of Research:
William N. Cox

Financial Structure:
B. Frank King. Research Officer
Larry D. Wall
Robert E. Goudreau
National Economics:
Robert E. Keleher, Research Officer
Mary S. Rosenbaum
Joseph A. Whitt, Jr.
Regional Economics:
Gene D. Sullivan, Research Officer
Charlie Carter
William J. Kahley
Bobbie H. McCrackin
Joel R. Parker
Database M a n a g e m e n t :
Delores W. Steinhauser
Pamela V. Whigham
Payments Research:
David D. Whitehead
Visiting Scholars:
George J. Benston
University of Rochester
Gerald P. Dwyer
Emory University
Robert A. Eisenbeis
University of North Carolina
John H e k m a n
University of North Carolina
Paul M. Horvitz
University of Houston
Peter Merrill
Peter Merrill Associates

C o m m u n i c a t i o n s Officer:
Donald E. Bedwell
Public Information Representative:
Duane Kline
Publications Coordinator:
Gary W. Tapp
Graphics:
Eddie W. Lee. Jr.
Cheryl D. Berry

The E c o n o m i c R e v i e w seeks lo inform the public
about Federal Reserve policies a n d the economic
environment and. in particular, to narrow the g a p
between specialists a n d c o n c e r n e d laymen. Views
expressed in the E c o n o m i c Review aren t necessarily
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ISSN 0 7 3 2 - 1 8 1 3


Can Interstate Banking Increase
Competitive Market Performance?
An Empirical Test

If banking firms expand and find themselves in
head-to-head competition with other firms in many
different markets, will competition increase or decrease? Recent geographic expansion by Florida
bank holding companies may provide a clue to
what the nation would experience under interstate
banking.

Deficits and Monetary Growth

Will continued high federal deficits inevitably lead
to higher inflation? An examination of the historical
record.

22

The Do-It-Yourself Movement
An Element of the
Shadow Economy

The do-it-yourself movement, a positive part of the
"shadow economy," is large and expanding. What
are the movement's dimensions, how does it affect
the economy and what are its prospects for the
future?

31

In-Store ATMs:
Steppingstone to POS

How fast are automated teller machines (ATMs)
moving into grocery and convenience stores 9 What
benefits do ATMs bring these retailers, and are
these ATMs seen as precursors to point-of-sale
terminals and debit cards?

43

The Future of
Deposit Insurance: The Insuring
Agencies' Proposals

Dramatic changes in thefinancial services industry
have prompted a reexamination of how the public's
deposits are insured. A summary of three federal
regulatory agencies' proposals for reforming the
system.

58

"Financial Crises" and
The Role of the Lender
of Last Resort

How do international and domestic "financial crises"
arise? What is their relationship to central bank
policy? How does the central bank function as the
"lender of last resort"?

68

Statistical Supplement

11




Can Interstate Banking Increase Competitive
Market Performance? An Empirical Test
A study of Florida bank holding companies suggests that geographic expansion
by different banks into several markets tends to increase the degree of
competition. The same type of expansion is expected if interstate banking
prohibitions
are removed.

The structure of the banking industry
has changed significantly during t h e
last 10 years, largely because
of t h e a c c e l e r a t i o n of multib a n k h o l d i n g c o m p a n y formation and acquisition
activity in t h e 1960s. In
1956, w h e n Congress
passed t h e Bank
Holding
Company A c t
it

covered
multibank
panies. 1
Between
1956 and the mid1960s, t h e pace of m u l t i bank holding c o m p a n y formations remained rather slow;
t h e n u m b e r stood at 74 in 1967. 2
By 1970, however, the n u m b e r had
e x p a n d e d t o 121, 3 by 1 9 7 6 t o 3 0 8 ,
and in 1982, the n u m b e r had grown t o
5 2 2 . These 522 m u l t i b a n k h o l d i n g c o m panies held over $821 billion in deposits and
controlled 3,039 banks. Y e t most importantly,
this organizational form had changed t h e struct u r e of t h e b a n k i n g industry. 4
Most multibank holding company acquisition
a c t i v i t y d u r i n g t h e 1 9 7 0 - 1 9 8 3 p e r i o d was of
t h e market extension type—acquisition of banks
in separate b a n k i n g markets. This is t h e t y p e of
a c q u i s i t i o n a c t i v i t y o n e w o u l d e x p e c t if geographic restrictions o n interstate b a n k i n g w e r e
r e m o v e d — b a n k s or h o l d i n g c o m p a n i e s in o n e

' B o a r d of Governors of the Federal Reserve System, F e d e r a l Reserve
B u l l e t i n , October 1958, p. 1224
••Ibid, August 1968, p. A-93
3
l b i d , August 1971, p. A-98.
4
Board of Governors of the Federal Reserve System, "Banking Holding
C o m p a n i e s a n d Subsidiary Banks as of December 31, 1976."

4




state a c q u i r i n g b a n k i n g organizatior
in o t h e r states.
S o m e e v i d e n c e of t h e prob (
ble c o m p e t i t i v e i m p a c t o
banking markets of allowir
this t y p e of expansio
m a y b e g l e a n e d froi
t h e Florida e x p e i
enee. Florida w<
a
hotbed <
h o l d i n g con

pany
activil
during
th
1970s. T h e stat
m a i n t a i n e d a un
banking
structur
through most of this pei
o d that fostered the growt
of a relatively large n u m b e r c
holding companies. This is analc
gous t o the interstate banking pre
h i b i t i o n s t h a t l i m i t e d banks' gee
graphic expansion t o a single state Th
interstate restrictions fostered t h e growt
of many banking organizations in the natior
In Florida each bank was limited t o o n e locatioi
b u t through t h e holding c o m p a n y device,
n u m b e r of geographically l i m i t e d banks couV'
be tied together. H o l d i n g companies in Floricv
e x p a n d e d largely by acquiring existing b a n k :
and because of t h e b a n k i n g authorities an
antitrust laws, their acquisitions w e r e largely <
t h e m a r k e t e x t e n s i o n t y p e . T h e same t y p e c
e x p a n s i o n is e x p e c t e d if interstate b a n k i n
p r o h i b i t i o n s are r e m o v e d .
The holding c o m p a n y structure allowed Floric
banking organizations t o expand into marke)
p r o h i b i t e d t o a single bank. Repeal of t h
interstate b a n k i n g p r o h i b i t i o n s w o u l d have i
similar e f f e c t o v e r a larger area. Florida h o l d i r
JANUARY 1984, E C O N O M I C REVIEW

F|

c o m p a n i e s f o u n d t h e m s e l v e s c o m p e t i n g headt o - h e a d w i t h similar i n s t i t u t i o n s t h r o u g h o u t
t h e state in d i s p e r s e d markets. M u c h t h e same
would occur nationwide.
W h a t can t h e Florida e x p e r i e n c e t e l l us
a b o u t w h a t t h e n a t i o n m a y e x p e r i e n c e if or
w h e n t h e i n t e r s t a t e b a n k i n g p r o h i b i t i o n s are
removed? If b a n k i n g firms are a l l o w e d t o e x p a n d
i n t o n e w m a r k e t s a n d f i n d t h e m s e l v e s in d i r e c t
c o m p e t i t i o n w i t h similar o r g a n i z a t i o n s in m a n y
of t h e s e m a r k e t s , w i l l t h e level o f m a r k e t
c o m p e t i t i o n increase o r decrease? This is an
i m p o r t a n t q u e s t i o n in t r y i n g t o d e t e r m i n e
w h e t h e r interstate expansion will benefit t h e
nation's e c o n o m y .

The Linkage Theory
Conceptually, t h e t h e o r y of " l i n k e d oligopoly"
has o f t e n b e e n a p p l i e d in analyzing t h e p r o b a b l e
c o m p e t i t i v e i m p a c t of m u l t i m a r k e t banking
firms in t h e b a n k i n g industry. The t h e o r y basically
asserts t h a t t h e m o r e o f t e n m u l t i m a r k e t f i r m s
c o m e i n t o d i r e c t c o n t a c t in a n u m b e r o f geog r a p h i c a l l y d i s p e r s e d markets, t h e less l i k e l y
t h e s e f i r m s are t o t a k e aggressive a c t i o n in any
o n e m a r k e t f o r fear o f r e t a l i a t i o n in o t h e r
markets w h e r e t h e y may be m o r e vulnerable. In
effect, it c o n t e n d s t h a t t h e p r e s e n c e o f a
n u m b e r o f m u l t i m a r k e t firms, c o m p e t i n g w i t h
o n e a n o t h e r in m a n y markets, w i l l t e n d t o
w e a k e n c o m p e t i t i o n regardless of t h e degree of
concentration in that local m a r k e t T h e e v i d e n c e
r e p o r t e d in t h i s a r t i c l e t e n d s t o r e j e c t t h e
l i n k e d o l i g o p o l y t h e o r y in t h e case of Florida.
T h e l i n k e d o l i g o p o l y t h e o r y is b a s e d o n t h e
idea t h a t t h e c o m p e t i t i v e b e h a v i o r o f rivals is
i n t e r d e p e n d e n t The c o o p e r a t i o n of t h e rivals is
basically t h e result o f t w o or m o r e f i r m s s h a r i n g
a r e l a t i v e l y large p o r t i o n of a m a r k e t . This
increases t h e c e r t a i n t y t h a t a c o m p e t i t i v e a c t i o n
w i l l a f f e c t a rival d i r e c t l y a n d adversely, thus
r e s u l t i n g in a p r e d i c t a b l e c o m p e t i t i v e reaction.
In c o n v e n t i o n a l f o r e c a s t i n g m o d e l s , t h i s leads
t o a s i t u a t i o n in w h i c h c o m p e t i t i o n is r e d u c e d
a n d is r e p l a c e d b y tacit agreements or coalitions
b e t w e e n rival o r g a n i z a t i o n s . Each f i r m recognizes t h a t its c o m p e t i t i v e a c t i o n s w i l l a d v e r s e l y
affect a rival, w h o w i l l react in a predictable
manner.
In s u c h situations, several a l t e r n a t i v e a c t i o n s
are possible. In o n e e x t r e m e , t h e rivals recognize t h e potential for a m o n o p o l y situtation
and f o r m a coalition t o c o o p e r a t e rather t h a n

FEDERAL RESERVE B A N K O F A T L A N T A




com pete.Alternatively, the organizations may
a t t e m p t t o second-guess t h e i r rivals, thus sharpe n i n g c o m p e t i t i o n . Elinor S o l o m o n r e c o g n i z e d
these t w o extremes a n d asserted that t h e
initial d e g r e e of c o m p e t i t i o n b e t w e e n firms in a
given m a r k e t m a y d e t e r m i n e h o w t h e y b e h a v e
as t h e y e x p a n d i n t o o t h e r markets:
" M u l t i p l e contact by the same banking
leaders w i t h i n a state, in p r o g r e s s i v e l y m o r e o f
that state's b a n k i n g markets, m a y serve to
s t r e n g t h e n t h e lines o f c o m m u n i c a t i o n bet w e e n t h e m a n d increase t h e a d h e r e n c e t o any
p r e - e x i s t i n g g r o u p c o m p e t i t i v e s t a n d a r d , " she
said. " O r , conversely, t h e i n t e r - m a r k e t m e s h i n g
of t h e s a m e b a n k s m a y h e i g h t e n c o m p e t i t i v e
i n t e r a c t i o n if i n t e r b a n k rivalry is i n t e n s e t o
begin with."5
B e t w e e n these t w o extremes, many different
courses of a c t i o n m a y result. T h e l i n k e d t h e o r y
of o l i g o p o l y is b a s e d o n t h e a s s u m p t i o n t h a t

"The holding company structure
allowed Florida banking
organizations to expand into
markets prohibited to a single bank
Repeal of the interstate banking
prohibitions would have a similar
effect over a larger a r e a "

t w o f i r m s r e c o g n i z e t h e a d v a n t a g e of c o a l i t i o n
and cooperation and, hence, limit their competitive actions.
In s u m m a r y , t h e rationale for t h e p r e d i c t a b l e
a c t i o n - r e a c t i o n s e q u e n c e is t h a t t w o f i r m s
share a r e l a t i v e l y large p o r t i o n of a g i v e n
market—therefore, any competitive action that
strengthens o n e firm's c o m p e t i t i v e position
will adversely affect its rival's competitive situation.
In a m u l t i m a r k e t s i t u a t i o n , a c c o r d i n g t o t h e
l i n k e d t h e o r y , t h e s a m e t y p e o f logic prevails.
As t w o firms f i n d t h e m s e l v e s c o m p e t i n g in a
larger n u m b e r of markets, t h e y f i n d it necessary
t o t a k e i n t o a c c o u n t t h e p o s s i b i l i t y t h a t an
aggressive c o m p e t i t i v e a c t i o n in a n y o n e market m a y cause t h e rival t o retaliate in s o m e

3

S e e Elinor Harris Solomon, "Bank Merger Policy a n d Problems: A
Linkage Theory ot Oligopoly," J o u r n a l of M o n e y , C r e d i t , a n d B a n k i n g ,
February 1970, pp. 323-35.

5

o t h e r m a r k e t T h e m o r e clearly t w o f i r m s rec o g n i z e t h a t t h e i r sales o r d e p o s i t s are originating from a c o m m o n group of markets, the
less l i k e l y t h e y are t o i n i t i a t e aggressive c o m p e t i t i o n , a c c o r d i n g t o this t h e o r y . F o l l o w i n g
t h i s t o its logical c o n c l u s i o n , w e c o u l d a r g u e
t h a t as t h e n u m b e r of m e e t i n g p o i n t s increases
a m o n g m u l t i m a r k e t f i r m s r e p r e s e n t e d in a
given market, t h e c o m p e t i t i o n w i t h i n that market
w i l l t e n d t o w e a k e n regardless o f t h e market's
level o f c o n c e n t r a t i o n o r o t h e r local factors.
This, t h e n , provides t h e h y p o t h e s i s t o b e
tested: if t h e l i n k e d t h e o r y is c o r r e c t t h e market's
competitive performance should be reduced
as t h e n u m b e r of m u l t i m a r k e t m e e t i n g p o i n t s
increases. If w e f i n d e m p i r i c a l s u p p o r t f o r t h e
l i n k e d t h e o r y , t h e n w e m a y argue t h a t this gives
some evidence that interstate banking will
c r e a t e less c o m p e t i t i v e markets. T h r o u g h a test
of this hypothesis, however, w e m a y discover
empirical s u p p o r t for a c o n c l u s i o n o p p o s i t e
t h a t s u g g e s t e d b y t h e l i n k e d t h e o r y — t h a t inc r e a s e d links a c t u a l l y stimulate m a r k e t c o m p e t i t i o n . In such a case, t h e e v i d e n c e w o u l d
suggest t h a t a l l o w i n g b a n k s t o m e e t in a greater
n u m b e r o f g e o g r a p h i c a l l y dispersed markets
may enhance c o m p e t i t i o n .

Testing the Hypothesis
This hypothesis has b e e n tested t h r e e previous
times, w i t h o n e study s u p p o r t i n g the linked
t h e o r y , w h i l e t w o o t h e r s u s i n g similar m o d e l s
b u t d i f f e r e n t d a t a sets f o u n d n o s u p p o r t f o r t h e
l i n k e d hypothesis. (See t h e box for a d e s c r i p t i o n
o f t h i s literature). M u c h o f t h e d i v e r g e n c e
resulted from the performance measures—the
measures of a market's c o m p e t i t i v e n e s s — u s e d .
A s e c o n d l i m i t a t i o n is t h a t e a c h o f t h e p r e v i o u s
s t u d i e s u s e d d a t a f o r a single year. T h e divergent findings, therefore, may have resulted
f r o m factors i n f l u e n c i n g m a r k e t p e r f o r m a n c e in
o n e t i m e p e r i o d b u t n o t in a n o t h e r . T o c o r r e c t
for these limitations, w e d e v e l o p e d a model
based o n an u n a m b i g u o u s m a r k e t p e r f o r m a n c e
m e a s u r e , profits. H i g h e r m a r k e t p r o f i t s w e r e
a s s o c i a t e d w i t h less c o m p e t i t i o n , a n d l o w e r
m a r k e t p r o f i t s w e r e a s s o c i a t e d w i t h a greater
d e g r e e of c o m p e t i t i o n . In a d d i t i o n , t o o f f s e t
t h e s e c o n d l i m i t a t i o n of t h e p r e v i o u s studies,
w e e m p l o y e d a b a n k i n g d a t a base u n i q u e t o
t h e Federal Reserve Bank of Atlanta. It i n c l u d e s
call a n d i n c o m e report i n f o r m a t i o n for all banks
6




in t h e Sixth Federal Reserve D i s t r i c t f r o m 1 9 6 9
t h r o u g h 1 9 7 7 . T h e base also adjusts for branches
and o t h e r organizational characteristics to
ensure that all c o m p e t i t i v e entities are i d e n t i f i e d
in all m a r k e t areas. W i t h this d a t a base, w e
w e r e a b l e t o p o o l cross-section a n d t i m e series
d a t a f o r t h e years 1 9 6 9 t h r o u g h 1 9 7 7 , w h i c h
a l l o w e d a test f o r t h e s t a b i l i t y of t h e r e s u l t i n g
coefficients.
W e e m p l o y e d t w o samples, b o t h using Florida
b a n k s o n l y . T h e first s a m p l e c o n s i s t e d o f 62
Florida m a r k e t s as d e f i n e d b y t h e A t l a n t a Fed
a n d u s e d b y t h e B o a r d of G o v e r n o r s in a c t u a l
m e r g e r a n d a c q u i s i t i o n cases. W e f e e l t h e s e
m a r k e t s are s u p e r i o r t o t h o s e t y p i c a l l y u s e d in

"If the linked theory is correct, as
the number of multimarket meeting
points increases in a given market,
the market's competitive
performance is reduced."

s u c h s t u d i e s , u s u a l l y Standard M e t r o p o l i t a n
Statistical Areas (SMSA) or c o u n t i e s . (Banks
o f t e n use n a r r o w e r m a r k e t d e f i n i t i o n s . For a
fuller e x p l a n a t i o n of b a n k i n g market definitions,
see D a v i d D. W h i t e h e a d , " R e l e v a n t G e o g r a p h i c
M a r k e t s : H o w S h o u l d T h e y Be D e f i n e d , " t h i s
Review, J a n u a r y - F e b r u a r y 1 9 8 0 , pp. 2 0 - 2 8 ) W e
also e m p l o y e d a s e c o n d sample consisting of
m a r k e t s d e f i n e d as SMSAs in o r d e r t o c o m p a r e
results w i t h earlier studies. W e calculated market
statistics t a k i n g h o l d i n g c o m p a n i e s a n d indiv i d u a l b a n k s as m a r k e t p a r t i c i p a n t s . D a t a o n
i n d i v i d u a l b a n k s a n d h o l d i n g c o m p a n y subsidiaries w e r e used t o i d e n t i f y organizations,
w h i c h a l l o w e d c o n s t r u c t i o n o f t h e l i n k e d variables d e s c r i b e d b e l o w . U n i t s o f observation for
t h e l i n k e d m e a s u r e s are b a n k i n g o r g a n i z a t i o n s ,
and w e aggregated these w i t h i n the geographic
b o u n d a r i e s f o r d e f i n e d m a r k e t s or SMSAs. T h e
m o d e l t e s t e d f o l l o w e d t h e general f o r m o f
those previously employed:
M a r k e t Profits = f ( n u m b e r o f m u l t i m a r k e t
links, t h e l e v e l of m a r k e t c o n c e n t r a t i o n , a n d
m a r k e t growth.)
Each v a r i a b l e is c a l c u l a t e d in t h e f o l l o w i n g
manner:
RRA = M a r k e t N e t I n c o m e
T o t a l M a r k e t Assets
JANUARY 1984, E C O N O M I C REVIEW

F|

H = H e r f i n d a h l i n d e x ( t h e s u m of t h e
s q u a r e d m a r k e t shares o f e a c h b a n k in t h e
market.)
G = p e r c e n t a g e c h a n g e in t o t a l d e p o s i t s
f r o m a base year f o u r years earlier
As f o r t h e l i n k variables, u n c e r t a i n t y as t o
precisely h o w m u l t i m a r k e t c o n t a c t s s h o u l d
affect c o l l u s i v e o r a n t i - c o l l u s i v e b e h a v i o r l e d
t o t h e d e v e l o p m e n t o f 10 l i n k a g e m e a s u r e s ,
designed to capture both quantitative and
q u a l i t a t i v e aspects of linkage. T h e c a l c u l a t i o n
follows that of W h i t e h e a d (1978).
L-j = n u m b e r of links or m a r k e t s in w h i c h
t h e t w o largest o r g a n i z a t i o n s in t h e g i v e n
market m e e t and c o m p e t e against o n e a n o t h e r

"In fact, our findings support the
opposite behavioral assumption—
that is, as the number of links
between firms increases, the degree
of competition between those firms
increases"
L2 = n u m b e r of links in w h i c h t h e t w o
largest o r g a n i z a t i o n s in a g i v e n m a r k e t c o m p e t e w h e r e b o t h are a m o n g t h e f i v e largest
o r g a n i z a t i o n s in t h e s e markets;
L3 = n u m b e r of links in w h i c h t h e t w o
largest o r g a n i z a t i o n s in a g i v e n m a r k e t c o m p e t e w h e r e e i t h e r is a m o n g t h e f i v e largest
o r g a n i z a t i o n s in t h e s e m a r k e t s ;
L4 = n u m b e r o f links in w h i c h t h e t w o
largest o r g a n i z a t i o n s in t h e g i v e n market
have a c o m b i n e d m a r k e t share t h a t e x c e e d s
33 p e r c e n t of that market's three-organization
c o n c e n t r a t i o n ratio;
L5 = n u m b e r o f links in w h i c h t h e t w o
largest o r g a n i z a t i o n s in a m a r k e t c o m p e t e
where the three-organization concentration
ratio e x c e e d s 8 0 p e r c e n t ;
l_6 = n u m b e r o f links in w h i c h t h e t w o
largest b a n k s in a m a r k e t c o m p e t e w h e r e
the market's total deposits exceed $50
million;
i y = n u m b e r o f links in w h i c h t h e t w o
largest o r g a n i z a t i o n s in a m a r k e t c o m p e t e
w h e r e t h e m a r k e t s are SMSAs a n d w h e r e
b o t h are a m o n g t h e t o p f i v e o r g a n i z a t i o n s in
t h e SMSAs.
Lg = n u m b e r of links in w h i c h a n y t w o of
t h e five largest o r g a n i z a t i o n s in t h e m a r k e t
c o m p e t e w i t h e a c h o t h e r in a n o t h e r m a r k e t ;
FEDERAL RESERVE B A N K O F A T L A N T A




L9 = t h e share of t o t a l d e p o s i t s t h e t w o
largest o r g a n i z a t i o n s in a m a r k e t o b t a i n from
c o m m o n m a r k e t s — c a l c u l a t e d as a p e r c e n t
of t h e t w o organizations' total s t a t e w i d e deposits;
L-10 = u s i n g t h e five largest o r g a n i z a t i o n s
in t h e m a r k e t — t h e actual deposits any t w o
organizations obtain from c o m m o n markets
d i v i d e d b y t h e total d e p o s i t s t h e organizations
p o t e n t i a l l y c o u l d h o l d in c o m m o n .
N o t e t h a t L7 uses SMSAs as t h e u n i t of
o b s e r v a t i o n . This gives us an a l t e r n a t i v e m a r k e t
d e f i n i t i o n t o c o m p a r e w i t h t h e d e f i n e d markets.
W e u s e d a s i m p l e c o v a r i a n c e m o d e l t o test t h e
s t a b i l i t y o f t h e c o e f f i c i e n t s o v e r t h e five year
p e r i o d f r o m 1 9 7 3 - 1 9 7 7 . In a d d i t i o n t o t h e
t h e o r e t i c a l l y i n s p i r e d RRA as a p e r f o r m a n c e
m e a s u r e , RRL ( r a t e o f r e t u r n o n loans, i.e.
i n t e r e s t a n d fees o n l o a n s / t o t a l loans) a n d RPD
(rate paid o n deposits, i.e. interest paid o n
deposits/total deposits) w e r e used f o l l o w i n g
o t h e r studies. Because t h e i n t e r p r e t a t i o n s o f
t h e results using RRL or R R D are not unambiguous, w e d o n o t r e p o r t t h e results here. 6

Test and Results
The m o d e l tested took the following form:
P = f(L, H, G)
w h e r e P is t h e m a r k e t p e r f o r m a n c e v a r i a b l e
a n d t h e i n d e p e n d e n t variables are t h e l i n k e d
m e a s u r e (L), t h e m a r k e t H e r f i n d a h l c o n c e n tration index (H), a n d t h e market g r o w t h variable
(G). T h e m o d e l was run 10 t i m e s , c h a n g i n g o n l y
t h e l i n k e d m e a s u r e used. T h e results of t h e 10
runs are r e p o r t e d in T a b l e 1.
Results of t h e e m p i r i c a l test of t h e l i n k e d
o l i g o p o l y h y p o t h e s i s are r e p o r t e d in T a b l e 1,
a n d are c o n s i s t e n t w i t h t h e results r e p o r t e d b y
R h o a d e s ( 1 9 8 3 ) a n d W h i t e h e a d ( 1 9 7 8 ) ; it
found no support for the linked oligopoly hypothesis. T a b l e 1 r e p o r t s t h e results o f o n l y n i n e runs;
t h e t e n t h r u n is r e p o r t e d in T a b l e 2 a n d w i l l b e
t r e a t e d separately. T h e reason is t h a t Ly is
b a s e d o n SMSAs a n d all o t h e r runs w e r e b a s e d
o n d e f i n e d m a r k e t s as t h e u n i t of o b s e r v a t i o n .
Table 1 shows that t h e Herfindahl c o n c e n t r a t i o n

6

S e e David D. Whitehead, "An Empirical Test of the Linked Oligopoly
Theory: A n Analysis of Florida Holding Companies," P r o c e e d i n g s f r o m
a C o n f e r e n c e o n B a n k S t r u c t u r e a n d C o m p e t i t i o n , Federal Reserve
Bank of Chicago, April 27-28, 1978, pp. 119-140.

7

Table 1: 1973-77 Pooled Defined Markets/Dependent Variable RRA
Link

H

Li

G

Constant

°2

°3

°4

R7F

L

1

-.0012974
(-2.5929)a

.0050338
(6.9661 )a

-.0005092
(-.90012)

.0093168
(12.621)

-.0013073
(-2.6044)3

-.0035556
(-6.7447)3

-.003947
(-5.413)3

-.0026502
(-4.4769)a

.3034
20.231

L

2

-.00031104
(-2.4426)a

.0051067
(7.1056)3

-.00045174
(-.80265)

.0092062
(12.639)

-.0013311
( - 2 . 6 0 8 1 )a

-.0035434
(-6.7153)3

-.0030802
(—5.3832)a

-0026731
(-4.4992)a

.3017
20.075

L

3

-.00016591
(—2.4637)3

.0050572
(6.9873)a

-.00045734
(-.81234)

.0092547
(12.59)

-.0013215
(-2.6282)a

-.0035641
(-6.7504)a

-.0030897
(-5.3985)3

-.0026341
(-4.4474)3

3020
20.096

L

4

-.0027507
(—2.9992)a

.0049193
(6.8031)3

-.0052452
(-.93613)

.0094176
(12.853)

-.0013287
(-2.6558)3

-0035729
(—6.8008)3

-.0031246
(—5 482)a

-.0026706
(-4.5287)3

.3085
20.697

-.00073591
(-1.5352)

.0053447
(7.4980)3

-.0002471
(-.44462)

.0088106
(12.552)

-.001283
(-2.5382)a

-0035166
(—6.6274)a

-.0030294
(—5.269)3

-.0025726
( - 4 . 3 2 1 7)a

.2935
19.334

l

5

L

6

-.00012974
(-2.5929)3

.0050338
(6.9661 )a

-.0005092
(-.90012)

.0093168
(12.621)

-.0013073
(-2.6044)a

-.0035556
(—6.7447)3

-.0030947
(-5.413)a

-.0026502
(-4.4769)3

.3034
20.231

L

8

-000076295
(-2.7142)3

.0042946
(5 1298)3

-.0004722
(-.84259)

.0096781
(12.181)

-.0011895
(—2 3712)a

-.0034843
(-6.6243)3

-.0029803
(—5.2313)a

-.0025464
(-4.3254)3

.3049
20.363

L

9

-0015064
(-2.3074)b

.0051191
(7 0999)3

-.00044099
(-.78185)

.0092051
(12.520)

-.0012893
(-2.5635)a

-.0035522
(-6.722)3

-.0030813
(—5.3778)a

-.0026383
(-4.4451)3

.3003
19.943

a = Significant at 1%
b = Significant at 2.25%
c = Significant at 5%

Table II: Pooled 1973-77 SMSAs(only Link 7)
Dependent
Variable
RRA

L7
-.00030044
(-.82275)

H
-.0045146
(-1.3219)

G

Constant

D1

D9

.0029191
.007534
-.0018020
-.0037597
(1.6409)
(4.5955)
(-2.2726)b
<-3.9226)a

Do

DA

-.0021668
-.0010597
(~1.8536)b
(-.82574)

R7F
.3545
7.199

a = Significant at 1%
b = Significant at 2.25%
c = Significant at 5%

m e a s u r e is p o s i t i v e a n d statistically s i g n i f i c a n t
in e x p l a i n i n g v a r i a t i o n in t h e rate of r e t u r n o n
assets or profits. This is consistent w i t h traditional
t h e o r y ; as c o n c e n t r a t i o n increases, p r o f i t s increase. In a d d i t i o n , T a b l e 1 s h o w s that, w i t h t h e
e x c e p t i o n o f L5 a n d L9, all t h e l i n k e d m e a s u r e s
are s i g n i f i c a n t at t h e 1 p e r c e n t level a n d L9 is
s i g n i f i c a n t at t h e 2.25 percent level. O n l y L 5
p r o v e d insignificant, b u t t h i s v a r i a b l e relates
o n l y t o v e r y h i g h l y c o n c e n t r a t e d markets, w i t h
three-firm concentrations above 80 percent.
T h e sign of e a c h o f t h e linked measures is
negative, w h i c h suggests t h a t as t h e n u m b e r of
links increases, profits are reduced, t h e o p p o s i t e
8




f r o m w h a t is e x p e c t e d u n d e r t h e l i n k e d oligopoly
h y p o t h e s i s . It s h o u l d b e n o t e d t h a t t h e p o o l e d
cross-section a n d t i m e - s e r i e s d a t a r e s u l t e d in R
squares of a r o u n d . 3 0 — a substantial improvem e n t o v e r t h e p r e v i o u s single p e r i o d observ a t i o n . 7 T h e test f o r v a l i d i t y o f p o o l i n g crosss e c t i o n a l a n d t i m e - s e r i e s d a t a p r o v e d positive
for all links e x c e p t L 10 , w h i c h c o n f i r m e d t h e
s t a b i l i t y of t h e v a r i a b l e across t i m e . T h e r e f o r e ,

'These results are reported and interpreted in the working paper version
of this study—interested readers are encouraged to request the full
study.

JANUARY 1984, E C O N O M I C REVIEW

F|

Banking Tests of the Theory
Corwin Edwards provided the basis for this concept in
1955, calling it "mutual forebearance." 8 Elinor Solomon
on a theoretical level applied this concept to the banking
industry and called it "linked oligopoly."9 Arnold Heggestad
and Stephen Rhoades were the first to empirically test
this concept as applied to the banking industry, concluding that multimarket meetings do adversely affect the
degree of competition within markets 10 Their study suffered
a number of shortcomings, some of which are corrected
in their second empirical test of this concept. By far the
most serious shortcoming of the original study was the
use of share stability as a measure of competition or
"rivalry." The authors argued that the greater the variability
in the market shares held by the top three firms the greater
the degree of competition. No model was developed,
however, depicting share stability as even an indirect
measure of competition. As a result, the rivalry measure
cannot be uniquely interpreted. At one end of the scale,
zero change in market share of the three largest organizations in a market could be interpreted as indicating no
competition or no rivalry among these organizations. The
same zero change in market share, however, could also
indicate a high degree of rivalry in that each firm has been
perfectly successful in meeting the competitive actions
of the others, therefore having no market share change.
At the other end of the scale, a large change in the shares
of the three largest organizations could indicate that
either the competitive actions of one firm have not been
offset by the reactions of the other firms (very little rivalry)
or that all firms have been competing strongly with one
another, thus showing a sizable shifting in their market
shares. To this extent, the rivalry measure is an inappro-

priate measure of market performance that undermines the
credibility of the findings.
David Whitehead (1978) performed a second empirical
test of this theory and found no evidence supporting the
linked oligopoly hypothesis 11 Although this study corrected
the inappropriate market performance measure used by
Rhoades, it too suffered from a number of theoretical
problems resulting largely from no explicit formulation of
a model and data from only one time period This study,
however, found no support for the linked hypothesis. In
fact, in every case showing a statistically significant
relationship between market links and competitive performance, the relationship was the direct opposite of that
predicted by the linked hypothesis, i.e. the greater the
number of links, the greater the degree of competition.
Stephen Rhoades performed a third empirical test of this
hypothesis in 1983, and in marked contrast to his earlier
study found no support for the mutual forebearance or
linked hypothesis. 12 Further, although he substantially
modified his early work he offered no definitive evaluation
of the divergent results.
Given the divergent results and the importance of the
question, we devised a fourth empirical test and presented
the major findings in this article. The findings agree with
thefindings of W h i t e h e a d ^ 978) and Rhoades(1983), i.e.
the more points of contact among firms across geographic
space, the stronger the degree of competition within
each of the markets where these firms compete. This
study is superior to its predecessors in two important
respects; a model is derived that results in an unambiguous
measure of market performance, and pooled cross section
and time series data are used that allow the resulting
regression coefficients to be tested for stability. The
results, therefore, are more robust than those of earlier
studies.

8

Corwin Edwards, "Conglomerate Bigness as a Source ot Power," B u s i n e s s
C o n c e n t r a t i o n a n d P r i c e Policy, N B E R : 1 9 5 5 . pp. 331-59.
"Solomon, op. cit.
'"Arnold A Heggestad a n d S t e p h e n A Rhoades, "Multimarket Interd e p e n d e n c e a n d Local Market Competition' R e v i e w of E c o n o m i c s a n d
S t a t i s t i c s (November 1978), pp. 523-532.

the evidence from Table 1 does not support
t h e l i n k e d o l i g o p o l y h y p o t h e s i s . I n fact, it l e n d s
rather strong s u p p o r t t o the p r o p o s i t i o n that
m u l t i m a r k e t links p r o d u c e m o r e , n o t less, c o m petition.
W e c a l c u l a t e d o n e link m e a s u r e (L7) using
S M S A s as t h e m a r k e t d e f i n i t i o n in c o n t r a s t t o
d e f i n e d markets. T a b l e 2 reports t h e results
u s i n g L7 in t h e s a m e m o d e l . C o n c e n t r a t i o n i n
t h e p r o f i t s e q u a t i o n u s i n g S M S A d e f i n i t i o n s is
i n s i g n i f i c a n t , w h i l e it is h i g h l y s i g n i f i c a n t in t h e
profits e q u a t i o n using d e f i n e d markets. This
i n d i c a t e s that d e f i n e d m a r k e t s m a y b e b e t t e r

FEDERAL RESERVE B A N K O F A T L A N T A




" W h i t e h e a d , op. cit.
,2
S t e p h e n Rhoades, "The Effect of Multimarket
Market Performance a n d Rivalry." (unpublished!.

Interdependence

on

o b s e r v a t i o n u n i t s t h a n S M S A s . But m o s t i m p o r t a n t l y , L7 is n o t s t a t i s t i c a l l y s i g n i f i c a n t . A g a i n ,
this offers no s u p p o r t for t h e l i n k e d o l i g o p o l y
hypothesis.
O u r results i n d i c a t e little or n o e m p i r i c a l
s u p p o r t for t h e l i n k e d o l i g o p o l y hypothesis,
w h i c h is c o n s i s t e n t w i t h t h e f i n d i n g s o f W h i t e h e a d ( 1 9 7 8 ) a n d R h o a d e s ( 1 9 8 3 ) . In fact, t h e
e m p i r i c a l results s h o w a s t r o n g inverse relationship b e t w e e n l i n k e d measures a n d rate of
r e t u r n o n assets (profits). In o t h e r w o r d s , profits
d e c r e a s e as l i n k s i n c r e a s e , w h i c h is t h e d i r e c t
opposite of what one w o u l d expect from the
linked hypothesis.
9

Conclusions
T h e e m p i r i c a l e v i d e n c e p r e s e n t e d does not
support t h e h y p o t h e s i s t h a t m a r k e t e x t e n s i o n
activities by b a n k i n g organizations have r e d u c e d
m a r k e t c o m p e t i t i o n . O n e a p p a r e n t reason f o r
this is t h a t t h e t h e o r y is set in a f r a m e w o r k of
f e w f i r m s c o m p e t i n g in a l i m i t e d n u m b e r of
geographic markets, w h i l e t h e b a n k i n g industry
e v e n w i t h i n states is characterized by a relatively
large n u m b e r o f c o m p e t i t o r s increasingly capable of entering dispersed geographic markets.
C o u p l e this w i t h t h e lack of scale e c o n o m i e s
f o u n d in t h e b a n k i n g i n d u s t r y a n d it b e c o m e s
clear t h a t e v e n r e l a t i v e l y small c o m p e t i t o r s may
b e i n f l u e n t i a l in g i v e n markets. This again
w o u l d suggest that collusion and tacit agreements
in t h e b a n k i n g i n d u s t r y w o u l d b e e x t r e m e l y
d i f f i c u l t t o i n i t i a t e or m a i n t a i n .

"The empirical e v i d e n c e - d o e s not
support the hypothesis that market
extension activities by banking
organizations have reduced market
competition."

T h e results s e e m t o s u p p o r t t h r e e m a j o r
c o n c l u s i o n s . First, o n a practical level, m u l t i market links d o affect t h e degree of c o m p e t i t i o n
w i t h i n r e l e v a n t geographic banking markets in
Florida. Every l i n k e d measure used e x c e p t t w o
s h o w e d a statistically significant negative relationship t o our measure of profits in d e f i n e d markets.
S e c o n d , o n t h e t h e o r e t i c a l level, w e f o u n d n o
e v i d e n c e that w o u l d s u p p o r t t h e l i n k e d o l i g o p o l y
hypothesis unambiguously. In fact, our findings
s u p p o r t t h e o p p o s i t e a s s u m p t i o n — t h a t is, as
t h e n u m b e r o f links b e t w e e n firms increases,
t h e degree of c o m p e t i t i o n b e t w e e n those firms
increases.

10




This s e e m s t o b e r e a s o n a b l e b e h a v i o r , e v e n
on theoretical grounds, w h e n t h e firms' multim a r k e t e x p a n s i o n a c t i v i t y is c o n s t r a i n e d t o a
single state. This c o n s t r a i n t limits t h e n u m b e r
of p o t e n t i a l m a r k e t s f i r m s m a y e n t e r a n d ,
h e n c e , increases t h e p o t e n t i a l t h a t a g i v e n
n u m b e r of m u l t i m a r k e t organizations m a y serve
all markets. At t h e e x t r e m e , all m u l t i m a r k e t
f i r m s m a y m e e t in all markets; t h e r e f o r e , all o f
t h e i r sales or d e p o s i t s m a y b e d e r i v e d f r o m
m u t u a l markets. M u l t i m a r k e t f i r m s w o u l d t h e n
find themselves in very m u c h t h e same position
as in a single m a r k e t : c o m p e t i n g for a l i m i t e d
n u m b e r of c o m m o n customers. The c o m p e t i t i o n
in any m a r k e t w o u l d t h e n d e p e n d o n t h e
r e l a t i v e size d i s t r i b u t i o n of all m u l t i m a r k e t
firms a n d n o t o n t h e n u m b e r of c o n t a c t points.
This observation leads t o our t h i r d conclusion,
that, j u d g i n g f r o m t h e Florida experience, multim a r k e t links b e t w e e n organizations t e n d t o
increase t h e d e g r e e of c o m p e t i t i o n w i t h i n
relevant geographic banking markets. Given
t h e large n u m b e r o f m u l t i m a r k e t o r g a n i z a t i o n s
in Florida a n d t h e i r relative size d i s t r i b u t i o n ,
this i n d i c a t e s that a policy of m a x i m i z i n g multim a r k e t m e e t i n g p o i n t s has p r o v e d t o b e desira b l e in t h a t state.
If g e o g r a p h i c barriers t o i n t e r s t a t e b a n k i n g
are r e m o v e d , links a m o n g b a n k i n g organizations
n a t i o n w i d e m a y increase. T o t h e extent that o u r
f i n d i n g s in Florida m a y b e applicable across t h e
n a t i o n , b a n k i n g c o m p e t i t i o n w o u l d increase.
T h e n a t i o n is s t a r t i n g w i t h a b a n k i n g s t r u c t u r e
r e s e m b l i n g t h a t o f Florida in t h e early 1 9 7 0 s —
large n u m b e r s of geographically dispersed c o m petitors. T h e r e f o r e , it s e e m s r e a s o n a b l e t o
c o n c l u d e t h a t legislative c h a n g e s t h a t increase
t h e n u m b e r of markets in w h i c h major firms
c o m p e t e t h r o u g h o u t t h e n a t i o n are likely t o
increase t h e level o f c o m p e t i t i o n .

— David D. W h i t e h e a d
and Jan Luytjes

JANUARY 1984, E C O N O M I C

REVIEW

Deficits and Monetary Growth
Despite low current inflation, the historic links between federal deficits and
monetary growth may have influenced last year's market expectations of future
increases in inflation.
W h a t d o e s a $ 2 0 0 b i l l i o n f e d e r a l d e f i c i t in 1 9 8 3
and a p r o j e c t e d n e a r - r e p e a t in 1 9 8 4 i m p l y f o r
U.S. i n t e r e s t rates a n d inflation? This article w i l l
look at t h e Reagan a d m i n i s t r a t i o n ' s m i d - 1 9 8 3
b u d g e t p r o j e c t i o n s f o r 1 9 8 3 a n d 1 9 8 4 . It w i l l
trace past a n d p r o s p e c t i v e d e f i c i t f i n a n c i n g
t h r o u g h t o p r i v a t e savings a n d i n v e s t m e n t in t h e
n a t i o n a l i n c o m e a c c o u n t s a n d t o c h a n g e s in t h e
c o m p o s i t i o n of t h e o u t s t a n d i n g f e d e r a l d e b t .
O u r s t u d y suggests that t h e r e c o r d of previous
links b e t w e e n f e d e r a l d e f i c i t s a n d m o n e t a r y
g r o w t h m a y h a v e f o r m e d t h e basis f o r m a r k e t
expectations in 1983 of future increases in inflation
despite l o w current inflation.
O v e r t h e p o s t - W o r l d W a r II p e r i o d , a o n e
p e r c e n t a g e p o i n t increase in t h e d e f i c i t r e l a t i v e
t o C N P has b e e n a s s o c i a t e d o n t h e average w i t h
a b o u t a o n e a n d o n e half p e r c e n t a g e p o i n t
increase in m o n e t a r y g r o w t h ( M l ) . This g r o w t h
in t u r n has b e e n a s s o c i a t e d w i t h a b o u t t h e s a m e
increase in i n f l a t i o n a f t e r a lag of m o r e t h a n t w o
years. T h e a d m i n i s t r a t i o n ' s p r o j e c t e d d e f i c i t s o f
r o u g h l y 6 p e r c e n t of G N P in 1 9 8 3 a n d 1 9 8 4
w o u l d , if past r e l a t i o n s h i p s w e r e r e p e a t e d , b e
associated w i t h a 9 p e r c e n t g r o w t h in b o t h M l
a n d i n f l a t i o n . Since a 9 p e r c e n t i n f l a t i o n rate is
a b o u t t w i c e t h e rate o b s e r v e d t h r o u g h m o s t o f

FEDERAL RESERVE B A N K O F A T L A N T A




1983, t h e historical record implies that inflation
c o u l d b e e x p e c t e d t o d o u b l e — a forecast roughly
in l i n e w i t h t h e t e r m s t r u c t u r e o f i n t e r e s t rates
last year. L o n g - t e r m g o v e r n m e n t b o n d rates
h o v e r e d a r o u n d a 12 p e r c e n t a n n u a l rate, rep r e s e n t i n g r o u g h l y a 3 p e r c e n t real y i e l d if
i n f l a t i o n w e r e t o persist a t 9 p e r c e n t f o r thQ life of
the bonds. O n t h e other hand, t h r e e - m o n t h
Treasury bills w e r e y i e l d i n g a b o u t 9 p e r c e n t ,
r e p r e s e n t i n g a real y i e l d o f 4 p e r c e n t g i v e n t h e
c u r r e n t i n f l a t i o n rate of a p p r o x i m a t e l y 5 p e r c e n t .
Expectations of m o n e t a r y g r o w t h a n d inflation,
as t h e y h a v e b e e n l i n k e d h i s t o r i c a l l y t o d e f i c i t s ,
a p p a r e n t l y w e r e an i m p o r t a n t f a c t o r a c c o u n t i n g
for high l o n g - t e r m yields in 1 9 8 3 . W h e t h e r history
has t o b e r e p e a t e d d e p e n d s o n t h e w i l l i n g n e s s
a n d a b i l i t y of U.S. e c o n o m i c p o l i c y e i t h e r t o
r e d u c e d e f i c i t s or t o b r e a k t h e i r link t o m o n e t a r y
g r o w t h . In o t h e r places a n d at o t h e r t i m e s ,
deficits have had but limited effects o n interest
rates a n d i n f l a t i o n , so t h e r e is h o p e t h a t t h e
i n f l a t i o n a r y p o t e n t i a l of u n p r e c e d e n t e d d e f i c i t s
might be contained.

Real Deficits and Real Interest Rates
A n a r t i c l e in t h e J a n u a r y 1 9 8 3 Economic
Review p r e s e n t e d e v i d e n c e t h a t t h r o u g h 1 9 8 1
11

Must Deficits Cause Inflation?
T a b l e 1 . Inflation, Real Déficits, a n d Real Interest R a t e s
(Percent)

3
Real Deficit
Year

Inflation

1981

8.9

1982

4.4

3.2

1983

4.6a

4.7C

1984

5.03

3.8°

a

High Employment G N P

Month

T r e a s u r y Bill R a t e
Nominal

Real

14.1

5.2

10.7

6.3

9.3°

4.7

M i d - S e s s i o n Review of the 1 9 8 4 B u d g e t Office of Management a n d

Budget, July 25, I983.
b

Assumes inflation was correctly anticipated.

C a l c u l a t e d based on economic assumption of a 3.0 percent growth rate in
high e m p l o y m e n t real output in 1982 a n d 3.5 percent in 1 9 8 3 a n d 1984.
d

J u l y 1.

real f e d e r a l d e f i c i t s a d j u s t e d for i n f l a t i o n prem i u m s in i n t e r e s t rates h a d m a d e o n l y a small
i m p a c t o n real interest rates similarly adjusted. 1 It
e s t i m a t e d f r o m t h e historical r e c o r d t h a t a o n e
p e r c e n t a g e p o i n t increase in t h e real d e f i c i t
r e l a t i v e t o h i g h e m p l o y m e n t G N P w o u l d raise
real rates r o u g h l y o n e p e r c e n t a g e p o i n t .

Real Deficits and Inflation
I n f l a t i o n d e c e l e r a t e d in 1 9 8 2 a n d i n t o 1 9 8 3
d e s p i t e large f e d e r a l deficits, p r o v i d i n g e v i d e n c e
t h a t large deficits n e e d n o t always b e inflationary.
T a b l e 1 s h o w s t h a t t h e r e l a t i v e real d e f i c i t rose t o
3.2 p e r c e n t in 1 9 8 2 f r o m z e r o in 1 9 8 1 , y e t
i n f l a t i o n fell f r o m 8.9 p e r c e n t t o 4.4 p e r c e n t 2
W h a t a b o u t t h e future? T a b l e 1 r e c o r d s a c t u a l
data for 1981 and 1 9 8 2 and data based o n mid1983 administration forecasts for 1 9 8 3 and 1984.
T h e p r o j e c t e d $ 2 0 0 b i l l i o n deficits w o u l d raise
r e l a t i v e real deficits, b u t n o t t o an u n p r e c e d e n t e d
d e g r e e . T h e d e f i c i t w a s t h a t high b r i e f l y d u r i n g
t h e 1 9 7 5 r e c o v e r y p e r i o d , a n d in W o r l d W a r II
t h e d e f i c i t rose t o an e n o r m o u s 25 p e r c e n t of
GNP.

'William G. Dewald. "Federal Deficits a n d Real Interest Rates: Theory a n d
Evidence,' Federal Reserve Bankof Atlanta E c o n o m i c R e v i e w ( J a n u a r y
1983), 20-29.
2
The relative real deficit is defined as:
2

°2

_ D E F -PE(DEBT)
YF

12




Historically, m a j o r i n f l a t i o n a r y p e r i o d s o f t e n
have b e e n a s s o c i a t e d w i t h g o v e r n m e n t deficits,
i n c l u d i n g e v e r y w a r t i m e e x p e r i e n c e in A m e r i c a n
history. O t h e r e x a m p l e s can b e f o u n d in t h e
h y p e r i n f l a t i o n s o f r e c e n t years in several Latin
A m e r i c a n c o u n t r i e s a n d in Israel. But t h e s e
examples d o not prove that inflation might not
o c c u r e v e n if t h e g o v e r n m e n t b u d g e t w e r e
b a l a n c e d nor t h a t i n f l a t i o n m u s t a c c o m p a n y
deficits. I n f l a t i o n f l a r e d in t h e d e c a d e s b e f o r e
W o r l d W a r I even t h o u g h b u d g e t s w e r e essentially
b a l a n c e d . T h a t i n f l a t i o n was largely a conseq u e n c e of increases in t h e w o r l d s u p p l y of n e w l y
m i n e d gold.
I n f l a t i o n can o c c u r w i t h o u t deficits. In t h e
1 9 7 0 s b o t h W e s t G e r m a n y a n d Japan experie n c e d m u c h larger g o v e r n m e n t b u d g e t d e f i c i t s
relative t o t h e i r national i n c o m e s t h a n t h e U n i t e d
States, b u t n e i t h e r h a d as m u c h inflation. A n o t h e r
e x a m p l e is T h e G r e a t D e p r e s s i o n of t h e 1 9 3 0 s ,
w h e n rising d e f i c i t s w e r e a c c o m p a n i e d b y deflation. B o t h t h e d e f i c i t a n d d e f l a t i o n w e r e acc o u n t a b l e t o a d e c l i n e in n a t i o n a l i n c o m e . Thus,
d e f i c i t s n e e d n o t cause i n f l a t i o n .

Structural Deficits
o

T h e s i t u a t i o n in t h e U n i t e d States in 1 9 8 1 a n d
1982 had s o m e similarities t o t h e 1930s: dt-N
c e l e r a t e d m o n e t a r y g r o w t h was a c c o m p a n i e d b \
d e c l i n i n g n a t i o n a l i n c o m e , excess p r o d u c t i v e
capacity a n d disinflation, w h i l e t h e federal deficit
rose r e l a t i v e t o n a t i o n a l i n c o m e . Taxes fell because o f t h e s h o r t f a l l of i n c o m e b e l o w its highe m p l o y m e n t level, a n d part o f t h e increase ir
g o v e r n m e n t s p e n d i n g w a s a t t r i b u t a b l e t o the
p a y m e n t of i n c r e a s e d u n e m p l o y m e n t c o m p e n sation a n d o t h e r assistance related t o t h e recession
Thus, at least s o m e of t h e d e f i c i t w a s c a u s e d b1.
t h e recession. W h a t w o r r i e s m a n y e c o n o m i s t s
t o d a y is t h e m a g n i t u d e o f t h e s t r u c t u r a l d e f i c i t ,
w h i c h w o u l d r e m a i n e v e n a f t e r slack in t h e
e c o n o m y is a b s o r b e d a n d f u l l e m p l o y m e n t res t o r e d . T h e s t r u c t u r a l d e f i c i t was $ 3 3 b i l l i o n in
1 9 8 2 . That was its highest level since t h e structural

DEF = National Income Accounts Deficit
PE = Expected Inflation
DEBT = Net Federal Debt
YF = High Employment GNP
The real interest rate is defined as:
S = TBR - PE
TBR = Three month Treasury Bill Rate

JANUARY 1984, E C O N O M I C REVIEW

F

T a b l e 2 . Federal Deficits - Fiscal Y e a r s
(Billions of Dollars)
Nominal3

Year

Current
Services
Basis

1983
1984

226
217

Realb

Structural

Current
Services
Basis

154
181

166
137

Structural

Inflation0
(Percent
per Year)

Federal0
Debt

97
104

4.6
5.0

1145
1339

a

Sources: Current Services Basis: Office of M a n a g e m e n t a n d Budget, Mid-Session Review of the 1984 Budget, July 2 5 , 1 9 8 3 , p. 20. Structural Deficit: Budget
of the United States Government, Fiscal Year 1984,2-18. ( 1 9 8 2 data cited in text is from Fedeal Reserve Bank of St. Louis M o n e t a r y T r e n d s , A u g u s t 1983.)
b

R e a l Deficit: = (Deficit - Inflation Rate x Federal Debt)/GNP Deflator, 1 9 8 2 = 100.

""Source: Office of M a n a g e m e n t a n d the Budget, Mid-Session Review of the 1 9 8 4 Budget, July 25, I983, p. 5. Fourth quarter over a year earlier.
d

S o u r c e : Ibid., p. 45. Federal Debt Outstanding Held by t h e P u b l i c

d e f i c i t o f m o r e t h a n $ 2 8 b i l l i o n in 1 9 7 5 , a f t e r t h e
Ford a d m i n i s t r a t i o n h a d i n t r o d u c e d a t e m p o r a r y
tax cut at t h e b o t t o m of t h e 1 9 7 4 - 1 9 7 5 recession.
In b o t h 1975 and 1 9 8 2 , inflation d e c l i n e d d e s p i t e
increased structural deficits. H o w e v e r , these w e r e
•- .mall c o m p a r e d w i t h t h e p r o j e c t e d s t r u c t u r a l
d e f i c i t s o f o v e r $1 5 0 b i l l i o n a year b e g i n n i n g in
1 9 8 3 ( T a b l e 2). Even real s t r u c t u r a l d e f i c i t s are
c a l c u l a t e d t o b e in t h e n e i g h b o r h o o d of $ 1 0 0
billion. A s s u m i n g t h e p r o j e c t e d figures are correct,
t h e q u e s t i o n is w h e t h e r s u c h d e f i c i t s c o u l d b e
financed w i t h o u t rekindling inflation.

Financing Deficits and the
¿National Income Accounts
It is a b s o l u t e l y necessary t h a t a f e d e r a l d e f i c i t
be e x t r a c t e d f r o m t h e e c o n o m y e i t h e r b y h i g h e r
real i n t e r e s t rates o r b y u n e x p e c t e d i n f l a t i o n . A
g o v e r n m e n t b u d g e t d e f i c i t is f i n a n c e d b y n e t
saving, d e f i n e d t o i n c l u d e n o t o n l y p r i v a t e saving
less i n v e s t m e n t b u t also n e t saving b y state a n d
local g o v e r n m e n t s a n d n e t f o r e i g n i n v e s t m e n t in
t h e U n i t e d States. As s h o w n in T a b l e 3, t h e
$ 1 4 7 . 0 b i l l i o n f e d e r a l b u d g e t d e f i c i t in c a l e n d a r
y e a r 1 9 8 2 was f i n a n c e d b y a $ 3 1 . 2 b i l l i o n s u r p l u s
of state a n d local g o v e r n m e n t s , $8.8 b i l l i o n n e t
i n v e s t m e n t b y f o r e i g n e r s in t h e U n i t e d States,
and a $ 1 0 7 b i l l i o n excess o f p r i v a t e saving o v e r
i n v e s t m e n t . T h e $ 8 4 . 8 b i l l i o n increase in t h e
d e f i c i t in 1 9 8 2 was f i n a n c e d p a r t l y b y a $ 1 6 . 5
b i l l i o n increase in n e t f o r e i g n i n v e s t m e n t in t h e

FEDERAL RESERVE B A N K O F A T L A N T A




U n i t e d States, b u t m a i n l y b y a $ 1 2 . 0 b i l l i o n
increase in p r i v a t e saving a n d a $ 6 0 . 4 b i l l i o n
decrease in p r i v a t e i n v e s t m e n t . In an a c c o u n t i n g
sense, f e d e r a l b u d g e t d e f i c i t s m u s t b e f i n a n c e d
either by c r o w d i n g o u t investment or c r o w d i n g
in saving. S o m e insights w i t h r e s p e c t t o t h e
e c o n o m i c s of f i n a n c i n g a d e f i c i t are r e v e a l e d b y
w h o buys t h e d e b t t h a t t h e f e d e r a l g o v e r n m e n t
issues.

The Net Federal Debt: What Is It?
Federal b u d g e t d e f i c i t s are n o t r e f l e c t e d precisely in f e d e r a l d e b t changes. Part o f t h e d e f i c i t
can b e f i n a n c e d b y t h e Federal Reserve's issuance
o f n o n i n t e r e s t b e a r i n g m o n e y in e x c h a n g e for
f e d e r a l d e b t i n s t r u m e n t s t h a t are n o t i n c l u d e d in
t h e p u b l i c d e b t . T h e r e is also a c o n c e r n w h e t h e r
deficits reflect t r u e changes in o u t s t a n d i n g federal
p r o m i s e s t o pay m o n e y in t h e f u t u r e . T h e o f f i c i a l
public debt does not include off-budget lending,
g o v e r n m e n t loan guarantees, or d e b t i m p l i c i t in
e n t i t l e m e n t programs. D e s p i t e t h e a m b i g u i t y
associated w i t h d e f i n i n g t h e true federal d e b t
p o s i t i o n , t h o u g h , t h e o f f i c i a l figures are m e a n i n g f u l f o r several reasons:
• S i n c e o f f - b u d g e t l e n d i n g is f i n a n c e d b y
b o r r o w i n g , it r e p r e s e n t s m a i n l y f i n a n c i a l interm e d i a t i o n except insofarasthere isan interest
rate s u b s i d y t h a t w o u l d b e t r e a t e d as a n
o r d i n a r y e x p e n d i t u r e . Thus, w h e n t h e g o v e r n m e n t b o r r o w s t o lend, its n e t d e b t is largely
unaltered.
13

T a b l e 3 . Deficits, Savings, a n d I n v e s t m e n t in t h e
National Income Accounts

1981

1982

1982
Change3

1983 k

Federal Deficits

62.2

147.0

+84.8

174.7

+27.7

State and Local
Government Surplus

35.3

31.2

-4.1

46.0

+14.8

N e t F o r e i g n I n v e s t m e n t in
the United States and
Statistical D i s c r e p a n c y

1983
Change3

-7.7

8.8

+16.5

17.7

+8.9

G r o s s Private S a v i n g
Personal
Business

135.3
374.2

125.4
396.1

-9.9
+21.9

106.6
431.5

-18.8
+35.4

Less:
G r o s s Private I n v e s t m e n t

509.5

521.5

+12.0

538.1

+16.6

474.9

414.5

-60.4

427.1

+12.6

62.2

147.0

+84.8

174.7

+27.7

Source: B u s i n e s s C o n d i t i o n s D i g e s t U.S. Dept of Commerce, BEA S e p t 1983
^ C h a n g e from previous year.
Based on the first t w o quarters of 1983.

• Loan guarantees r e q u i r e g o v e r n m e n t financi n g if i m p l e m e n t e d , b u t n o t o t h e r w i s e . T h e
guarantees doubtless have s o m e e x p e c t e d
v a l u e , b u t o v e r t h e years o n l y a c t u a l p a y m e n t s
m a d e u n d e r g u a r a n t e e s are r e f l e c t e d i n t h e
net debt.
• Entitlement programs entail prospective
e x p e n d i t u r e s u n d e r a u t h o r i z e d p r o g r a m s . So
l o n g as a p r o g r a m e x i s t s — u n e m p l o y m e n t c o m p e n s a t i o n o r Social S e c u r i t y p a y m e n t s f o r
e x a m p l e — i t r e p r e s e n t s a f e d e r a l liability. O f
course, t h e g o v e r n m e n t is a l w a y s i n a p o s i t i o n
to change the entitlement.
The official public d e b t reflecting only actual
p a y m e n t s a n d r e c e i p t s is t h u s a r e a s o n a b l e
measure of the federal government's outstanding
debt

The Net Federal Debt:
W h o Holds It?
As s h o w n i n T a b l e 4, t h e p u b l i c d e b t h e l d
p r i v a t e l y t o t a l e d $ 9 8 2 . 7 b i l l i o n in S e p t e m b e r
1983, u p $134.3 billion over t h e calendar year 1982.
14




T h e d e b t h a d i n c r e a s e d $ 7 8 . 1 b i l l i o n in 1 9 8 1 a n d
b y n e a r l y $ 4 0 0 b i l l i o n f r o m 1 9 7 0 t o 1 9 8 0 , nearly
t r i p l i n g . W h o h e l d it? Banks h a d a c c u m u l a t e d
$ 1 7 6 billion b y 1983, b u t they actually had cut
t h e i r share of t o t a l h o l d i n g s t o 1 8 p e r c e n t , d o w n
f r o m m o r e t h a n 2 7 p e r c e n t in 1 9 7 0 . I n d i v i d u a l s
and nonfinancial corporations cut their holdings
f r o m m o r e t h a n 4 0 p e r c e n t of t h e t o t a l in 1 9 7 0 t o
a b o u t 2 0 p e r c e n t in 1 9 8 3 .
F r o m 1 9 7 0 t o 1 9 8 0 t h e b i g r e l a t i v e increase
was by foreign a n d i n t e r n a t i o n a l investors, w h o s e
d e b t h o l d i n g s g r e w f r o m o n l y $ 2 0 . 6 b i l l i o n in
1 9 7 0 to $127.7 billion in 1980, m o r e than a
s i x f o l d increase. O f t h e $ 3 8 6 . 5 b i l l i o n increase in
t h e net federal d e b t f r o m 1 9 7 0 t o 1980, foreign
a n d international investors a c q u i r e d $107.1 billion,
m u c h m o r e t h a n i n v e s t o r s in a n y o t h e r category.
T h a t p a t t e r n d i d n o t c o n t i n u e in 1 9 8 1 a n d 1 9 8 2 ,
h o w e v e r . H a r d pressed b e c a u s e of t h e w o r l d w i d e
r e c e s s i o n a n d a p p r e c i a t i o n of t h e U.S. dollar,
foreign a n d international investors t o o k only
1 8 p e r c e n t o f p u b l i c d e b t o f f e r i n g in 1 9 8 2
in c o n t r a s t t o 2 1 p e r c e n t f r o m 1 9 7 0 t o 1 9 8 0 .
C o n s e q u e n t l y , p a r t o f t h e p r o b l e m in f i n a n c i n g
large f e d e r a l d e f i c i t s t h e last c o u p l e o f years has

J A N U A R Y 1984, E C O N O M I C

REVIEW

1

Table 4 . Public Debt Securities Held by Private Investors
(Billions of Dollars)
Year End

Commercial Banks
Mutual Savings Banks
Insurance Companies
Other Companies
Individuals
Savings Bonds
Other Securities g
Other Miscellaneous
State and Local
Governments
Foreign and
International
Total

1982

Percent

1983c

Percent

15.8
0.7
2.8
5.4

131.4

15.5

176.3

17.9

39.1

4.6

68.0
75.6
152.3

9.8
10.9
21.9

68.3
48.2
H
231.5°

8.1
5.7
27.3

12.8

85.6

12.3

1 13.4p

13.4

127.7

20.7

141.4

20.4

149.4

17.6

616.4

100.0

694.5

100.0

848.4

100.0

1970

Percent

1980

Percent

1981

Percent

62.7
2.8
7.0
10.5

27.3
1.2
3.0
4.6

116.0
5.4
20.1
25.7

18.8
0.9
3.3
4.2

109.4
5.2
19.1
37.8

52.1
29.8
21.4

22.7
13.0
9.3

72.5
56.7
106.9

11.8
9.2
17.3

23.1

10.0

78.8

20.6

9.0

229.9

100.0

70.6p
57.9p

7.2
5.9

1 60.8 p

16.4

982.7

100.0

i n c l u d e s savings and loan associations, nonprofit institutions, corporate pension trust funds, dealers a n d brokers, certain government deposit accounts, and
government sponsored a g e n c i e s
" i n c l u d e s " a ' plus credit unions a n d mutual savings banks.
c
t h r o u g h September, 1983.
p = preliminary
Source: F e d e r a l Reserve B u l l e t i n . 1 9 7 0 (FRB, September 1972), 1980-82 (FRB. May 1983) a n d T r e a s u r y B u l l e t i n , 4 t h Quarter. Fiscal Year 1983.

b e e n t h a t t h e f e d e r a l g o v e r n m e n t was f o r c e d t o
turn increasingly t o t h e private d o m e s t i c e c o n o m y
to a b s o r b f e d e r a l d e b t issues, c r o w d i n g f e d e r a l
securities i n t o p r i v a t e p o r t f o l i o s . N e v e r t h e l e s s ,
c o m p a r a t i v e l y high U.S. real i n t e r e s t rates cont i n u e d t o a t t r a c t f o r e i g n c a p i t a l in 1 9 8 3 a n d
c o n t r i b u t e d t o a p p r e c i a t i o n of t h e d o l l a r in t e r m s
of f o r e i g n c u r r e n c i e s d e s p i t e a large c u r r e n t
account deficit.

T h a t t h e g o v e r n m e n t can f i n a n c e a $ 2 0 0
b i l l i o n f e d e r a l d e f i c i t in 1 9 8 4 is a c e r t a i n t y . Both
f o r e i g n investors a n d state a n d local g o v e r n m e n t s can b e e x p e c t e d t o a b s o r b an i n c r e a s i n g
f r a c t i o n o f f e d e r a l d e b t as r e c o v e r y f r o m t h e
e c o n o m i c d o l d r u m s of 1 9 8 0 - 8 2 continues. Private
saving t o o can b e e x p e c t e d t o rise a l o n g w i t h
n a t i o n a l i n c o m e a n d as n e w tax i n c e n t i v e s encourage thrift.

Individual investors divested many of their
g o v e r n m e n t s e c u r i t i e s h o l d i n g s in 1 9 8 2 a n d
1983. These securities w e r e a b s o r b e d by insurance
c o m p a n i e s a n d other institutional investors such
as p e n s i o n funds, savings and loan associations,
and especially m o n e y market m u t u a l funds
( M M M F s ) . T h e latter h a d g r o w n s p e c t a c u l a r l y
u n t i l b a n k s late in 1 9 8 2 b e g a n issuing m o n e y
market deposit accounts ( M M D A s ) , w h i c h then
i n c r e a s e d e x p l o s i v e l y in t h e first half o f 1 9 8 3 .
Both M M M F a n d M M D A a c c o u n t s p r o v e d
e n o r m o u s l y popular savings repositories, p r o v i d i n g
issuing i n s t i t u t i o n s t h e f u n d s t o invest h e a v i l y in
highly l i q u i d short-term instruments i n c l u d i n g
g o v e r n m e n t securities.

Financing Deficits and Federal Reserve
O p e n Market Operations

FEDERAL RESERVE B A N K O F A T L A N T A




T a b l e 5 r e c o r d s t h e a c t u a l b u d g e t d e f i c i t for
fiscal 1 9 8 2 a l o n g w i t h e s t i m a t e s of its f i n a n c i n g .
Even m o r e b o r r o w i n g t h a n t h e S i 2 8 b i l l i o n 1 9 8 2
d e f i c i t w a s r e q u i r e d b e c a u s e o f a $7 b i l l i o n
increase in t h e Treasury's net holdings of m o n e t a r y
assets in v a r i o u s a c c o u n t s . O f t h e t o t a l S I 3 5
b i l l i o n b o r r o w i n g r e q u i r e m e n t , $ 1 0 b i l l i o n was
p u r c h a s e d b y t h e Federal Reserve in t h e o p e n
m a r k e t a n d a c c u m u l a t e d in its Federal O p e n
M a r k e t A c c o u n t , w h i c h t o t a l e d S I 3 4 b i l l i o n at
t h e e n d o f fiscal 1 9 8 2 . T h e a c c o u n t also i n c l u d e d
$ 1 0 b i l l i o n in f e d e r a l a g e n c y securities. T h e
15

T a b l e 5 . B u d g e t Financing
(Billions of Dollars)
Fiscal Years
1981
Actual
Deficit
M e a n s of Treasury Financing O t h e r
T h a n B o r r o w i n g from t h e P u b l i c 3
C h a n g e in Federal Reserve H o l d i n g s
of Federal D e b t
Total R e q u i r e m e n t for B o r r o w i n g
From O t h e r s

Treasury Debt H e l d by Federal
Reserve
Others

124
670

1982
Actual

1983
Actual

1984
Estimate

-128

-208

-203

-7

-5

0

+10

+21

+125

+192b

+(203-?)

134
795

155b
987b

1 55+?
1190-?

b

+? c

Sources: Budget of the United States Government, Fiscal Year 1984, 9 - 1 3 and Federal Reserve Bulletin, November 1983.
a

S e i g n o r a g e on c o i n s (+), Increase in Treasury Cash and Monetary Assets ( - ) , a n d Increase in Treasury liabilities for checks outstanding and deposit fund
balances.
b
Calculated by the author from budget figures.
C

T h e question mark indicates the u n k n o w n quantity of g o v e r n m e n t securities t o be purchased by the Federal Reserve in fiscal 1984.

Federal Reserve's a c c u m u l a t i o n of t h e s e assets
o v e r t h e years has c r e a t e d o v e r 8 0 p e r c e n t of t h e
m o n e t a r y base. It consists of b a n k reserves o n
d e p o s i t w i t h Federal Reserve Banks a n d c u r r e n c y
in c i r c u l a t i o n . T h e m o n e t a r y base in t u r n has
b e e n t h e m a i n m o n e t a r y policy factor i n f l u e n c i n g
t h e d e t e r m i n a t i o n of M l m o n e y — c o n s i s t i n g o f
the c h e c k i n g accounts and currency holdings of
t h e p u b l i c — a n d in t u r n b r o a d e r m o n e t a r y aggregates a n d t o t a l d e m a n d in t h e e c o n o m y .
T h e a c t u a l fiscal 1 9 8 3 d e f i c i t r e c o r d e d in T a b l e
5 is $ 2 0 8 b i l l i o n . But t h e Treasury's b o r r o w i n g
r e q u i r e m e n t is d i f f e r e n t b e c a u s e o f t w o factors.
O n e is t h e Treasury's n e t a c c u m u l a t i o n in its
m o n e t a r y a c c o u n t s of $5 b i l l i o n . T h e o t h e r i s n e w
base m o n e y issued b y t h e Federal Reserve in
exchange for g o v e r n m e n t securities of $21 billion,
w h i c h reduces t h e a m o u n t of securities t h e
T r e a s u r y m u s t sell t o o t h e r s . B o t h are e l e m e n t s o f
" f i a t m o n e y " — t h e base m o n e y t h a t m o n e t a r y
a u t h o r i t i e s issue t o a l l o w t h e g o v e r n m e n t t o
s p e n d m o r e t h a n it t a k e s in taxes a n d sales of
securities. In 1 9 8 3 t h e r e was a s u b s t a n t i a l l y
larger increase in fiat m o n e y t h a n in 1 9 8 2 .
16




W h e t h e r t h e p a t t e r n is r e p e a t e d again in 1 9 8 4
has i m p o r t a n t c o n s e q u e n c e s f o r i n f l a t i o n and, in
t u r n , for i n t e r e s t rates. T a b l e 5 s h o w s t h a t t h e
p r o j e c t e d b o r r o w i n g r e q u i r e m e n t in 1 9 8 4 m a y
b e a b o u t t h e s a m e as in 1 9 8 3 .
T a b l e 5 is p a r a d o x i c a l if n o t m i s l e a d i n g . It
i n d i c a t e s t h a t t h e m o r e securities t h e Federal
Reserve buys, t h e s m a l l e r t h e Treasury's requirem e n t for b o r r o w i n g f r o m o t h e r s a n d t h u s t h e
l o w e r interest rates w o u l d be. That interpretation is
simply wrong. It overlooks t h e f e e d b a c k of Federal
Reserve p u r c h a s e s o f s e c u r i t i e s o n m o n e t a r y
g r o w t h , i n f l a t i o n , a n d i n t e r e s t rates. T h e m o r e
s e c u r i t i e s t h e Federal Reserve b u y s a n d t h e
m o r e m o n e t a r y g r o w t h it p e r m i t s , t h e h i g h e r t h e
i n f l a t i o n rate t e n d s t o be, at least after t h e
e s t i m a t e d t w o years it takes m a r k e t s t o a d j u s t t o
a c c e l e r a t e d m o n e t a r y g r o w t h . Insofar as h i g h e r
i n f l a t i o n is r e f l e c t e d in i n f l a t i o n p r e m i u m s in
i n t e r e s t rates p a i d o n t h e f e d e r a l d e b t , t h e larger
t h e d e f i c i t a n d t h e Treasury b o r r o w i n g r e q u i r e m e n t w i l l be. For a g i v e n f e d e r a l d e f i c i t , it is t r u e
t h a t t h e m o r e securities t h e Federal Reserve
buys, t h e less t h e Treasury n e e d s t o b o r r o w f r o m

JANUARY 1984, E C O N O M I C REVIEW

F|

t h e p u b l i c . T h a t a p p e a r a n c e , r e f l e c t e d in T a b l e 5,
is d e c e p t i v e b e c a u s e Federal Reserve s e c u r i t i e s
purchases w o u l d a f f e c t i n f l a t i o n a n d i n t e r e s t
rates a n d t h e r e b y increase t h e d e f i c i t . It w o u l d
not r e m a i n u n c h a n g e d — a s T a b l e 5 i m p l i e s — i f
the Federal Reserve i n c r e a s e d its p u r c h a s e s o f
Treasury securities.
W i t h r e s p e c t t o T a b l e 5, causality m a y run
either f r o m increases in Federal Reserve purchases of s e c u r i t i e s t o d e f i c i t s or v i c e versa. I n t h e
latter case a f e d e r a l d e f i c i t a n d t h e p r o s p e c t of
rising i n t e r e s t rates m i g h t i n d u c e t h e Federal
Reserve t o b u y s e c u r i t i e s o r l e n d t o b a n k s t o
p r e v e n t s h o r t - r u n increases in i n t e r e s t rates.
Such e x p a n s i o n a r y m o n e t a r y p o l i c y w o u l d a l l o w
accelerated m o n e t a r y growth. W h i c h e v e r w a y
causality runs, h i g h e r m o n e t a r y g r o w t h w o u l d
t e n d t o b e a s s o c i a t e d w i t h h i g h e r d e f i c i t s unless
t h e Federal Reserve a c t i v e l y k e e p s v a r i a t i o n in
m o n e t a r y g r o w t h i n d e p e n d e n t of deficits. T h a t is
a big u n a n s w e r e d question a b o u t 1984.
A s e c o n d a r y i n f l a t i o n a r y i m p u l s e f r o m Federal
Reserve securities purchases also bears mentioning.
An increase in Federal Reserve h o l d i n g s of governm e n t s e c u r i t i e s can cause a d i s p r o p o r t i o n a l increase in inflation because holders of base m o n e y
r e d u c e t h e i r d e m a n d for it w h e n n o m i n a l
interest
rates increase.
Reduced
demand
for base m o n e y w o u l d increase d e m a n d f o r
commodities a n d thus a u g m e n t inflation. The
inflation of 1 9 7 0 - 1 9 8 0 d e m o n s t r a t e d this relationship. Federal Reserve h o l d i n g s of f e d e r a l d e b t
overthe period more than doubled, increasingat
a 7.67 p e r c e n t a n n u a l rate. T h e m o n e t a r y base
and M l t r a n s a c t i o n s b a l a n c e s also m o r e t h a n
d o u b l e d . But C N P ( t o t a l d e m a n d ) g r e w e v e n
faster at 1 0 . 2 6 p e r c e n t a year ( a l m o s t t r i p l i n g ) ,
f u e l i n g i n f l a t i o n at an 7.31 p e r c e n t a n n u a l rate
d e s p i t e average real o u t p u t g r o w t h o f 2.95 percent. Thus, i n f l a t i o n o v e r t h i s p e r i o d r e f l e c t e d
not o n l y t h e large b u d g e t deficits, an a s s o c i a t e d
high rate of Federal Reserve purchases of governm e n t securities a n d g r o w t h in m o n e t a r y aggregates, b u t also m o r e i n t e n s i v e use o f m o n e y
i n d u c e d b y h i g h e r i n t e r e s t rates.

Deficits and M o n e t a e Growth:
Is There An Association?
D o large b u d g e t deficits, w h i c h a p p e a r l i k e l y
for years t o c o m e , n e e d t o b e inflationary? T h e
a n s w e r a p p e a r s t o d e p e n d critically o n w h e t h e r
monetary g r o w t h is i n d u c e d by deficits. A surprising

amount

of c o n t r o v e r s y has c e n t e r e d o n

this

subject.
A c o n v e n t i o n a l K e y n e s i a n v i e w is t h a t t h e
thrust of federal deficits resulting f r o m countercyclical fiscal p o l i c y a c t i o n s o u g h t n o t b e o f f s e t
b y i n d u c e d i n t e r e s t rate changes. H e n c e , a
f a c i l i t a t i n g i n c r e a s e in m o n e t a r y g r o w t h a p p r o priately a c c o m p a n i e s a d e f i c i t 3 T h e c o n v e n t i o n a l
m o n e t a r i s t v i e w is t h a t d e f i c i t s p u t pressure o n
t h e Federal Reserve t o b u y g o v e r n m e n t securities
t o r e d u c e t h e d e f i c i t ' s i m p a c t o n i n t e r e s t rates. 4
Politicians a n d in t u r n t h e Federal Reserve h a v e
b e e n a c c u s e d o f ignoring t h e long-run inflationary
c o n s e q u e n c e s of s h o r t - r u n p o l i c y a c t i o n s t o

" D o large budget deficits...need to
be inflationary? The answer appears
to d e p e n d critically on whether
monetary growth is induced by
deficits."

d a m p e n i n t e r e s t rates. 5 In e i t h e r case, t h e r e is n o
necessary association b e t w e e n m o n e t a r y g r o w t h
a n d d e f i c i t s b e c a u s e t h e Federal Reserve c o u l d
always forestall m o n e t a r y g r o w t h . It w o u l d n o t
h a v e t o b u y g o v e r n m e n t securities. If necessary
it c o u l d o f f s e t m o n e t a r y g r o w t h i n d u c e d b y rising
i n t e r e s t rates b y selling securities or b y c h a n g i n g
r e q u i r e d reserve ratios. A t t i m e s t h e Federal
Reserve has t a k e n r e s t r i c t i v e a c t i o n s in t h e face
of c o m p a r a t i v e l y large deficits. It d o u b l e d r e q u i r e d
reserve ratios in 1 9 3 6 - 1 9 3 7 , a n d it r e i n e d in
m o n e t a r y g r o w t h in 1 9 7 4 - 1 9 7 5 a n d m o r e recently
in 1 9 8 1 - 1 9 8 2 w h e n m o n e t a r y g r o w t h d e c e l e r a t e d
d e s p i t e g r o w i n g deficits. O n occasion t h e Federal
Reserve has also t a k e n a c t i o n s t h a t i n c r e a s e d
m o n e t a r y g r o w t h w h e n t h e r e w e r e deficits. T h e
Fed t o o k s u c h a c t i o n d u r i n g a n d a f t e r W o r l d W a r
11 w h e n it t a r g e t e d i n t e r e s t rates a n d again in t h e
late 1 9 7 0 s .
O n e complication that clouds the relationship
b e t w e e n m o n e t a r y g r o w t h a n d d e f i c i t s is t h e i r
d i v e r g e n t cyclical v a r i a t i o n . 6 T h e r e c o r d s h o w s

3See for example. Walter W. Heller a n d Milton Friedman, M o n e t a r y vs.
Fiscal P o l i c y , A D i a l o g u e , New York: W. W. Norton 8 Co., 1969.
- S e e for example. Darreil R. Francis, " H o w a n d Why Fiscal Actions Matter
to a Monetarist," Federal Reserve Bank of S t Louis R e v i e w (May 1974),
4-7
\ J a m e s A Buchanan and Richard E Wagner D e m o c r a c y i n D e f i c i t : T h e
P o l i t i c a l L e g a c y of L o r d K e y n e s New York: Academic Press, 1 9 7 /
"William G. Dewald, "Disentangling Monetary a n d Fiscal Policy," Federal
Reserve Bank of San Francisco E c o n o m i c R e v i e w (Winter 1982), 7-18.

17
FEDERAL RESERVE B A N K O F A T L A N T A




that, t h r o u g h o u t the p o s t - W o r l d War I period,
m o n e t a r y g r o w t h as m e a s u r e d b y M l , M 2 , a n d A
( t h e m o n e t a r y base) w a s m o s t r a p i d d u r i n g
business cycle expansions, whereas t h e deficit
was largest d u r i n g contractions. M o n e t a r y g r o w t h
was generally procyclical; deficits, counter-cyclical.
S u c h d i v e r g e n t p a t t e r n s suggest t h a t t h e r e has
b e e n n o p o s i t i v e association, a n i n t e r p r e t a t i o n
i l l u s t r a t e d in t h e e x t r e m e w h e n , d u r i n g t h e o n s e t
o f t h e G r e a t D e p r e s s i o n in t h e early 1 9 3 0 s ,
n e g a t i v e m o n e t a r y g r o w t h a c c o m p a n i e d rising
deficits.
It is clear t h a t t h e r e is n o necessary a s s o c i a t i o n
b e t w e e n deficits and monetary growth despite
K e y n e s i a n a n d m o n e t a r i s t t h e o r i e s of s u c h a
linkage. T h e m o n e t a r y a u t h o r i t i e s can always
take contractionary actions to prevent monetary
g r o w t h w h a t e v e r t h e d e f i c i t . T h e q u e s t i o n is n o t
w h e t h e r m o n e t a r y g r o w t h a n d deficits must be
r e l a t e d b u t w h e t h e r t h e y have b e e n . In s e p a r a t e
tests of t h e conventional view, Barro 7 and N iskanen 8
f o u n d n o significant link b e t w e e n annual M l
growth and the deficit over the post-World War
II p e r i o d . But it w a s a f i c k l e f i n d i n g , b e i n g
reversed w h e n H a m b u r g e r a n d Z w i c k p e r f o r m e d
t h e e x e r c i s e again j u s t f o r t h e p e r i o d s i n c e 1 9 6 0
t h a t saw, a c c o r d i n g t o B u c h a n a n a n d W a g n e r ,
m a j o r c h a n g e s in t h e w a y m a c r o e c o n o m i c p o l i c y
is f o r m u l a t e d . 9 This result in t u r n was r e v e r s e d
w h e n M c M i l l a n a n d Beard u s e d r e v i s e d G N P
data in t h e c a l c u l a t i o n s . 1 0 It was r e v e r s e d o n c e
again w h e n H a m b u r g e r a n d Z w i c k again r e d i d
their work.11
From t h i s l i t e r a t u r e it c e r t a i n l y is n o t clear
w h e t h e r d e f i c i t s a n d m o n e t a r y g r o w t h are posit i v e l y related. N e v e r t h e l e s s , business c y c l e d a t a
strongly confirm the conventional v i e w that t h e y
have b e e n p o s i t i v e l y associated. J u d g i n g f r o m
t h e e x p e r i e n c e o f e n t i r e business cycles, m o n e tary g r o w t h a n d d e f i c i t s have b e e n r e l a t e d significantly since W o r l d W a r 11 and variation in m o n e t a r y
g r o w t h rates f r o m c y c l e t o c y c l e have b e e n
e x p l a i n e d at least in part b y d i f f e r e n c e s in
deficits.

'Robert J. B a r r o , ' C o m m e n t from an Unreconstructed Ricardian," J o u r n a l
of M o n e t a r y E c o n o m i c s (August 1978), 564-81
"William A Niskanen, "Deficits, Government Spending, and Inflation: What
is the Evidence?, J o u r n a l of M o n e t a r y E c o n o m i c s ( A u g u s t 1978, 591 602.
9
M i c h a e l J. Hamburger a n d Burton Zwick, "Deficits, M o n e y a n d Inflation,"
J o u r n a l of M o n e t a r y E c o n o m i c s (January 1981), 141-50.
10
W. Douglas McMillin a n d Thomas R. Beard, Deficits, M o n e y a n d
Inflation," J o u r n a l of M o n e t a r y E c o n o m i c s ( S e p t e m b e r 1982), 273-77.
" M i c h a e l J. Hamburger and Burton Zwick, 'Deficits, Money a n d Inflation:
Reply," J o u r n a l of M o n e t a r y E c o n o m i c s (September 1982), 278-83.

18




Cyclical Average Data Show That
Monetary Growth Has Been Related
To Deficits
It is a p p r o p r i a t e t o l o o k at c o m p l e t e b u s i n e s s
cycles b e c a u s e t h e d e b t issued t o f i n a n c e a
d e f i c i t d u r i n g a recession r e m a i n s in t h e m a r k e t
d u r i n g t h e f o l l o w i n g e x p a n s i o n . T h e r e f o r e , it
c o m e s into c o m p e t i t i o n w i t h private d e b t for a
p l a c e in investors' p o r t f o l i o s . 1 2 If t h e f e d e r a l
b u d g e t w e r e b a l a n c e d regularly o v e r a business
cycle, d e b t issued t o f i n a n c e d e f i c i t s d u r i n g
r e c e s s i o n s s h o u l d b e m a t c h e d b y d e b t red e m p t i o n s f r o m surpluses d u r i n g e x p a n s i o n s ,
neutralizing the i m p a c t of g o v e r n m e n t d e b t on
c r e d i t m a r k e t s . Just as m o n t h l y or q u a r t e r l y d a t a
are a v e r a g e d o v e r years o r seasonally a d j u s t e d t o
i d e n t i f y o t h e r t h a n regular seasonal changes,
data can b e a v e r a g e d o v e r business cycles or
c y c l i c a l l y a d j u s t e d t o i d e n t i f y o t h e r t h a n regular
cyclical changes. T h e s o - c a l l e d s t r u c t u r a l f e d e r a l
b u d g e t d e f i c i t is an e x a m p l e of a c y c l i c a l l y
a d j u s t e d series. But t h a t statistic is s u b j e c t t o
c r i t i c i s m o w i n g t o t h e a r b i t r a r y a s s u m p t i o n s reg a r d i n g n o r m a l levels o f e m p l o y m e n t a n d ass o c i a t e d real o u t p u t g r o w t h a n d prices u s e d t o
c o n s t r u c t t h e series. In a n y case, t o d e t e r m i n e
w h e t h e r t h e r e has b e e n a statistical a s s o c i a t i o n
b e t w e e n m o n e t a r y g r o w t h a n d deficits, it is
s u f f i c i e n t t o c o m p a r e cyclical averages o f t h e
two.
T h e s e d a t a s h o w a close a s s o c i a t i o n b e t w e e n
monetary growth and deficits b e t w e e n 1948 and
1 9 8 2 . T a b l e 6 r e c o r d s t r o u g h t o t r o u g h averages,
at a n n u a l rates. Federal deficits are s h o w n relative
to nominal GNP. M o n e t a r y growth measures
i n c l u d e M 1 , M 2 , A ( t h e m o n e t a r y base a d j u s t e d
f o r r e q u i r e d reserve rate changes), a n d F ( t h e fiat
m o n e t a r y base a d j u s t e d f o r r e q u i r e d reserve
r a t i o changes). F m e a s u r e s t h e m o n e t a r y base's
policy-controlled contribution to growth.
B u d g e t surpluses or s m a l l d e f i c i t s p e r s i s t e d
o v e r t h e t w o business cycles f r o m 1 9 4 8 t h r o u g h
1958. The Korean War, w h i c h o c c u r r e d d u r i n g

,2

A link between deficits and future monetary growth is developed by
Sargent, who argues that only money issued to finance deficits is
inflationary, not money issued against private liabilities
Thomas J. Sargent, "The Ends of Four Big Inflations,'" Federal Reserve
Bank of Minneapolis Working Paper # 1 5 8 , December 1980.
Thomas J. Sargent a n d Neil Wallace, "The Real Bills Doctrine vs. the
Quarterly Theory: A Reconsideration," Federal Reserve Bank of Minneapolis Staff Report 64, January 1981.
Thomas J. Sargent, " S t o p p i n g Moderate Inflations: "The M e t h o d s of
Poincare' and Thatcher," photocopy, May 1981.

f u r t h e r a n d m o n e t a r y g r o w t h a c c e l e r a t e d in t h e
case of M l a n d r e m a i n e d h i g h f o r t h e o t h e r
aggregates.

Table 6. Federal Budget Deficits a n d Monetary Growth
(Annual Rates over Business Cycles)

Monetary
Growth
Rates
Business Cycle Dates

DEF/GNP

M1

M2

A3

Fb

8.78

r
Trough to Trough Averages
1949:4-1954:2

-.44

3.22

3.71 2.87

1954:2-1958:2

-.05

1.18

2.45

.88

1.64

1958:2-1961:1

.63

1.85

3.06

1.16

7.19

1961:1-1970:4
1970:4-1975:1

.34 4.13
1.18

5.40

6.51 4.84

7.65

8.17 6.82

7.76
8.11

1975:1-1980:2

2.03

6.82

9.00 7.90

1980:2-1982-4

3.26

7.82

9.61 6.73

7.20

.99

4.35

6.07 4.46

6.90

Average

A is the monetary base adjusted tor required reserve ratio c h a n g e s
b

F is the fiat monetary base a d j u s t e d for required reserve ratio changes. The
fiat base is d e f i n e d as Federal Reserve holdings of g o v e r n m e n t securities,
plus Treasury c u r r e n c y outstanding, less Treasury Deposits with Federal
Reserve Banks, less Treasury cash holdings.
C

Comparable results are obtained with peak to peak business cycle averages

this p e r i o d , was n o t w o n b u t at least it w a s
bought a n d paid for. M o n e t a r y g r o w t h as measured
by t h e s t a n d a r d a g g r e g a t e s — M l , M 2 , a n d A —
was a r o u g h l y 3 p e r c e n t a n n u a l rate o v e r t h e
1 9 4 9 - 1 9 5 4 cycle, w h i c h c o r r e s p o n d s t o t h e real
g r o w t h rate. In t h e 1 9 5 4 - 1 9 5 8 cycle, m o n e t a r y
g r o w t h d e c e l e r a t e d b y e a c h m e a s u r e . T h e r e was
essentially n o i n f l a t i o n e x c e p t f o r a f l u r r y o f p r i c e
increases at t h e b e g i n n i n g of t h e war.
In t h e 1 9 5 8 - 1 9 7 0 p e r i o d , a n n u a l b u d g e t deficits rose t o average $2 t o $3 b i l l i o n o v e r t h e t w o
cycles. T h o u g h average m o n e t a r y growth increased,
it r e m a i n e d l o w in 1 9 5 8 - 1 9 6 1 b e f o r e accelerating
c o n s i d e r a b l y in 1 9 6 1 - 1 9 7 0 . T h e e x p e r i e n c e t o
1 9 7 0 s u g g e s t e d at b e s t a w e a k a s s o c i a t i o n bet w e e n m o n e t a r y g r o w t h a n d deficits. 1 3 But t h e
v a r i a t i o n t h a t o c c u r r e d in t h e n e x t t h r e e cycles
reveals a s t r o n g association. O v e r 1 9 7 0 - 1 9 7 4 ,
t h e average d e f i c i t q u a d r u p l e d a n d m o n e t a r y
g r o w t h a c c e l e r a t e d f u r t h e r f r o m rates t h a t w e r e
already w e l l a b o v e t h e real g r o w t h rate. O v e r
1 9 7 4 - 1 9 8 0 and 1980-1982, deficits increased

l3

See, for example, Scott E Hein, "Deficits a n d Inflation," Federal Reserve
Bank of St. Louis R e v i e w (March 1981), 3 - 1 0 and Michael W. Keran a n d
Christopher T. Babb, "An Explanation of Federal Reserve Actions (193368)," Federal Reserve Bank of St. Louis Review (July 1969), 7-20.

FEDERAL RESERVE B A N K O F ATLANTA




Thus, t h e d a t a c l e a r l y s h o w an a s s o c i a t i o n
b e t w e e n m o n e t a r y g r o w t h a n d d e f i c i t s . Regressions of m o n e t a r y g r o w t h v a r i o u s l y d e f i n e d
o n t h e ratio o f t h e d e f i c i t t o G N P reveal a
s i g n i f i c a n t link, w i t h a o n e p e r c e n t a g e p o i n t
increase in t h e d e f i c i t r e l a t i v e t o G N P b e i n g
a s s o c i a t e d o n t h e average w i t h a b o u t a 2.5
p e r c e n t a g e p o i n t rise in t h e M 2 a n d A g r o w t h
rates a n d a b o u t a 1.5 p e r c e n t a g e p o i n t rise in F
a n d M l g r o w t h rates. T h e o b s e r v a t i o n p e r i o d
was a c o m p l e t e b u s i n e s s cycle, f r o m t r o u g h t o
trough.
P r o j e c t e d $ 2 0 0 b i l l i o n d e f i c i t s in 1 9 8 3 a n d
1 9 8 4 represent 5 t o 6 percent of GNP. Judging
f r o m past links o f M l g r o w t h t o d e f i c i t s , a n 8 o r 9
p e r c e n t M l g r o w t h rate a n d an 8 or 9 p e r c e n t
i n f l a t i o n rate c o u l d b e e x p e c t e d if t h e v e l o c i t y of
M l increases a t 3 p e r c e n t a year a n d so d o e s real
g r o w t h . T h a t is far m o r e i n f l a t i o n t h a n t h e 5
p e r c e n t e x p e r i e n c e d in 1 9 8 3 . Yet i n f l a t i o n has
t e n d e d t o lag b e h i n d m o n e t a r y g r o w t h b y t w o
years o r l o n g e r o n average since t h e e n d o f
W o r l d W a r II. A n earlier a r t i c l e 1 4 e s t i m a t e d h o w
l o n g it h a d t a k e n f o r c h a n g e s in m o n e t a r y g r o w t h
t o b e r e f l e c t e d in i n f l a t i o n o v e r t h e 1 9 5 3 - 1 9 8 0
p e r i o d . T h e s e results can b e u s e d t o i n t e r p r e t
h o w l o n g it w o u l d h a v e t a k e n i n f l a t i o n t o a c c e l e rate t o 9 p e r c e n t if t h e Federal Reserve h a d
a l l o w e d M l t o g r o w at s u c h a rate d u r i n g t h e
estimation period. Assuming that t h e e c o n o m i c
s t r u c t u r e has n o t c h a n g e d a n d t h a t t h e Federal
Reserve a l l o w e d M l g r o w t h at 9 p e r c e n t — a b o u t
in line w i t h t h e past r e l a t i o n s h i p o f M l g r o w t h t o
a b u d g e t d e f i c i t of 5 or 6 p e r c e n t o f G N P — t h e
G N P d e f l a t o r w o u l d increase f r o m 5 p e r c e n t in
1 9 8 3 t o m o r e t h a n 7 p e r c e n t in 1 9 8 4 . It w o u l d
g r o w t o m o r e t h a n 8 p e r c e n t in 1985,8 1 /2 p e r c e n t
in 1 9 8 6 , a n d 9 p e r c e n t in 1 9 8 7 — p e r h a p s e v e n
m o r e if a s s o c i a t e d increases in n o m i n a l i n t e r e s t
rates raised t r e n d g r o w t h in t h e v e l o c i t y o f
money.
As n o t e d , a 9 p e r c e n t M l g r o w t h rate m a y n o t
in fact b e a s s o c i a t e d w i t h a 9 p e r c e n t i n f l a t i o n
rate if t h e e s t i m a t e s are in error. N e v e r t h e l e s s , it
is i n t e r e s t i n g t h a t t e r m h i g h - g r a d e c o r p o r a t e

'"William G. Dewald, " H o w Fast Does Inflation Adjust to Its Underlying
Determinants?", Proceedings of the Fifth West Coast Academic/Federal
Reserve Economic Research Seminar, Federal Reserve Bank of San
Francisco (December 1981), 221-39.

19

b o n d rates rose t o a b o u t 13 p e r c e n t in t h e last
half of 1 9 8 3 . This rate w o u l d r e p r e s e n t a 4
p e r c e n t real y i e l d if t h e e x p e c t e d i n f l a t i o n rate
w e r e 9 p e r c e n t . G o v e r n m e n t b o n d rates rose t o
a b o u t 12 "percent, w h i c h translates i n t o a real
y i e l d o f 3 p e r c e n t if t h e u n d e r l y i n g i n f l a t i o n rate
is 9 p e r c e n t T h e historic linkage b e t w e e n deficits,
m o n e t a r y g r o w t h , a n d i n f l a t i o n a p p a r e n t l y goes a
l o n g w a y in e x p l a i n i n g n o m i n a l i n t e r e s t rates in
1 9 8 3 b e c a u s e of t h e e x p e c t e d i n f l a t i o n i m p l i c i t
in large b u d g e t d e f i c i t s a n d m o n e t a r y g r o w t h .

"The historic linkage between
deficits, monetary growth and
inflation apparently goes a long
way in explaining nominal interest
rates in 1983 because of the
expected inflation implicit in large
budget deficits and monetary
growth."

Conclusion: Monetary Growth
Has Been Related to Budget Deficits
T h e c o n v e n t i o n a l v i e w is t h a t large g o v e r n m e n t
d e f i c i t s p u t pressure o n i n t e r e s t rates, i n d u c i n g
t h e Federal Reserve t o b u y g o v e r n m e n t securities
and t h e r e b y t o stimulate m o n e t a r y growth. M o n e tary g r o w t h a n d d e f i c i t s h a v e in fact b e e n r e l a t e d
in t h e p o s t - W o r l d W a r II p e r i o d , w i t h c o m p a r a t i v e l y h i g h rates in t h e 1 9 7 0 s a n d early 1 9 8 0 s .
But, e x c e p t f o r t h o s e years, t h e r e w a s n o close
a s s o c i a t i o n b e t w e e n d e f i c i t s a n d g r o w t h in t h e
fiat m o n e t a r y base. T h a t suggests t h e f i n a n c i a l
s y s t e m was a l l o w e d t o m o n e t i z e g o v e r n m e n t
d e f i c i t s b y raising n o n c o n t r o l l e d s o u r c e s o f t h e
m o n e t a r y base o r t h e m o n e t a r y base m u l t i p l i e r s .

20




This does n o t e x o n e r a t e t h e m o n e t a r y authorities
f r o m r e s p o n s i b i l i t y for i n f l a t i o n a r y a n d c y c l i c a l l y
destabilizing m o n e t a r y g r o w t h i n d u c e d by budget d e f i c i t s . It o n l y m a k e s clear t h a t t h e y w e r e in
fact u n w i l l i n g t o p r e v e n t t h e m o n e t a r y g r o w t h
that a c c o m p a n i e d federal b u d g e t deficits after
W o r l d W a r 11 a n d p a r t i c u l a r l y since 1 9 7 0 . A n d it
gives c r e d e n c e t o t h e w i d e s p r e a d v i e w t h a t large
f e d e r a l d e f i c i t s n o w a n d in t h e near f u t u r e w i l l b e
accompanied by accelerated monetary growth
a n d i n f l a t i o n if t h e m o n e t a r y a u t h o r i t i e s react as
t h e y have in t h e p a s t
Past r e l a t i o n s h i p s o f real d e f i c i t s t o real i n t e r e s t
rates suggest t h a t $ 2 0 0 b i l l i o n d e f i c i t s in 1 9 8 3
a n d again in 1 9 8 4 w o u l d b e associated w i t h a
real d e f i c i t o f a b o u t 4 p e r c e n t of high e m p l o y m e n t G N P a n d real T r e a s u r y bill rates o f 5
p e r c e n t . T h e past r e l a t i o n s h i p s o f d e f i c i t s t o M l
g r o w t h — a n d m o n e t a r y g r o w t h in turn t o i n f l a t i o n suggest t h a t t h e 1 9 8 3 a n d 1 9 8 4 d e f i c i t s w o u l d
b e a s s o c i a t e d w i t h 8 or 9 p e r c e n t M l g r o w t h a n d
8 or 9 p e r c e n t i n f l a t i o n . If t h a t i n f l a t i o n w e r e f u l l y
a n t i c i p a t e d , t h e n o m i n a l T r e a s u r y bill rate w o u l d
rise t o 13 or 14 p e r c e n t M o n e t a r y p o l i c y rea c t i o n s are n o t t h e s a m e f o r e v e r y cycle, so t h e s e
figures o f f e r o n l y t h e r o u g h e s t o f n o r m s f r o m t h e
past t o c o m p a r e w i t h w h a t is h a p p e n i n g presently.
For 1 9 8 3 , t h e $ 2 0 0 b i l l i o n d e f i c i t was in fact
a s s o c i a t e d w i t h a 4 t o 5 p e r c e n t real Treasury bill
rate, a 1 0 t o 11 p e r c e n t M l g r o w t h rate, a n d o n l y
5 p e r c e n t i n f l a t i o n in t h e G N P d e f l a t o r . For 1 9 8 4 ,
w e can o n l y guess. Yet past r e l a t i o n s h i p s p r o v i d e
s o m e clues t o e x p l a i n w h y t h e r e w e r e h i g h
n o m i n a l y i e l d s a n d high i n f l a t i o n e x p e c t a t i o n s in
1 9 8 3 in t h e face of l o w i n f l a t i o n .
— W i l l i a m G. D e w a l d *

•Professor of economics at Ohio State University and iormer editor ot the
(ournal of Money, Credit and Banking, This research was presented at an Atlanta
fed Research Seminar on Sept. 8, 1983.

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The Do-It-Yourself Movement:
An Element of the Shadow Economy
Do-it-yourselfers, who participate, to a degree, in the shadow economy, account for
billions of dollars in retail trade every year. Demographic and economic trends
suggest that the movement will continue to expand.

M o s t o f us are f a m i l i a r w i t h t h e so c a l l e d
s h a d o w e c o n o m y , its c o n s t i t u e n t parts a n d its
a l l e g e d e f f e c t s o n n a t i o n a l m o n e t a r y a n d fiscal
p o l i c y . T h e p o p u l a r press has f o c u s e d o n t h e
size o f t h e illegal d r u g business o r h o w m u c h
i n c o m e o t h e r w i s e l a v ^ o b e y i n g citizens conceal
f r o m t h e IRS. But w h e n e v e r an individual chooses
t o w o r k on a project himself rather than hiring a
professional, he also participates in t h e s h a d o w
economy. A n d even though the do-it-yourself
m o v e m e n t m a y lack t h e m e d i a a p p e a l of s o m e
e l e m e n t s of t h e s h a d o w e c o n o m y , it represents
b i g business in t h e U n i t e d States, w i t h an
e s t i m a t e d $ 3 4 . 1 b i l l i o n w o r t h o f a n n u a l retail
t r a d e in 1 9 8 2 , i n c l u d i n g 35 p e r c e n t of t h e h o m e
a n d a u t o repair markets.
M o t i v a t i o n s f o r d o i n g - i t - y o u r s e l f span a w i d e
range, i n c l u d i n g saving m o n e y t o f i n a n c e o t h e r

22




leisure activities, saving time, sidestepping costly
and t i m e - c o n s u m i n g g o v e r n m e n t regulations,
and just plain e n j o y m e n t .
A n o t h e r m o t i v a t i o n m a y b e tax a v o i d a n c e , a
m o t i v a t i o n t h a t t h e m o v e m e n t shares w i t h
o t h e r e l e m e n t s of t h e s h a d o w e c o n o m y . T h e
do-it-yourself m o v e m e n t falls i n t o this c a t e g o r y
b e c a u s e t h e v a l u e a d d e d b y s e l f - h e l p tasks
escapes t a x a t i o n . If a h a n d y m a n (or w o m a n )
b u i l d s a t a b l e , t h e final p r o d u c t is w o r t h m o r e
t h a n t h e cost o f t h e materials t h a t w e n t i n t o it,
b u t its b u i l d e r pays n o tax o n t h e a d d i t i o n a l
value. T h e b u i l d e r avoids this tax w i t h o u t breaki n g a n y law. If t h e t a b l e w e r e p u r c h a s e d , o n t h e
o t h e r h a n d , t h e b u y e r w o u l d pay t h e seller f o r
t h e cost of materials, l a b o r a n d a n i n c r e m e n t
for v a l u e a d d e d . T h e v a l u e a d d e d in t h a t case
w o u l d b e t a x e d t o t h e w o r k e r s as i n c o m e tax

JANUARY 1984, E C O N O M I C R E V I E W

F|

Chart 1 . 25 to 44 Year Age Group as a
Percent of the U.S. Population
%

Source: C o n f e r e n c e Board, " G u i d e to Consumer Markets"

a n d t o t h e i r c o m p a n y as i n c o m e a n d i n v e n t o r y
taxes.

The Scope of the Movement
T h e d o - i t - y o u r s e l f ( o r DIY) m o v e m e n t is large
and expanding. The Do-It-Yourself Research
I n s t i t u t e r e p o r t e d t h a t as m a n y as 8 5 p e r c e n t
of U.S. h o u s e h o l d s d i d s o m e D I Y w o r k in 1 9 8 1 .
T h e s e e f f o r t s are f o r e c a s t t o g e n e r a t e $ 4 6
b i l l i o n in r e t a i l sales b y 1 9 8 5 f o r t h e n e c e s s a r y
t o o l s a n d s u p p l i e s . D I Y a p p e a r s t o c u t across all
d i s t i n c t i o n s o f age, sex, i n c o m e , e d u c a t i o n ,
geography a n d labor groupings.
T h e d e m o g r a p h i c m a k e u p of t h e A m e r i c a n
p o p u l a t i o n has b e e n c h a n g i n g in a w a y t h a t
may boost t h e m o v e m e n t ' s g r o w t h t h r o u g h t h e
e n d of this c e n t u r y . Surveys have s h o w n that
m e n a n d w o m e n in t h e 25 t o 4 4 a g e g r o u p a r e
the m o s t active " D I Y e r s . " This age group's
p r o p o r t i o n o f t h e p o p u l a t i o n has e x p a n d e d
f r o m 2 5 . 2 p e r c e n t in 1 9 7 5 t o 2 7 . 9 p e r c e n t in
1 9 8 0 , a r e m a r k a b l e g r o w t h o v e r o n l y f i v e years.
A n d d e m o g r a p h e r s p r e d i c t t h a t it w i l l c o n t i n u e
t o e x p a n d i n t o t h e 1990s, q u i c k e n i n g its g r o w t h
rate b e g i n n i n g a r o u n d 1 9 8 5 ( C h a r t 1). T h e
e x p a n s i o n of this age g r o u p p r o m i s e s t o facilitate
expansion of the DIY industry.

'Do-It-Yourself Markets: H o m e & Auto, Predicasts Inc., 1981, from a
compilation of ideas a n d sources on DIY published in 1983 by M e c h a n i x
Illustrated.

FEDERAL RESERVE B A N K O F A T L A N T A




The growing n u m b e r of such households and
disposable i n c o m e available to t h e m
have
certainly s p u r r e d DIY activity. H o u s e h o l d s are
the focus of such efforts because these groups
o w n houses a n d several a u t o m o b i l e s
more
o f t e n t h a n d o i n d i v i d u a l s w h o live alone. A n d
houses a n d autos receive a d i s p r o p o r t i o n a t e
share of t h e effort e x p e n d e d . T h e n u m b e r of
h o u s e h o l d s is e x p e c t e d t o g r o w f r o m a b o u t 8 3
m i l l i o n in 1 9 8 2 t o r o u g h l y 9 8 m i l l i o n b y 1 9 9 0 ,
or by a b o u t 18 p e r c e n t ( C h a r t 2).2 T h e g r o w i n g
n u m b e r of households will have m o r e disposable i n c o m e available for projects. The Confere n c e B o a r d e x p e c t s h o u s e h o l d d i s p o s a b l e inc o m e e x p r e s s e d i n 1 9 7 2 d o l l a r s t o rise f r o m
a b o u t $ 1 3 , 0 0 0 p e r h o u s e h o l d in 1 9 8 2 t o o v e r
$ 1 5 , 0 0 0 b y 1 9 9 5 (Chart 3).
T h e raw materials of t h e DIY m o v e m e n t —
the people, households and associated disposa b l e i n c o m e s — h a v e all e x p a n d e d r a p i d l y s i n c e
the mid-1960s. They will most likely c o n t i n u e
t o e x p a n d i n t o t h e 1 9 9 0 s . B u t as w i t h all
c o m p o n e n t s of t h e s h a d o w e c o n o m y , t h e m o v e m e n t ' s t o t a l e f f e c t o n t h e U.S. e c o n o m y c a n n o t
b e m e a s u r e d d i r e c t l y . T h e o n l y p o i n t at w h i c h
the DIY effort touches the officially m o n i t o r e d
e c o n o m y is at t h e r e t a i l o u t l e t w h e r e D I Y e r s
m u s t b u y materials t o use in t h e i r w o r k . Predicasts

2

G u i d e t o C o n s u m e r M a r k e t s , Conference Board, from a compilation of
ideas a n d sources on DIY published in 1983 by M e c h a n i x I l l u s t r a t e d .

23

Chart 3. Disposable Income Per Household
in 1972 Dollars

Chart 4. DIY and U.S. Age Profiles

T h o u s Dollars

%

15.0 -

40

14.0

30

13.0

20

12.0

10

1965

1970

1975

1980

1985

1990

1995

2000

<25

Source: Conference Board "Guide to Consumer Markets"

I n c , a n industrial m a r k e t research firm, c o m p i l e d
d a t a s h o w i n g t h a t t h e v a l u e o f sales t o t h e D I Y
retail m a r k e t g r e w o v e r 5 0 0 p e r c e n t f r o m 1 9 6 7
t o 1980, and w o u l d e x c e e d S98 billion by
1 9 9 5 . B u t t h e s e f i g u r e s d o n o t i n c l u d e a significant dollar a m o u n t of value a d d e d by DIY
e f f o r t Using estimates d e v e l o p e d for the h o m e
building industry, w e derived a total value
a d d e d a t t r i b u t a b l e t o DIY repair a n d fix-up
w o r k o f $5.1 b i l l i o n i n 1 9 8 2 . 3 T h u s in t h a t y e a r
alone, DIY c o n t r i b u t e d $39.2 billion to the
national e c o n o m y , only $34.1 billion of w h i c h
w a s c o u n t e d in G N P . 4

The DIY Profile
A m e r i c a n D I Y e r s s t a n d a p a r t f r o m t h e rest o f
t h e p o p u l a t i o n b e c a u s e o f a d i s t i n c t i v e set o f
d e m o g r a p h i c a n d p s y c h o l o g i c a l characteristics.
T h e i r a g e d i s t r i b u t i o n is s k e w e d t o w a r d y o u t h ,
a l t h o u g h a l m o s t 3 0 p e r c e n t of t h o s e p o l l e d are
4 5 o r o l d e r ( C h a r t 4 ) . 5 It is l o g i c a l t h a t 8 4
p e r c e n t o f h o m e D I Y e r s a r e in t h e 2 5 t o 5 4 a g e
b r a c k e t b e c a u s e t h o s e a r e t h e p r i m e years f o r
c h i l d r e a r i n g f a m i l i e s . T h o s e w i t h f a m i l i e s are
l i k e l y t o o w n h o m e s a n d t o e n g a g e in h o m e
m a i n t e n a n c e and fix-up. The surprisingly small

3
B u i l d e r , January 1983, p. 42.
••Estimates of value added in the residential construction industry range
from 7 percent to 30 percent in "normal times." W e used 15 percent as
our estimate of how much DIY work adds to the value of the materials
involved. This is probably on the conservative side.

24




I

DIY
I U.S.

c

-L

-L

11.0

_ _

25-34

35-44

45-54

55-64

>64

Source: Predicasts, Inc. a n d the Statistical Abstract of the U S

p r o p o r t i o n (12 p e r c e n t ) of h o m e DIYers o v e r
a g e 5 5 is e x p l a i n e d p a r t i a l l y b y t h e t e n d e n c y o f
p e o p l e t o sell t h e i r h o u s e s a f t e r c h i l d r e n h a v e
b e e n r a i s e d a n d t h e b r e a d w i n n e r has r e t i r e d .
Those w h o o u t of e c o n o m i c necessity d i d their
o w n h o m e repair a n d f i x - u p w o r k w h e n y o u n g e r ,
o f t e n h a v e t h e i n c o m e in later y e a r s t o h i r e
others t o d o t h e w o r k . O l d e r h o m e - o w n e r s are
also s o m e t i m e s physically u n a b l e t o d o s o m e
tasks t h e m s e l v e s . T h e t i n y 4 p e r c e n t of h o m e
D I Y e r s y o u n g e r t h a n 2 5 r e f l e c t s t h e facts t h a t
f e w e r in t h i s a g e g r o u p c a n q u a l i f y f o r a h o m e
m o r t g a g e a n d t h a t t h o s e at l o w e r i n c o m e s are
less l i k e l y t o d o t h e i r o w n w o r k .
M e n m a k e u p t h e largest c o m p o n e n t o f t h e
A m e r i c a n DIY p o p u l a t i o n : 68 p e r c e n t of h o m e
DIYers a n d 9 1 p e r c e n t o f a u t o DIYers. 6 W o m e n
m a k e u p 32 p e r c e n t a n d 9 p e r c e n t of t h e s e
groups, respectively.
T h e i n c o m e p r o f i l e o f h o m e D I Y e r s is h e a v i l y
w e i g h t e d t o w a r d t h o s e w h o can qualify for
h o m e m o r t g a g e s ( C h a r t 5 ) . In c o n t r a s t t o t h e
h o m e g r o u p , t h e p r o f i l e o f a u t o D I Y e r s is
w e i g h t e d m o r e t o w a r d l o w e r i n c o m e catagories. 7
T h i s m e a n s , first, t h a t m o r e D I Y e r s e a r n i n g
$ 1 0 , 0 0 0 a y e a r o r less c a n a f f o r d cars t h a n c a n
a f f o r d h o u s e s . A n d , also, i n t h e $ 3 0 , 0 0 0 a n d

5

D o - l t - Y o u r s e l f M a r k e t s : H o m e & A u t o , 1981, from a compilation of
ideas a n d sources on DIY published by M e c h a n i x I l l u s t r a t e d in 1983.
"Ibid.

JANUARY 1984, E C O N O M I C REVIEW

F|

Chart 6 . DIY and U.S. Education Profiles

Chart 5. Income Profiles of Home DIYers
and the Total U.S. Population

U.S.

U.S.

DIY
College
<1,000

10-20,000

20-30,000

High

Less than
High School

>30,000
Source: Predicasts, Inc. a n d the Statistical Abstract of the U.S

Source: Predicasts, ln& and the Statistical Abstract of the U.S.

above i n c o m e group, p e o p l e t e n d to s h o w
m o r e i n t e r e s t in w o r k i n g o n t h e i r o w n h o u s e s
t h a n o n t h e i r cars. I n 1 9 8 2 , t h e a v e r a g e D I Y e r
had a h o u s e h o l d i n c o m e of $ 2 1 , 6 0 0 , w h i l e
n o n - D I Y e r s h a d i n c o m e s of $ 1 5 , 5 0 0 , 2 8 p e r c e n t
less o n a v e r a g e .
T h e e d u c a t i o n l e v e l o f D I Y e r s is s k e w e d
heavily t o w a r d t h o s e w h o have a t t e n d e d college,
with a smaller p r o p o r t i o n having finished only
high s c h o o l a n d t h e s m a l l e s t p r o p o r t i o n h a v i n g
left h i g h s c h o o l ( C h a r t 6 ) . 8 M o r e D I Y e r s w h o
attended college tackle their o w n household
projects t h a n a u t o - r e l a t e d projects. A n d of
those w h o d i d not finish high school, m o r e d o
their o w n a u t o - r e l a t e d p r o j e c t s t h a n h o u s e h o l d
projects.
T h e " t y p i c a l " d o - i t - y o u r s e l f e r , t h e n , is a m a l e
h o m e o w n e r , b e t w e e n 2 5 a n d 5 4 , w h o has
a t t e n d e d c o l l e g e a n d earns in excess of $ 2 0 , 0 0 0

per year. According to the Yankelovitch

Monitor,

he d o e s his o w n w o r k o n his car a n d h o m e
p r i m a r i l y b e c a u s e h e e n j o y s it ( C h a r t 7).

DIY in the South
A l t h o u g h D I Y a c t i v i t y r e p r e s e n t s a large a n d
g r o w i n g s e g m e n t o f t h e n a t i o n a l e c o n o m y , it

'Ibid.
"Ibid.

s e e m s t o b e m o r e i m p o r t a n t in t h e S o u t h t h a n

in any other region. Building

Supply

News

c o n d u c t e d a s u r v e y in 1 9 8 2 t o d e t e r m i n e
w h e t h e r DIY effort differed by region (Chart
8).10 A s a m p l e of t h o s e w h o h a d d o n e w o r k o n
their homes s h o w e d that t h e South had the
most such projects, f o l l o w e d by the N o r t h
C e n t r a l states, t h e N o r t h e a s t a n d t h e n t h e
W e s t . T h e s t r e n g t h o f D I Y e f f o r t in t h e S o u t h
c o u l d b e i n f l u e n c e d b y t h e region's m i l d w e a t h e r
or t h e m i g r a t i o n of p e o p l e a n d c o m m e r c e t o
t h e S u n b e l t o v e r t h e last f e w years. M o r r y

Robinson, editor of Building

Supply

News,

suggests t h a t s o u t h e r n e r s h a v e m a i n t a i n e d m o r e
o f t h e f r o n t i e r s p i r i t o f self r e l i a n c e , w h i c h has
b e e n m u t e d in t h e m o r e u r b a n areas o f t h e
country. The West c o u n t e d the fewest DIY
p r o j e c t s , p r e d i c t a b l y , b e c a u s e it has f e w e r
h o m e s t h a n t h e o t h e r regions.
T h e S o u t h ' s p o p u l a t i o n has m o v e d s t r o n g l y
o v e r t h e last d e c a d e t o w a r d t h e c h a r a c t e r i s t i c s
i d e n t i f i e d w i t h D I Y a c t i v i t y . T h e 2 5 - 4 4 y e a r age
g r o u p , w h i c h t a k e s in 6 7 p e r c e n t o f all D I Y e r s in
t h e n a t i o n a l s u r v e y , g r e w b y 4 p e r c e n t in t h e
South from 1970 to 1980. The i n c o m e group
m o s t s t r o n g l y a s s o c i a t e d w i t h D I Y e f f o r t exp a n d e d f r o m 3 4 p e r c e n t o f t h e p o p u l a t i o n in

^ Y a n k e l o v i t c h M o n i t o r , Yankelovitch, Skelly and White Inc., marketing,
social a n d public opinion research. From a compilation of sources a n d
ideas on DIY published in 1983 by M e c h a n i x I l l u s t r a t e d .
' » B u i l d i n g S u p p l y N e w s , Morry Robinson, from a compilation of sources
and ideas on DIY published in 1 9 8 3 by M e c h a n i x I l l u s t r a t e d .

25
FEDERAL RESERVE B A N K O F A T L A N T A




Chart 7. Reasons for DIY Enthusiasm

Chart 8. Percent Home DIY Projects by Region

%
28.5%

20

16

14

A
B.
C.
D.
E
F.

Enjoyment
Economic-don't have the money to pay to have it done
Preference-prefer to spend the money on other things
Easiest-most expedient way to get things done
NonDIYers-prefer having others do work for them
Other-cannot DIY due to poor health, advanced age
or lack of free time

Source: Yankelovitch Monitor

t h e S o u t h in 1 9 7 0 t o 4 5 p e r c e n t in 1 9 8 0 . T h e
s e g m e n t of t h e s o u t h e r n p o p u l a t i o n w i t h a
high school d i p l o m a or better grew f r o m 34
p e r c e n t in 1 9 7 0 t o 4 5 p e r c e n t b y 1 9 8 0 . C o l l e g e
graduates, active in t h e m o v e m e n t , g r e w f r o m
1 0 p e r c e n t t o 14 p e r c e n t o f t h e s o u t h e r n
p o p u l a t i o n o v e r t h e last d e c a d e .

What's Behind the Movement?
Probably t h e most intuitively straightforward
reason for d o i n g a j o b yourself rather t h a n
b u y i n g a p r o d u c t o r s e r v i c e in t h e m a r k e t p l a c e
is t o save m o n e y . Fully 3 2 p e r c e n t o f D I Y e r s
g i v e t h i s as a r e a s o n f o r t h e i r a c t i v i t y . P e o p l e
h a v e l e a r n e d t h a t t h e y c a n c h a n g e t h e o i l in
t h e i r cars f o r a t h i r d o f w h a t a s e r v i c e s t a t i o n
w o u l d charge, a n d that hiring s o m e o n e to d o a
s i m p l e h o m e i m p r o v e m e n t c h o r e like a d d i n g
laundry r o o m shelves m i g h t b e 10 times m o r e
costly t h a n d o i n g it t h e m s e l v e s . D o i n g it yourself
a p p e a l s t o a s e n s e o f t h r i f t a n d f o r s o m e it is t h e
o n l y w a y t h e y can afford to get a j o b d o n e .
H o w e v e r , w h e t h e r a task a c t u a l l y saves m o n e y
d e p e n d s o n i n c o m e , tax b r a c k e t , t h e c o s t o f
26




Source: Building Supply News, M.R. Robinson, 1982

t h e p a r t i c u l a r j o b a n d h o w l o n g it w i l l t a k e . A
m i l l w o r k e r m i g h t f i n d it e c o n o m i c a l t o p a i n t
his h o u s e r a t h e r t h a n h i r i n g a p a i n t e r , b u t a
heart surgeon w o u l d not. W h i l e , f e w p e o p l e
c o u l d c a l c u l a t e p r e c i s e l y w h e t h e r it is e c o n o m i cal f o r t h e m t o d o a p a r t i c u l a r j o b t h e m s e l v e s ,
m o s t have an i m p l i c i t feel for t h e trade-off.
T h e a v e r a g e i n c o m e tax r a t e is p r o b a b l y o f
m o r e c o n c e r n t h a n t h e m a r g i n a l t a x rate t o
people trying t o decide whether to d o a project
t h e m s e l v e s o r t o h i r e s o m e o n e else. B e c a u s e
t h e f e d e r a l i n c o m e tax tables n o w c o v e r i n c o m e s
o f u p t o $ 5 0 , 0 0 0 , m a n y , if n o t m o s t , use t h e
tables instead of t h e tax rate s c h e d u l e s t o
calculate their taxes. N i n e t y - t h r e e p e r c e n t of
D I Y e r s h a v e i n c o m e s o f less t h a n $ 4 0 , 0 0 0 . 1 1
W h e n u s i n g t h e t a x t a b l e s , o n e is o n l y a w a r e o f
t h e t o t a l tax d u e relative t o t a x a b l e i n c o m e .
T h e tax rate schedules, o n t h e o t h e r hand,
s h o w t h e m a r g i n a l t a x rates.
Chart 9 illustrates t h e process o n e m i g h t go
t h r o u g h in d e c i d i n g w h e t h e r t o u n d e r t a k e a
p r o j e c t o r t o have t h e w o r k d o n e professionally.
T h e h o r i z o n a l axis s h o w s i n c o m e a n d t h e
v e r t i c a l axis t h e n u m b e r o f h o u r s it w o u l d t a k e
t o finish. T h e c u r v e i n d i c a t e s a series o f p r o j e c t
t i m e p o i n t s for w h i c h t h e i n d i v i d u a l at each
i n c o m e , $ 1 0 , 0 0 0 , $ 3 0 , 0 0 0 , $ 5 0 , 0 0 0 , etc., is
i n d i f f e r e n t as t o w h e t h e r h e s h o u l d d o t h e

" D o - I t - Y o u r s e l f M a r k e t s : H o m e & A u t o , 1981, from a compilation of
ideas a n d sources on DIY published in 1983 by M e c h a n i x I l l u s t r a t e d .

JANUARY 1984, E C O N O M I C

REVIEW

a p r o f e s s i o n a l . H o w e v e r t h e d a t a fail t o s u p p o r t
t h i s e x p l a n a t i o n . T h e p a r a d o x is t h a t d o - i t yourselfers are s k e w e d t o w a r d higher, n o t lower,
i n c o m e s . O v e r 5 0 p e r c e n t e a r n in e x c e s s o f
$ 2 0 , 0 0 0 a year, A n d n e a r l y a q u a r t e r o f all
D I Y e r s m a k e o v e r $ 3 0 , 0 0 0 a year. T h e h e a v y
r e p r e s e n t a t i o n o f r e l a t i v e l y h i g h i n c o m e s disp u t e s t h e h y p o t h e s i s t h a t DIYers act p r i n c i p a l l y
o u t of e c o n o m i c need.

Chart 9. DIY vs. Pay-to-Have-it-Done
Decision Curve
Project Hours

0

20

40

60

80

100

Income in Thousands of Dollars

p r o j e c t h i m s e l f o r h a v e it d o n e p r o f e s s i o n a l l y .
In his m i n d t h e d o l l a r s a n d c e n t s c o s t w o u l d b e
e x a c t l y t h e s a m e e i t h e r w a y . For a n i n d i v i d u a l
e a r n i n g o f $ 3 0 , 0 0 0 a year, p o i n t A, b e l o w t h e
curve, c o i n c i d e s w i t h a project w h i c h he w o u l d
r e c o g n i z e as m o n e t a r i l y b e n e f i c i a l t o d o himself.
G i v e n his i n c o m e a n d a v e r a g e t a x rate, h e
w o u l d s p e n d m o r e hours earning the m o n e y t o
h a v e t h e j o b d o n e p r o f e s s i o n a l l y t h a n it w o u l d
t a k e t o d o it h i m s e l f . Still at t h e $ 3 0 , 0 0 0
i n c o m e level, p o i n t B, a b o v e t h e curve, c o i n c i d e s
with a project the individual w o u l d contract to
have d o n e professionally, if h e bases t h e d e c i s i o n
s t r i c t l y o n t h e v a l u e o f his t i m e . T h i s p r o j e c t o f
about 150 hours w o u l d take more t i m e to
handle personally than the t i m e required to
e a r n t h e m o n e y t o h a v e it d o n e p r o f e s s i o n a l l y .
If p e o p l e w e r e g u i d e d s t r i c t l y b y d o l l a r s a n d
c e n t s in d e c i d i n g w h e t h e r t o u n d e r t a k e a
p r o j e c t o r p a y t o h a v e it d o n e f o r t h e m , t h o s e a t
l o w i n c o m e s w o u l d d o m o s t of their o w n repair
w o r k and t h e m o r e prosperous w o u l d hire
m o s t o f it o u t . B u t t h i s is n o t t h e case. T h e D I Y
i n c o m e p r o f i l e is w e l l r e p r e s e n t e d b y h i g h
i n c o m e g r o u p s . T h e Y a n k e l o v i t c h s u r v e y tells
us t h a t m a n y o f t h e h i g h e a r n e r s d o t h e i r o w n
w o r k , n o t for t h e savings, b u t f o r t h e satisfaction
a n d e n j o y m e n t it g i v e s t h e m . O v e r t h e w h o l e
s p e c t r u m of incomes, n o n m o n e t a r y
factors
motivate m a n y self-help chores.
D I Y w o r k c a n b e v i e w e d as s u b s t i t u t i n g o n e ' s
o w n labor t i m e for t h e m o r e e x p e n s i v e labor of

FEDERAL RESERVE B A N K O F A T L A N T A




O n e c e r t a i n r e q u i s i t e f o r t h e h a n d y m a n is
f r e e t i m e a w a y f r o m a r e g u l a r j o b . L a c k i n g this,
a p e r s o n m u s t h i r e s o m e o n e t o d o all o f t h e
projects that m i g h t o t h e r w i s e be d o n e himself.
Several i n d i c a t o r s t e l l us t h a t t h e A m e r i c a n
worker, o n average, enjoys m o r e t i m e away
f r o m his o r h e r j o b t h a n e v e r b e f o r e . T h e
a m o u n t of t i m e and m o n e y spent d u r i n g this
t i m e are e v i d e n t f r o m t h e t r e m e n d o u s g r o w t h
o f l e i s u r e i n d u s t r i e s o v e r t h e last 2 0 years. This
t i m e a p p a r e n t l y is a l s o b e i n g u s e d f o r r e p a i r
and fix-up jobs.
T h e a v e r a g e A m e r i c a n w o r k e r is p u t t i n g in a
s h o r t e r w o r k w e e k t o d a y t h a n w o r k e r s 2 0 years
ago. T h e a v e r a g e w o r k w e e k has d e c l i n e d f r o m
3 7 . 1 t o 3 4 . 8 h o u r s , a r e d u c t i o n o f j u s t o v e r 15
w o r k d a y s o v e r a yeaKs t i m e . 1 2 A n d t h e l a b o r
m a r k e t p a r t i c i p a t i o n r a t e has b e e n d e c l i n i n g
f o r m e n u n d e r t h e age o f 5 0 . 1 3 M e n h a v e
d r o p p e d o u t of t h e official w o r k force a n d
m a k e their living f r o m sources not a c c o u n t e d
f o r in o f f i c i a l statistics. T h e o f f i c i a l u n e m p l o y m e n t rate has h o v e r e d b e t w e e n 5 p e r c e n t t o
1 0 p e r c e n t o f t h e w o r k f o r c e f o r t h e last
d e c a d e . V i r t u a l l y all o f t h i s j o b l e s s g r o u p ' s t i m e
is f r e e , a l t h o u g h t h e i r lack o f d i s c r e t i o n a r y
i n c o m e restricts t h e a m o u n t o f self-help a c t i v i t y
they can afford t o undertake.
G o v e r n m e n t r e g u l a t i o n also p r o m p t s s o m e
p e o p l e t o d o w o r k themselves rather than
p a y i n g f o r a l i c e n s e o r h a v i n g t h e i r w o r k ins p e c t e d . For instance, v i r t u a l l y e v e r y m u n i c i p a l i t y
requires a building permit before residential
construction w o r k above a certain value can
b e g i n . T h e p e r m i t s raise r e v e n u e , a l e r t t h e
b u i l d i n g i n s p e c t o r t o c h e c k t h e h o u s e for c o d e
c o m p l i a n c e , a n d alert t h e tax assessor t o increase
t h e h o u s e ' s v a l u a t i o n a f t e r t h e w o r k is d o n e .
Failure t o b u y a p e r m i t is c e r t a i n l y illegal, b u t a
h o m e o w n e r p l a n n i n g a small, i n e x p e n s i v e j o b

" S u r v e y of C u r r e n t B u s i n e s s , U. S. Department of Commerce, Bureau ot
Economic Analysis, J u n e 1983.
u
H a n d b o o k of L a b o r S t a t i s t i c s U. S. Department of Labor, Bureau of
Labor Statistics.

27

m a y c o n s i d e r it w o r t h t h e risk. T h e h o m e o w n e r
m a y fear t h a t t h e b u i l d i n g i n s p e c t o r a n d tax
assessor will cause h i m t o d o extra, unnecessary
w o r k to c o m p l y w i t h the building code or may
a r b i t r a r i l y raise t h e tax v a l u a t i o n o n his h o m e .
W i t h t h e s e c o n s i d e r a t i o n s in m i n d , he m a y
d e c i d e t o d o t h e w o r k because licensed tradesm e n m a y refuse t o j e o p a r d i z e t h e i r s t a n d i n g b y
w o r k i n g o n an u n l i c e n s e d p r o j e c t , n o m a t t e r
h o w small.
Sometimes the market cannot deliver the
q u a n t i t y , q u a l i t y a n d t i m i n g o f services t h a t an
i n d i v i d u a l w a n t s a n d t h e j o b requires. D o i n g
t h e j o b p e r s o n a l l y is s o m e t i m e s t h e o n l y w a y t o
satisfy all t h e requirements. In Chart 7 referenced
earlier, t h e Yankelovitch
Monitor
reports that
a b o u t 15 p e r c e n t of DIYers r e s p o n d i n g said
t h e y d i d their o w n w o r k because it was expedie n t O f t e n , t h e m a r k e t is less r e s p o n s i v e t o t h e
h o m e o w n e r t h a n he can b e t o h i m s e l f .
Tax a v o i d a n c e m o t i v a t e s s o m e DIY w o r k .
Workers w i t h flexible schedules may choose to
w o r k e x t r a h o u r s t o c o v e r t h e cost of h a v i n g a
p r o j e c t d o n e f o r t h e m . H o w e v e r , t h e y p a y tax
o n this a d d i t i o n a l i n c o m e . Because t h e tax
increases t h e h o u r s of w o r k r e q u i r e d t o t a k e
h o m e a given a m o u n t of m o n e y , workers may
f i n d t h a t t h e y can save t i m e b y d o i n g a p r o j e c t
themselves rather t h a n w o r k i n g m o r e hours t o
e a r n t h e m o n e y t o h a v e it d o n e p r o f e s s i o n a l l y .
Finally, in t h i s age o f self-help, a n y t h i n g t h a t
increases a p e r s o n ' s self-reliance, or gives t h e
a p p e a r a n c e of d o i n g so, is f a s h i o n a b l e . D o - i t yourself psychology, t h e emphasis on physical
fitness a n d h o m e gardening are a f e w examples.
From t h i s g e n e r a l m i n d - s e t , d o i n g repair a n d
f i x - u p w o r k m u s t a p p e a r v e r y attractive. In
addition, being a h a n d y m a n adds t o t h e personal
c o n t r o l o n e exercises over his t i m e and resources.
Such personal initiative offers a positive, a l t h o u g h
sometimes token, response t o s o m e of the
problems m o d e r n Americans complain about:
inflation, high interest rates, high taxes, governm e n t r e g u l a t i o n s a n d so forth.

The Prosumer
In his b o o k , The Third Wave, A l v i n T o f f l e r
d e s c r i b e s D I Y as part o f a w o r l d w i d e socioeconomic evolution. He coined the w o r d "prosumer" t o describe those w h o p r o d u c e for
their o w n c o n s u m p t i o n , a d e f i n i t i o n that includes
DIYers. T o f f l e r calls t h e e c o n o m i c s t r u c t u r e of
primitive agricultural societies t h e "first wave."
28




In t h e s e s o c i e t i e s e a c h p e r s o n ( o r family)
g r o w s f o o d a n d c o n s t r u c t s t h e necessities o f
life f o r p e r s o n a l use. T h e s e are t h e a r c h e t y p a l
p r o s u m e r s . In " s e c o n d - w a v e " s o c i e t i e s p e o p l e
p r o d u c e f o r d i s t r i b u t i o n b y m a r k e t s ; t h e y are
p a i d f o r t h e i r e f f o r t s w i t h m o n e y t h a t t h e y use
t o p u r c h a s e g o o d s a n d services f r o m o t h e r s . In
t h e " t h i r d w a v e , " T o f f l e r says, p e o p l e w i l l again
p r o d u c e for their o w n c o n s u m p t i o n , relying
m u c h less o n m a r k e t s t o d e l i v e r t h e i r g o o d s
a n d services t h a n d o s e c o n d - w a v e societies.
In t h e t h i r d w a v e , n e w c o m m u n i c a t i o n s ,
microprocesser a n d laser technologies will serve
as catalysts t h a t i n t e g r a t e t h e c o n s u m e r i n t o
t h e p r o d u c t i o n process. C o m p u t e r - l i k e a u t o matic teller machines already have replaced
m o s t h u m a n tellers at s o m e banks. Sophisticated
s w i t c h i n g e q u i p m e n t a l l o w s us t o dial o u r o w n
l o n g d i s t a n c e t e l e p h o n e calls, a n d users can
install m o s t p h o n e s w i t h o u t help f r o m a servicem a n . S o m e cars n o w h a v e light e m i t t i n g d i o d e
(LED) displays t h a t spell o u t f o r t h e d r i v e r t h e
s o u r c e o f v a r i o u s service p r o b l e m s . Each of
t h e s e e x a m p l e s illustrates a case in w h i c h t h e
e n d c o n s u m e r of a service—banking, t e l e p h o n e
communication and auto repair—through new
t e c h n o l o g y is m o v e d a little closer t o t h e a c t u a l
p r o d u c t i o n of t h e service.
Toffler explains t h e c o n v e r g e n c e of c o n s u m e r
a n d p r o d u c e r in t h e " t h i r d w a v e " b y c i t i n g w h a t
h e calls t h e l a w o f r e l a t i v e i n e f f i c i e n c y . 1 4
A c c o r d i n g t o t h i s a r g u m e n t , as t h e cost o f
g o o d s d e c l i n e s r e l a t i v e t o t h e cost o f h a n d i c r a f t
or o t h e r n o n - a u t o m a t e d services, t h e services
b e c o m e m o r e expensive a n d p e o p l e substitute
their o w n t i m e instead. DIY appears t o be o n e
t y p e of substitution resulting f r o m this p h e n o m e non.

Support Industries
The do-it-yourself m o v e m e n t manifests itself in
four w e l l - k n o w n areas: specialized publications,
special television a n d radio programming, special
courses g i v e n at c o m m u n i t y colleges, h i g h
s c h o o l s a n d t e c h schools, a n d s e l f - h e l p retail
stores. It is part o f a greater m o v e m e n t in
A m e r i c a t o w a r d p u t t i n g n e w l y e m e r g i n g technologies t o w o r k in e v e r y d a y lives.
D o i n g s o m e t h i n g ourselves, w h e t h e r it b e
p l a n t i n g a g a r d e n o r f i x i n g a car, r e q u i r e s a

,4

Alvin Toffler, T h e T h i r d W a v e , (New York: Bantam, 1981), p. 273.

JANUARY 1984, E C O N O M I C R E V I E W

F|

detailed k n o w l e d g e of t h e t e c h n o l o g y involved.
After w o r d of m o u t h , b o o k s a n d m a g a z i n e s
p r o v i d e t h e c h e a p e s t a n d m o s t accessible
sources for t h i s i n f o r m a t i o n . S u c h m a g a z i n e s as

New Shelter,
Handyman

Popular

Mechanics

offer specialized

and Family

articles

focusing

on t h e s u b j e c t .
C o m p a r i n g t h e p e r f o r m a n c e of several related
magazines w i t h t h e 5 0 mass m a r k e t m a g a z i n e s
w i t h t h e h i g h e s t 1 9 8 1 r e v e n u e s gives s o m e
clues t o t h e m o v e m e n t itself. A c c o r d i n g t o
Folio, t h e m a g a z i n e a b o u t magazines, t h e DIY
category (Folio calls it t h e men's service category)
e x p e r i e n c e d $ 1 3 3 m i l l i o n in sales in 1 9 8 1 , 1 5
t h e latest year f o r w h i c h Folio
has c o m p i l e d
data. T h e m a g a z i n e s in t h i s g r o u p are:
Popular

Mechanics, Popular Science, Mechanix Illustrated,
The Family Handyman, Popular Electronics and
New Shelter.
From 1 9 7 9 t o 1 9 8 1 this m a r k e t
s e g m e n t i n c r e a s e d its share of Folio's
t o p 50
c i r c u l a t i o n m a g a z i n e s f r o m 3.5 p e r c e n t t o 3.8
p e r c e n t , w h i l e t h e t o t a l c i r c u l a t i o n of t h o s e 5 0
fell b y 2.2 p e r c e n t . T h e m a r k e t f o r h o w - t o - d o - i t
t y p e m a g a z i n e s c l e a r l y has b e e n e x p a n d i n g .

The d e m a n d for s e l f - h e l p t e c h n o l o g y has
f o u n d a n o t h e r o u t l e t in r a d i o a n d t e l e v i s i o n
shows o f f e r i n g " h o w - t o " a d v i c e o n j u s t a b o u t
any t o p i c Public television has b e e n particularly
responsive t o this d e m a n d t h r o u g h such programs as "This O l d House," explaining m e t h o d s
of r e n o v a t i n g o l d h o m e s ; " T h e W o o d w r i g h t ' s
Shop," o f f e r i n g w o o d w o r k i n g k n o w - h o w f o r
those w h o like t o use a n t i q u e tools and m e t h o d s ,
and " C r o c k e t t ' s Victory Garden," offering general
h o m e gardening advice. At least o n e specialized
retail chain store sponsors radio advertisements
that give h i n t s o n h o w t o p e r f o r m c h o r e s
quickly and cheaply.
The t h i r d w i d e l y available source of technical
j i n f o r m a t i o n is t h e n e w a n d e x p a n d i n g area of
one-shot courses o f f e r e d by c o m m u n i t y colleges
and t e c h n i c a l schools. T h e c o u r s e s usually are
narrow in s c o p e a n d are o f t e n t a u g h t b y a
p r a c t i t i o n e r in t h e f i e l d , such as a p l u m b e r ,
auto m e c h a n i c or n u r s e r y m a n . T h e courses
usually o f f e r n o d e g r e e c r e d i t . Examples are
courses o n w o o d w o r k i n g , auto mechanics, landscaping a n d increasing h o m e energy efficiency.
T h e DIY retail o u t l e t is t h e m o s t v i s i b l e
manifestation of t h e activity going o n in America,
today. A u t o m o b i l e parts stores are everywhere.

A n d h o m e i m p r o v e m e n t outlets have sprung
u p close t o t h e s u b u r b a n h o m e o w n e r s w i t h
w h o m t h e y d o business. A s t u d y b y
Mechanix
Illustrated
p u b l i s h e d in Folio m a g a z i n e r e p o r t s
t h a t t h e d o l l a r v a l u e of m a n u f a c t u r e r s ' shipm e n t s for this h o m e m a r k e t (see C h a r t 10) rose
b y 4 7 0 p e r c e n t f r o m 1 9 6 7 t o 1 9 8 0 a n d is
f o r e c a s t t o go u p 1 4 5 p e r c e n t f r o m 1 9 8 5 t o
1 9 9 5 . 1 6 T h e s l o w e r u p c o m i n g g r o w t h rate is
p r e m i s e d o n less r a p i d i n f l a t i o n a n d a s l o w e r
rate of h o u s e h o l d f o r m a t i o n t h r o u g h 1 9 9 5 .
Manufacturers' s h i p m e n t s for 1982 are e s t i m a t e d
t o be $12.7 billion.
T h e retail v a l u e of sales b y h o m e c e n t e r
stores w a s $ 2 5 . 3 b i l l i o n in 1 9 8 1 , u p 58 p e r c e n t
o v e r 1 9 7 7 . T h e largest 1 0 0 h o m e c e n t e r c o m panies e x p e r i e n c e d an 11.7 p e r c e n t increase
in sales t o h a n d y m e n in 1 9 8 2 o v e r 1 9 8 1 ; a n d
t h e t o p 25 u p p e d t h e i r sales 12.3 p e r c e n t . O f
course, h o m e c e n t e r stores sell t o c o n t r a c t o r s
t o o . But of t h e t o p 1 0 0 , 76 p e r c e n t of sales
w e r e t o h o u s e h o l d e r s , a n d 79 p e r c e n t f o r t h e
t o p 25.17

Conclusion
O n e o b s e r v e r of t h e d o - i t - y o u r s e l f m o v e m e n t r e m a r k e d recently t h a t there is absolutely

,6

lbid., p. 236.
,
. . .
.
" N a t i o n a l H o m e C e n t e r N e w s , 1982, from a compilation of ideas a n d
sources on DIY published in 1983 by M e c h a n i x I l l u s t r a t e d .
15

Folio, September 1982. p. 238.

29
FEDERAL RESERVE B A N K O F A T L A N T A




n o t h i n g n e w a b o u t it. T h e A m e r i c a n p i o n e e r s
d i d almost e v e r y t h i n g themselves, o u t of necessity. T h e n e w s is t h a t p e o p l e in m o d e r n , hight e c h n o l o g y A m e r i c a are d o i n g it, a n d f o r m u c h
less c o m p e l l i n g reasons t h a n t h e p i o n e e r s .
T a c k l i n g a j o b p e r s o n a l l y is still a w a y of or
getting things d o n e , expeditiously if y o u lack t h e
m o n e y t o b u y a g o o d or a service, b u t it has
b e c o m e m u c h m o r e . It is a w a y of e n j o y i n g
o n e ' s t i m e , a w a y o f saving m o n e y t o f i n a n c e
a n o t h e r leisure activity, a w a y of a v o i d i n g taxes
legally and a w a y of sidestepping costly a n d t i m e c o n s u m i n g g o v e r n m e n t regulations.
Prospects for c o n t i n u e d g r o w t h of t h e movem e n t appear excellent. The 25-to-54 segment
of t h e p o p u l a t i o n identified w i t h t h e m o v e m e n t
w i l l g r o w t h r o u g h t h e e n d of t h i s c e n t u r y . A n d ,

30




although t h e orginal i m p e t u s came on t h e
d e m a n d side f r o m t h o s e d o i n g t h e i r o w n w o r k ,
t h e businesses m a n u f a c t u r i n g a n d r e t a i l i n g
m a t e r i a l a n d t o o l s have j u m p e d o n t h e b a n d
w a g o n a n d are p u s h i n g t h e c o n c e p t f o r all it is
worth.
In t h e e n d , t h e c u l t u r a l or p s y c h o l o g i c a l
bases f o r h a n d l i n g a task p e r s o n a l l y m a y have
t h e most t o d o w i t h t h e trend's persistence.
The reason m o s t c o m m o n l y given by h a n d y m e n
is e n j o y m e n t If this is t h e case, and if Americans
o n average are g a i n i n g m o r e f r e e t i m e a w a y
f r o m t h e i r j o b s as g o v e r n m e n t d a t a suggest,
t h e n DIY m a y b e in t h e early stages of e v e n
m o r e rapid g r o w t h t o c o m e .
—Joel R. Parker

JANUARY 1984, E C O N O M I C REVIEW

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In-Store ATMs:
Steppingstone to POS

An Atlanta Fed survey found that 66 percent of major grocery and convenience
stores have installed or plan to install automated teller machines. Retailers say
the ATMs attract customers, reduce bad check problems and, perhaps most
importantly, prepare consumers for point-of-sale terminals and debit cards.

R e c e n t l y , m a n y A m e r i c a n c o n s u m e r s have
e n t e r e d t h e i r local s u p e r m a r k e t t o d i s c o v e r a n
a u t o m a t e d t e l l e r m a c h i n e ( A T M ) i n s t a l l e d in
t h e f r o n t o f t h e store. A T M s l o c a t e d off b a n k
premises appear to be spreading t h r o u g h o u t
s h o p p i n g malls, supermarkets a n d c o n v e n i e n c e
stores across t h e n a t i o n . In fact, t h e Florida
Interchange G r o u p — t h e forerunner of Florida's
H O N O R network—estimated that by 1986,
half o f Florida's p r e d i c t e d 3 , 5 0 0 A T M s w i l l b e
l o c a t e d o f f - p r e m i s e . 1 C e r t a i n l y , as i n d i c a t e d b y
substantial transaction volumes, consumers
find these A T M s c o n v e n i e n t Beyond increased
c u s t o m e r c o n v e n i e n c e , h o w e v e r , o t h e r farreaching implications may be drawn from the

'"Igniting an EFT Revolution in Florida," B a n k N e t w o r k News, Vol. 1
(February 8, 1983), p. 2.

FEDERAL RESERVE B A N K O F A T L A N T A




i n s t a l l a t i o n of s h a r e d o f f - p r e m i s e A T M s . T h e y
r e p r e s e n t a significant s t e p in t h e g r a d u a l
d i s p l a c e m e n t o f p a p e r checks.
In o r d e r t o p r o b e t h i s s u b j e c t m o r e d e e p l y ,
t h e Federal Reseive Bank of Atlanta surveyed 35
of t h e largest g r o c e r y a n d c o n v e n i e n c e s t o r e
c h a i n s in t h e Southeast. T h e results clearly
demonstrate that southeastern grocery and
c o n v e n i e n c e stores are m o v i n g aggressively t o
o f f e r b a n k i n g services t o t h e i r c u s t o m e r s . T h e
s u r v e y f o u n d t h a t 6 6 p e r c e n t of m a j o r g r o c e r y
a n d c o n v e n i e n c e store operators either already
have A T M s o r h a v e d e f i n i t e plans t o install
a u t o m a t i c teller machines on their premises.
They feel that this initiative promises distinct
a d v a n t a g e s in a t t r a c t i n g c u s t o m e r s , r e d u c i n g
p r o b l e m s w i t h b a d checks, a n d e x p a n d i n g
t h e i r range of c u s t o m e r services. F u r t h e r m o r e ,
31

m o s t of these organizations v i e w t h e A T M as a
steppingstone t o t h e point-of-sale cash register
t e r m i n a l a n d t h e d e b i t card.
Thus t h e survey confirms another evolutionary
s t e p in t h e d i s p l a c e m e n t of p a p e r c h e c k s b y
electronic substitutes. 2 O n c e customers a c c e p t e d
t h e A T M as a c a s h - a c q u i s i t i o n d e v i c e at t h e i r
b a n k or o t h e r d e p o s i t o r y i n s t i t u t i o n , b a n k s
b e g a n t o p l a c e t h e i r p r o p r i e t a r y A T M s in o t h e r
l o c a t i o n s , s u c h as s h o p p i n g centers a n d airports.
A n o t h e r significant step involves t h e shift f r o m
proprietary to shared A T M networks, through
w h i c h account-holders at o n e d e p o s i t o r y instit u t i o n can utilize t h e A T M s of o t h e r institutions.
W i t h t h e f o r m a t i o n of shared networks—curr e n t l y w e l l u n d e r w a y — b a n k s can m u l t i p l y t h e
c o n v e n i e n c e o f f e r e d b y their plastic A T M cards
w i t h o u t having to purchase additional ATMs.
T y p i c a l l y , special service c o r p o r a t i o n s established b y t h e participating institutions 3 administer t h e shared networks.

"To the customer, it is only a small
step from using a plastic card to
acquire cash and then groceries to
using the plastic card to purchase
groceries directly."

Grocery a n d c o n v e n i e n c e stores, m e a n w h i l e ,
h a d b e e n w a t c h i n g a n d w a i t i n g f o r a large base
of A T M c u s t o m e r s t o d e v e l o p . As l o n g as A T M s
w e r e o n l y a c c e s s i b l e b y a f e w p e o p l e , or as l o n g
as a grocer's ( p r o p r i e t a r y ) A T M c o u l d o n l y b e
used b y customers of a single financial institution,
i n s t a l l a t i o n w a s n o t justified o n a n y t h i n g o t h e r
t h a n an e x p e r i m e n t a l basis. As t h e A T M - c a s h
d i s p e n s e r b e c a m e w i d e l y accepted, however,
c o n c u r r e n t w i t h t h e e v o l u t i o n of s h a r e d A T M
n e t w o r k s at t h e local level, grocers c o u l d install
A T M s w i t h t h e e x p e c t a t i o n that a significant
p r o p o r t i o n of their customers w o u l d benefit.
The survey d e s c r i b e d here indicates that grocers
are i n d e e d t a k i n g a d v a n t a g e o f t h e n e w o p p o r tunity.

2For a more comprehensive description of this evolution, see "Displacing
the Check." this Review, August 1983. See also " P a y m e n t s in the
Financial Services Industry of the 1980s" this Review, December 1982,
especially quotes by Peter Merrill that "the financial services industry is
now shifting into a second phase involving shared delivery systems."
3
S e e " S h a r e d ATM Networks: The Nation a n d the Southeast," this Review,
December 1982.

32




T h e i n s t a l l a t i o n o f in-store A T M s is signific a n t b e y o n d t h e s p r e a d o f A T M cash dispensers. A T M s in retail l o c a t i o n s p r o v i d e a n
evolutionary steppingstone or "transition prod u c t " b e t w e e n cash a c q u i s i t i o n a n d d e b i t card
purchases. T o t h e c u s t o m e r , it is o n l y a small
s t e p f r o m u s i n g a plastic c a r d t o a c q u i r e cash
a n d t h e n groceries, in t o d a y ' s case, t o u s i n g t h e
plastic c a r d t o p u r c h a s e groceries d i r e c t l y .
From a t e c h n i c a l s t a n d p o i n t , t h e A T M is transf o r m e d into a point-of-sale terminal, t h e A T M
c a r d b e c o m e s a d e b i t card, a n d t h e s h a r e d
A T M n e t w o r k b e c o m e s a shared d e b i t card
n e t w o r k . Yet m a r k e t t e s t i n g i n d i c a t e s t h a t such
a t r a n s i t i o n w i l l a p p e a r t o b e r e l a t i v e l y m i n o r in
t h e eyes of t h e c o n s u m e r .
G r o c e r s a n d c o n v e n i e n c e store o p e r a t o r s
r e c o g n i z e t h i s c o n n e c t i o n , o u r survey i n d i cates. T h u s t h e A T M s in g r o c e r y a n d c o n v e n i e n c e stores m a y b e p a v i n g t h e w a y t o
w i d e s p r e a d p e n e t r a t i o n a n d a c c e p t a n c e of
d e b i t cards, w h i c h in t u r n w i l l b e c o m e m o r e
prevalent in o t h e r retail establishments such as
gas stations and d e p a r t m e n t stores. 4 Potentially,
d e b i t cards w i l l d i s p l a c e a large n u m b e r o f
p e r s o n a l checks, b e c a u s e a l m o s t t h r e e t i m e s
as m a n y c h e c k s are w r i t t e n f o r retail p u r c h a s e s
as are w r i t t e n f o r cash a c q u i s i t i o n . 5
W h y are g r o c e r y a n d c o n v e n i e n c e stores so
i m p o r t a n t in this e v o l u t i o n ? G r o c e r s cash a
t r e m e n d o u s n u m b e r of checks; in m a n y cases
c h e c k v a l u e e x c e e d s gross sales. T h e y n e e d a
q u i c k e r a n d c h e a p e r m e a n s of n e g o t i a t i n g
.such p a y m e n t s a n d of e l i m i n a t i n g b a d checks.
C o n v e n i e n c e stores are m o r e c o n c e r n e d w i t h
e l i m i n a t i n g c u r r e n c y in cash registers, t h e r e b y
d i s c o u r a g i n g r o b b e r i e s . Both t y p e s of . stores
p r o v i d e a large n u m b e r o f w i d e l y d i s p e r s e d
sites o p e n for long hours. Furthermore, c u s t o m e r
t r a f f i c is already established and regular. The
great m a j o r i t y o f t h e i r c u s t o m e r s are local, w i t h
p a y m e n t s d r a w n against local f i n a n c i a l i n s t i t u tions. Because of this c o m b i n a t i o n of characteristics, g r o c e r y a n d c o n v e n i e n c e stores p r o v i d e
a g o o d " t e s t i n g g r o u n d " f o r retail p o i n t - o f - s a l e
transactions.

"The c h e c k displacement forecasts for debit cards e m b o d i e d in "Displacing the Check" are somewhat more aggressive than that of s o m e
other observers because of the expected impact from retailers (p. 18-24,
41-42).
5
"Displacing the Check," Table 4, p. 32.

JANUARY 1984, E C O N O M I C

REVIEW

Table 1. Stores in Some Stage of ATM Installation
Hours of Operation

Transaction Types Handled

SUPERMARKETS
ATMs Already Installed
Bruno's Inc., Alabama

24 Hours

Full-Line'

Food Giant, Georgia

24 Hours/Store

Full-Line/plus
Traveler's Checks

Jitney Jungle, Mississippi

24 Hours/Store

Full-Line

Kroger-Atlanta Division
Kroger-Nashville Division

Store Hours
Store Hours

Full-Line
Full-Line

24 Hours

Full-Line

The Red Food Stores, Tennessee

24 Hours/Stores

Full-Line

Sunflower Stores, Mississippi

24 Hours/Stores

Full-Line

Store Hours

Full-Line

24 Hours

Cash Withdrawals

Grand Union, Florida, Georgia

24 Hours/Store

Full-Line

Pantry Pride, Florida

24 Hours/Store

Full-Line

Store Hours

Cash Withdrawals

Publix, Florida

Winn-Dixie, Florida
Finalized Installations
Albertson's, Florida

Definite Plans to Install; Lack Final Commitment
Bi-Lo Inc., South Carolina
National Supermarkets, Louisiana
Schwegman Giant Stores, Louisiana

Undecided

Undecided

Store Hours

Cash Withdrawals

Probably Store Hours

Cash Withdrawals

Undecided

Undecided

Store Hours

Full-Line

Vague Installation Plans
Dixieland Food Stores, Alabama
Food Town Stores, North Carolina
Harris-Teeter Supermarkets,
North Carolina

Sub-Total: 17 or 63% of 27 Supermarket Chains Surveyed
CONVENIENCE STORES
ATMs Already Installed
Fast Fare Inc., North Carolina

24 Hours

Full-Line

Munford Inc., Georgia

24 Hours

Full-Line

The Pantry Inc., North Carolina

24 Hours

Full-Line

Finalized Installation Plans
Cash Withdrawals;

Little General Stores, Florida

24 Hours/Store

Shop & Go Inc., Florida

24 Hours/Store

Full-Line Except Deposits

24 Hours

Full-Line

24 Hours

Full-Line Except Deposits;
Cash Advances on Credit Cards

Sunshine Jr. Stores, Florida

Barnett Bank Deposits Only

Pilot in Texas
National Convenience Stores,
(Shop-N-Go), Georgia 2
Pilot in Philadelphia
Store Hours/
Southland Corporation (7-11 Stores),
Usually 24
Louisiana2
Sub-Total: 6 or 75% of 8 Convenience Store Chains surveyed

Full-Line Except Deposits

TOTAL: 23 or 66% of 35 SURVEY PARTICIPANTS
'Full-Line: Deposits, withdrawals, balance inquiries, transfers b e t w e e n a c c o u n t s
2

These t w o c o n v e n i e n c e store chains are not included in survey totals because they have not c o m m e n c e d
in their southeastern s t o r e s

FEDERAL RESERVE B A N K O F A T L A N T A 33




A T M installation

Survey Results
O u r survey, w h i c h w a s c o n d u c t e d in A u g u s t ,
i n c l u d e d eight southeastern states—Alabama,
Florida, Georgia, Louisiana, Mississippi, N o r t h
C a r o l i n a , S o u t h Carolina, a n d T e n n e s s e e . T h e
t h i r t y - f i v e c o r p o r a t i o n s i n c l u d e d in t h e s a m p l e
w e r e c u l l e d f r o m a list o f t h e 2 0 0 largest
s u p e r m a r k e t a n d c o n v e n i e n c e c h a i n s in t h e
n a t i o n . U n d e r t h e a s s u m p t i o n t h a t t h e largest
stores usually serve as i n d u s t r y l e a d e r s — i n
general t h e y are t h e first t o i m p l e m e n t innov a t i o n s — t h e s u r v e y is r e f l e c t i v e of e l e c t r o n i c
b a n k i n g a c t i v i t y o c c u r r i n g in s o u t h e a s t e r n grocery a n d c o n v e n i e n c e chains.
T w e n t y - t h r e e of t h e t h i r t y - f i v e c h a i n s quest i o n e d e i t h e r have A T M s in t h e i r stores or p l a n
t o install t h e m w i t h i n t w o years. Eleven stores
have a l r e a d y i n s t a l l e d A T M s ; six stores have
s i g n e d c o n t r a c t s t o d o so w i t h i n t h e n e x t six
m o n t h s . T h r e e stores d e f i n i t e l y p l a n t o install
A T M s b u t lack f i n a l c o m m i t m e n t s . T h r e e o t h e r
c h a i n s i n t e n d t o install A T M s w i t h i n t h e n e x t
t w o years b u t plans r e m a i n s o m e w h a t v a g u e at
t h e m o m e n t . F u r t h e r m o r e , of t h e e l e v e n stores
w i t h o u t A T M installation plans, o n e is c o n d u c t i n g
a n e x t r e m e l y p r e l i m i n a r y i n v e s t i g a t i o n of t h e
t o p i c . Also, t w o f i r m s are n a t i o n a l c h a i n s w i t h
A T M pilot programs in o t h e r parts of t h e country.
Q u i t e c o n c e i v a b l y , A T M i n s t a l l a t i o n in t h e i r
s o u t h e a s t e r n stores c o u l d f o l l o w successful
pilots.
After ascertaining t h e n u m b e r of supermarkets
a n d c o n v e n i e n c e stores i n s t a l l i n g A T M s , w e
c o m p a r e d v a r i o u s o p e r a t i o n a l details. O f t h e
A T M s c u r r e n t l y o p e r a t i n g , all are a c c e s s i b l e
t w e n t y - f o u r h o u r s a day, as w i l l b e t h o s e A T M s
currently being installed u n d e r contract. A T M s
t e n d t o b e l o c a t e d in stores o p e n t w e n t y - f o u r
h o u r s a day; t h i s m a x i m i z e s c o n v e n i e n c e f o r
customers.
All of t h e presently f u n c t i o n i n g in-store A T M s
o f f e r a f u l l - l i n e of t r a n s a c t i o n s — d e p o s i t s , cash
w i t h d r a w a l s , transfers b e t w e e n a c c o u n t s , a n d
b a l a n c e i n q u i r i e s . In a d d i t i o n , t h e A m e r i c a n
Express M o n e y S t o p A T M s l o c a t e d in s e v e n
A t l a n t a F o o d G i a n t s u p e r m a r k e t s d i s p e n s e traveler's checks. O f t h e stores still in t h e p l a n n i n g
stages, h o w e v e r , f o u r i n d i c a t e d t h a t t h e mac h i n e s w i l l b e f o r cash d i s p e n s i n g o n l y . A p p a r e n t l y , s o m e b a n k s i n v o l v e d feel t h a t it
w o u l d not be economical to collect deposits
f r o m such w i d e l y s c a t t e r e d l o c a t i o n s .
34




W h i l e m o s t of t h e s u p e r m a r k e t s a n d conv e n i e n c e c h a i n s i n t e n d t o install o n l y o n e A T M
p e r store, t h e n u m b e r of A T M l o c a t i o n s varies
widely. T w o distinct patterns of installation
e m e r g e . First, t h e r e are t h o s e g r o c e r y a n d
c o n v e n i e n c e s t o r e c h a i n s in w h i c h a single
b a n k installs f r o m o n e t o t e n A T M s . W i t h o u t
exception, the bank owns these machines.
Since o n l y t h a t p a r t i c u l a r b a n k ' s c u s t o m e r s
m a y access t h e m a c h i n e , it is a p r o p r i e t a r y
n e t w o r k ; n o o n e e x c e p t t h o s e possessing t h e
bank's proprietary card m a y m a k e transactions.
In contrast, s e v e n chains are i n s t a l l i n g A T M s
o n a m u c h w i d e r scale, w i t h a n y w h e r e f r o m
f i f t y t o o v e r o n e - h u n d r e d i n c l u d e d in t h e plans.
T h e s e A T M s w i l l b e part of large regional
n e t w o r k s c o m p r i s e d of m a n y banks. I n d e e d ,
t h e shared n e t w o r k s represent a large c a r d h o l d e r
base t h a t m a k e s massive i m p l e m e n t a t i o n of
A T M s e c o n o m i c a l l y feasible. T h u s a d i c h o t o m y
exists b e t w e e n plans t o install a f e w A T M s

"Twenty three of the thirty five
chains questioned either have
ATMs in their stores or plan to
install them within two y e a r s "

u n d e r a single b a n k ' s p r o p r i e t a r y n e t w o r k a n d
t h e p l a c i n g of m a n y A T M s p a r t i c i p a t i n g in a
shared n e t w o r k of regional banks. The situation in
Florida serves as an e x c e l l e n t e x a m p l e o f t h e
latter a l t e r n a t i v e .
Florida's H O N O R n e t w o r k b e c a m e operational
o n S e p t e m b e r 30, 1 9 8 3 . Representing approxim a t e l y $ 5 0 b i l l i o n in d e p o s i t s , 1 2 0 f i n a n c i a l
institutions comprise the H O N O R network.
T h e c o m b i n e d t o t a l of 3.6 m i l l i o n A T M access
cards issued b y t h e n e t w o r k a p p r o x i m a t e s 75
p e r c e n t of Florida's c a r d - h o l d i n g base. N e t w o r k
m e m b e r s w i l l h a v e access t o 4 0 7 o f f - p r e m i s e
machines, 125 of w h i c h b e l o n g t o t h e Publix
T e l l e r N e t w o r k . 6 B e g i n n i n g n e x t June, H o n o r
n e t w o r k m e m b e r s will share o n - p r e m i s e ATMs,
creating a totally shared electronic e n v i r o n m e n t
in Florida. In D e c e m b e r 1 9 8 3 , t w o o f Georgia's

Florida's H o n o r Racing to Grab the Network L e a d , " B a n k N e t w o r k
News, Vol. 2 (September 24, 1983), p. 7.

JANUARY 1984, E C O N O M I C REVIEW

F|

Table 2. Number of ATMs and Type of Network

Number

Network

Do You View This
As a Steppingstone
To Point-of-Sale?

7

Shared

Yes

Around 6 0

Shared

Yes

2

Proprietary

Uncertain

Shared

Yes

7

Shared

No

Food Town Stores Inc., North Carolina

Undecided

Undecided

Yes

Grand Union, Georgia & Florida

Around 50

Shared

Yes

1 - 10

Undecided

Yes

Jitney Jungle, Mississippi

1

Proprietary

Yes

Kroger-Atlanta Division
Kroger-Nashville Division

3
6

Proprietary
Proprietary

Yes

3

Proprietary

Uncertain

50-60

Shared

Yes

100 - 500

Shared

Yes

Schwegman Giant Super Stores, Louisiana

11

Undecided

No

Sunflower Stores, Inc., Mississippi

2

Proprietary

No

97

Shared

Yes

Fast Fare Inc., North Carolina

2

Proprietary

Uncertain

Little General Stores, Florida

20

Supermarkets
Albertson's, Florida
Bi-Lo, Inc, South Carolina
Bruno's Inc., Alabama
Dixieland Food Stores, Alabama
Food Giant Georgia

Harris-Teeter Supermarkets Inc.,
North Carolina

National Supermarkets, Louisana
Pantry Pride Inc., Florida
Publix, Florida

The Red Food Stores Inc., Tennessee

Convenience Stores

Munford, Inc., Georgia
1

National Convenience Stores (Stop-N-Go),

Shared

Yes

1

Proprietary

No

81

Shared

No

20

Shared

Yes

200

Shared

Yes

Georgia
Shop & Go Inc., Florida
'Southland Corporation (7-11 Stores),
Louisiana
Sunshine Jr. Stores, inc, Florida
The Pantry Inc., North Carolina

1

Proprietary

Yes

1

Proprietary

Yes

'These two convenience store chains are not included in survey totals b e c a u s e they have not c o m m e n c e d ATM installation in their s o u t h e a s t e r n stores.

FEDERAL RESERVE B A N K O F A T L A N T A




35

Table 3. Motives Underlying ATM Installation
Supermarkets 1

Convenience
Stores 2

Total 3

13 (48%)

7 (87%)

20 (87%)

1 (4%)

6 (48%)

7 (30%)

11 (41%)

1 (1%)

12 (52%)

Reduce Check Volume

8 (30%)

1 (1%)

9 (39%)

Reduce Bad Checks

7 (26%)

—

7 (30%)

Reduce Cash Security Problems

2 (7%)

—

2 (9%)

Reduce Labor Involved

1 (4%)

—

Increase Customer Convenience
Increase Customer Traffic
Reduce Check Processing Costs

1 (4%)

' P e r c e n t a g e of the 17 supermarket chains pursuing ATM installation.
?

P e r c e n t a g e of the 8 convenience store chains pursuing ATM installation.

3

Percentage of the 2 3 stores with plans for ATM installation.

largest f i n a n c i a l i n s t i t u t i o n s a n n o u n c e d p l a n s
t o establish a similar network, a n d invited other
G e o r g i a f i n a n c i a l i n s t i t u t i o n s t o p a r t i c i p a t e as
charter members.
I n A t l a n t a , K r o g e r is i n v o l v e d in a p i l o t w i t h
H e r i t a g e Bank. W i t h i n t h e p a s t year, H e r i t a g e
B a n k has e s t a b l i s h e d b r a n c h b a n k s in t h r e e o f
KrogeKs stores. T h e s e b r a n c h l o c a t i o n s s e r v e
as f u l l - s e r v i c e b a n k s , o f f e r i n g e v e r y t h i n g f r o m
loans to c h e c k i n g accounts. Generally b r a n c h
b a n k s are v i e w e d as " t e m p o r a r y a n d i n a d e q u a t e
e i t h e r because t h e y are t o o labor intensive a n d
i n e f f i c i e n t or t h e y serve a l i m i t e d c u s t o m e r
base."7 Yet B o b H o d g e , v i c e - p r e s i d e n t of
KrogeKs A t l a n t a d i v i s i o n , r e p o r t s t h a t : " T h e
customers seem to be very pleased with the
a d d i t i o n a l s e r v i c e . I p r e s u m e H e r i t a g e is d o i n g
e n o u g h business t o justify labor a n d costs of
p u t t i n g b a n k s i n . " 8 It is t o o e a r l y t o r e a c h a n y
d e f i n i t i v e c o n c l u s i o n s a b o u t t h e feasibility of
b r a n c h banks; h o w e v e r , installing A T M s accessib l e b y all m e m b e r s o f a s h a r e d n e t w o r k s e e m ingly constitutes a m o r e viable alternative.

Customer Convenience
O f greater i n t e r e s t t h a n details of l o c a t i o n
a n d o p e r a t i o n are t h e o b j e c t i v e s b e h i n d installing

' " C r a i g Gieler How Kroger Wants POS to Work," B a n k N e t w o r k N e w s ,
Vol. 1 (January 25, 1983), p. 4.
" B o b Hodge, vice president, Atlanta division, Kroger Co., t e l e p h o n e
interview, August 26, 1983.

36




t h e s e i n - s t o r e A T M s . For t h e m o s t p a r t , t h e
Floridians i m m e d i a t e l y r e s p o n d e d that t h e y
a c t e d i n s e l f - d e f e n s e . In a n n o u n c i n g its i n t e n tions t o establish t h e Publix Teller n e t w o r k in
1 9 8 1 , Publix super-markets initiated a m a d
s c r a m b l e t o install in-store A T M s . Thus m a n y
F l o r i d a s t o r e s p l u n g e d i n t o t h e p u r s u i t o f instore e l e c t r o n i c b a n k i n g in an effort t o r e m a i n
competitive.
A l t h o u g h c o m p e t i t i v e pressure r u s h e d Florida's
s t o r e s i n t o i n s t a l l i n g A T M s , real b e n e f i t s m u s t
a c c r u e f r o m t h e s e s y s t e m s in o r d e r t o j u s t i f y
s u c h i n t e r e s t . In q u e s t i o n i n g t h e s u p e r m a r k e t s
•and c o n v e n i e n c e s t o r e o p e r a t o r s , w e f o u n d
they resoundingly answered that their major
goal w a s t o p r o v i d e c u s t o m e r c o n v e n i e n c e .
T h e g r o c e r y i n d u s t r y is t r a d i t i o n a l l y sensitive
t o t h e n e e d s of t h e c o n s u m e r . E m p h a s i z i n g t h e
i m p o r t a n c e of t h e c u s t o m e r , t h e m a n a g e r of
financial services at Kroger explains " . . . o u r
h i g h l y c o m p e t i t i v e business is d r i v e n e x c l u s i v e l y
b y t h e c o n s u m e r . T h a t is u n b e l i e v a b l y critical." 9
T w e n t y of t h e survey p a r t i c i p a n t s listed c u s t o m e r
c o n v e n i e n c e as t h e i r primary, o v e r i d i n g c o n c e r n .
As M i k e W a r e o f L i t t l e G e n e r a l Stores, a F l o r i d a
c o n v e n i e n c e c h a i n , states, " W e v i e w t h e A T M
as a c o n v e n i e n c e i t e m a n d w e ' r e in t h e business
of selling c o n v e n i e n c e . " 1 0 W i t h t h e slim profit

9

"Craig G i e l e r How Kroger Wants POS to Work," B a n k N e t w o r k News,
Vol. 1 (January 25, 1983), p 4

JANUARY 1984, E C O N O M I C REVIEW

F

margins c h a r a c t e r i s t i c of t h e g r o c e r y i n d u s t r y ,
retailers seize u p o n a n y m e a n s of o f f e r i n g
a d d i t i o n a l c u s t o m e r c o n v e n i e n c e a n d gaining a
c o m p e t i t i v e edge.
H a n d - i n - h a n d w i t h t h e n o t i o n of a d d e d
c u s t o m e r c o n v e n i e n c e is t h e d e s i r e t o increase
c u s t o m e r t r a f f i c in t h e stores. Retailers h o p e
that c u s t o m e r s , a f t e r e n t e r i n g t h e s t o r e t o
o b t a i n cash, w i l l p u r c h a s e a f e w items. J o h n
Polizzi o f Florida's S h o p - N - G o stores e x p o u n d s
on this: " O n e o f t h e l o n g - t e r m o b j e c t i v e s is t o
increase average t r a n s a c t i o n size b y b e i n g a
source of cash for t h e c u s t o m e r . " 1 1 Seven o t h e r
survey p a r t i c i p a n t s i n d i c a t e d t h a t t h e y e x p e c t
that easier access t o f u n d s w i l l spark i m p u l s e
b u y i n g a n d s t r e n g t h e n sales.
Because c u s t o m e r c o n v e n i e n c e is t h e primary
motivation b e h i n d installing in-store ATMs,
s u p e r m a r k e t s a n d c o n v e n i e n c e stores insist o n
a shared n e t w o r k of regional banks before
a d o p t i n g a c o u r s e o f w i d e s p r e a d installation.
For instance, Carl Schauss of Mississippi's Jitney
Jungle Stores of A m e r i c a , c o m m e n t s t h a t his

"Retailers hope that customers,
after entering the store to obtain
cash, will purchase a few items."

c o r p o r a t i o n has " n o s p e c i f i c plans t o install
m o r e A T M s ( c u r r e n t l y it has o n e in-store A T M )
b u t a d e f i n i t e i n c l i n a t i o n t o m a k e plans in t h a t
d i r e c t i o n e x c e p t f o r t h e single b a n k m o d e
e x i s t i n g in M i s s i s s i p p i . W i t h o u t a s h a r e d netw o r k , A T M s are s i m p l y n o t f e a s i b l e . " 1 2 For
e l e c t r o n i c b a n k i n g services t o h e i g h t e n c o n v e n i e n c e significantly, t h e A T M s m u s t b e available t o a s u b s t a n t i a l p o r t i o n o f t h o s e in t h e
region possessing A T M access cards.
The t o p i c of regional n e t w o r k s leads t o a n o t h e r
p e r t i n e n t issue, n a m e l y t h a t of t h e r e g i o n
i n v o l v e d . Several of t h e p a r t i c i p a n t s c l a i m e d
t h a t t h e y w e r e n o t i n t e r e s t e d in i n s t a l l i n g A T M s
b e c a u s e of t h e rural n a t u r e of t h e i r business.

Retailers c i t e d f o u r m a i n reasons w h y i n - s t o r e
A T M s are n o t f e a s i b l e in small t o w n s a n d rural
areas. First o f all, m a n y o f t h e local b a n k s d o n o t
have A T M s . O b v i o u s l y , o n - p r e m i s e A T M s m u s t
exist b e f o r e o f f - p r e m i s e o n e s spread.
Even in small t o w n s possessing A T M s , transa c t i o n v o l u m e s u f f i c i e n t t o j u s t i f y i n s t a l l i n g ins t o r e A T M s c a n n o t b e g e n e r a t e d . A PigglyWiggly Southern s p o k e s m a n explains:
W e ' r e basically o p e r a t i n g in small t o w n s .
W e ' v e h a d p r o p o s a l s ( t o install A T M s ) b u t
as a m a t t e r of c o m p a n y p o l i c y t u r n e d t h e m
d o w n b e c a u s e of: (1) c u s t o m e r a c c e p t a n c e — c u s t o m e r c o n t a c t is a m a j o r part o f
o u r business. A T M s are t o o i m p e r s o n a l ; (2)
n o t e n o u g h transaction v o l u m e ; (3) m i n i m a l
b a d c h e c k losses d u e t o t h e local n a t u r e of
t h e business. 1 3
O t h e r c h a i n s s e r v i n g small t o w n a n d rural
c o m m u n i t i e s also c i t e d l o w a n t i c i p a t e d c u s t o m e r
a c c e p t a n c e as d e t e r r i n g A T M installation. Even
w h e r e c u s t o m e r a c c e p t a n c e is n o t a p r o b l e m ,
B o b H u g h e s o f N o r t h C a r o l i n a ' s T h e Pantry Inc.
p o i n t s o u t t h a t " o u r t y p e of m a r k e t area—
m o s t l y rural a r e a s — c a n n o t g e n e r a t e e n o u g h
t r a n s a c t i o n s t o m a k e A T M s p r o f i t a b l e . " 1 4 Ins t o r e A T M s prove m u c h m o r e feasible in areas
s u p p o r t i n g denser populations; in m o r e c r o w d e d
areas A T M s truly d o boost customer convenience.
Because increased c u s t o m e r c o n v e n i e n c e
s e e m s t o b e t h e p i v o t a l issue in successful o f f p r e m i s e A T M i n s t a l l a t i o n programs, marketing
assumes an i m p o r t a n t role. A c c o r d i n g t o a
recent Synergistics Research C o r p o r a t i o n study
of o f f - p r e m i s e A T M s , 39 p e r c e n t of t h e participants e x p r e s s d a d e s i r e t o access A T M s at
s u p e r m a r k e t s . 1 5 If this is t h e case—if a d e m a n d
for in-store A T M s a l r e a d y e x i s t s — t h e n p r o p e r
m a r k e t i n g s h o u l d e n s u r e t h e success of instore ATMs. M i k e W a r e describes t h e m a r k e t i n g
p l a n of Florida's Little G e n e r a l Stores as " i n stalling A T M s at k e y t r a f f i c a r t e r i e s w i t h h i g h
v o l u m e s . . . at areas w i t h a high c o n c e n t r a t i o n of
a p a r t m e n t s a n d c o n d o m i n i m u m s a n d n o areas
w i t h a p r e d o m i n a n c e of o l d e r p e o p l e . O l d e r
p e o p l e are n o t c o n c e r n e d w i t h c o n v e n i e n c e ;
t h e r e is m o r e of a d i f f e r e n c e in age t h a n i n c o m e

13
,0

M i k e Ware, vice-president of finance, Little General Stores, telephone
interview, August 23, 1983.
" J o h n Polizzi, Shop & G o Inc., telephone interview, August 24, 1983.
12
Carl Schauss, executive vice president of finance, Jitney Jungle Stores
of America, telephone interview, August 26, 1983.

Larry Olsen, vice-president a n d treasurer, Piggly-Wiggly, Southern Inc.
telephone interview, August 22, 1983.
' " B o b Hughes, vice-president of finance, The Pantry Inc., t e l e p h o n e
interview, August 19, 1983.
15
"Study S h o w s Consumers Prefer Shopping Malls for Off-Premise ATMs,
B a n k Letter, Vol. 7 (May 16, 1983), p. 7.

37
FEDERAL RESERVE B A N K O F A T L A N T A




as far as t a r g e t i n g A T M installation." 1 6 O t h e r s
i n d i c a t e d plans t o install in higher i n c o m e
areas. A l l p l a n t o install A T M s at t h e stores w i t h
t h e highest v o l u m e o f traffic.
For t h o s e businesses w i t h o n l y o n e or t w o
b a n k - o w n e d A T M s , t h e b a n k i n v o l v e d assumes
responsibility for locational " o n - t h e - s p o t " advertising. M o s t s u p e r m a r k e t s a n d c o n v e n i e n c e
stores e m b a r k i n g o n m a j o r A T M i n s t a l l a t i o n
plans i n t e n d t o share advertising responsibilities
w i t h t h e n e t w o r k or bank o w n i n g t h e machines.
In Florida, f o r e x a m p l e , b o t h t h e H O N O R
system a n d W i n n - D i x i e will advertise. In addition,
B a r n e t t Bank a n d N C R w i l l h e l p a d v e r t i s e f o r
t h o s e stores j o i n i n g t h e i r s w i t c h . T h u s retailers,
bankers, a n d o t h e r n e t w o r k p a r t i c i p a n t s d e r i v e
mutual benefits from each o t h e r s marketing
campaigns.

Reduced Check Processing
Volume and Costs
While customer convenience undoubtedly
serves as t h e c h i e f reason for i n s t a l l i n g offpremise ATMs, most grocery and c o n v e n i e n c e
store chains h o p e r e d u c e d c h e c k processing
v o l u m e a n d costs w i l l result as a b y - p r o d u c t .
I n d e e d , this is a t o p i c o f p r e s s i n g c o n c e r n
a m o n g retailers. A s p o k e s m a n f o r W a r e h o u s e
G r o c e r i e s M a n a g e m e n t in A l a b a m a says, " a s far
as c h e c k s are c o n c e r n e d , s o m e t h i n g has got t o
h a p p e n b e c a u s e it's a b u r d e n a n d a costly
o n e . " 1 7 T w e l v e s u r v e y p a r t i c i p a n t s listed red u c i n g t h e costs o f c h e c k p r o c e s s i n g / c a s h i n g
as a very i m p o r t a n t o b j e c t i v e in A T M installation;
n i n e c i t e d t h e n e c e s s i t y of d e c r e a s i n g t h e h u g e
check processing v o l u m e ( w h i c h greatly c o m p l i cates t u r n i n g c h e c k s i n t o c o l l e c t e d f u n d s ) .
Besides a c c e p t i n g c h e c k s f o r p u r c h a s e s ,
retailers also serve in a cash dispensing capacity
after bank hours. For t h e most part, c o n v e n i e n c e
stores d o n o t a c c e p t checks. T h e m a j o r i t y o f
t h e grocers s u r v e y e d , o n t h e o t h e r h a n d , bew a i l e d t h e e x t e n t t o w h i c h t h e y act as surrogate
b a n k s in c a s h i n g checks. T w e l v e c l a i m e d t o
cash m a n y m o r e c h e c k s t h a n t h e local banks.
In t r u t h , it is a c k n o w l e d g e d in t h e g r o c e r y
i n d u s t r y t h a t t h e v a l u e o f c h e c k s c a s h e d in
m a n y stores or chains e x c e e d s t h e t o t a l a n n u a l
sales. S e v e n t y p e r c e n t o f all c h e c k s w r i t t e n at
,6

M i k e Ware, L i t t l e G e n e r a l S t o r e s .
" R o g e r Dryer, e x e c u t i v e v i c e - p r e s i d e n t W a r e h o u s e G r o c e r i e s M a n a g e ment, t e l e p h o n e interview, A u g u s t 22, 1 9 8 3 .

38




t h e retail level are w r i t t e n t o f o o d retailers. 1 8 In
1981, supermarkets averaged 2,786 checks
per w e e k , l e a d i n g t o a t o t a l o f 4.2 b i l l i o n c h e c k s
t h a t year. F u r t h e r m o r e , w h i l e t h e n u m b e r of
c h e c k s t h a t g r o c e r y stores cash is rising, t h e
average p u r c h a s e size is d e c r e a s i n g . 1 9
C o n s e q u e n t l y , c h e c k p r o c e s s i n g costs are
i m p a c t i n g retailers q u i t e dramatically. Estimated
c h e c k h a n d l i n g costs in 1 9 8 1 a v e r a g e d 45
cents. T h u s a s t o r e t y p i c a l l y s p e n t $ 1 , 2 5 0 per
w e e k o n c h e c k cashing. Since t h e average store
nets $ 1 5 0 , 0 0 0 e a c h w e e k , c h e c k i n g costs app r o x i m a t e d 0.83 p e r c e n t of sales. For close t o a
d e c a d e , s u p e r m a r k e t s ' net margins h a v e b e e n
a b o u t o n e p e r c e n t C h e c k p r o c e s s i n g costs,
t h e r e f o r e , n e a r l y e q u a l t h e s u p e r m a r k e t s ' net
margins. 2 0
It is very e v i d e n t w h y retailers w a n t t o reduce
t h e v o l u m e of c h e c k s cashed. N o t o n l y have
retailers h a d t o p a y f o r t h e l a b o r a n d p r o c e s s i n g
costs i n v o l v e d , t h e y also have t o p a y a f e e for
e a c h c h e c k d e p o s i t e d . As t h e a s t r o n o m i c a l a n d
s o m e w h a t i n e q u i t a b l y d i s t r i b u t e d costs of check

"In 1981, supermarkets averaged
2,786 checks per week....Estimated
check handling costs in 1981
averaged 45 c e n t s "

p r o c e s s i n g c o n t i n u e t o rise, t h e r e is a " n e w
• m o o d of retailers w h o insist t h a t t h e c h e c k i n g
b u r d e n has b e c o m e so great that a n e w p a y m e n t s
process at t h e s u p e r m a r k e t is in o r d e r . " 2 1 A n d
in-store A T M s c o m p r i s e o n e step a l o n g t h e w a y
t o this goal.
In fact, s u p e r m a r k e t A T M s r e p r e s e n t s o m e w h a t of a role reversal b e t w e e n b a n k s a n d
retailers. Instead of stores absorbing processing
costs a n d p a y i n g t h e b a n k d e p o s i t fees, t h e
b a n k pays t h e store a rental f e e f o r t h e s p a c e in
w h i c h t h e A T M is l o c a t e d . G r o c e r y a n d conv e n i e n c e stores r e c e i v e rental fees; t h e o w n e r
of t h e A T M a n d t h e o p e r a t o r of t h e s w i t c h split

'»"Craig G i e l e n H o w K r o g e r W a n t s P O S to Work," B a n k N e t w o r k N e w s ,
Vol. 1 ( J a n u a r y 25, 1983), p. 4.
' ' " G r o c e r y C h e c k V o l u m e Soars, R e p o r t s F M I" B a n k N e t w o r k N e w s , Vol. 1
( J u n e 2 1 , 1982), p. 1, 3.
20
Ibid.
2
' " C r a i g G i e l e n H o w K r o g e r W a n t s POS t o Work." B a n k N e t w o r k N e w s ,
Vol. 1 ( J a n u a r y 2 5 , 1983), p. 4.

JANUARY 1984, E C O N O M I C REVIEW

F|

t h e t r a n s a c t i o n fee. O f t e n , t h e t r a n s a c t i o n fees
are volume-related; that is, t h e fee per transaction
d e p e n d s u p o n t h e a m o u n t of m o n t h l y transaction v o l u m e . For instance, in Florida's H O N O R
n e t w o r k , if t h e r e a r e f e w e r t h a n 5 0 0 , 0 0 0 transactions p e r m o n t h , a w i t h d r a w a l costs 61 cents.
40 c e n t s w i l l go t o t h e A T M o w n e r ; t h e s w i t c h
itself w i l l r e c e i v e 21 cents. W i t h d r a w a l s cost
only 55 cents if m o r e t h a n 1.5 million m o n t h l y
transactions occur. Balance inquiries a n d transfers
b e t w e e n a c c o u n t s c o s t 2 0 c e n t s less. 22 T h e
bank of t h e c u s t o m e r w h o s e a c c o u n t was
d e b i t e d pays t h e s e fees; it m a y in t u r n pass t h e
charge o n t o t h e c u s t o m e r . But t h e retailer
does n o t p a y a n y o n e .
F u r t h e r m o r e , if t h e s u p e r m a r k e t o r c o n v e n i e n c e store o w n s t h e m a c h i n e s , it w i l l r e c e i v e
t h e t r a n s a c t i o n fees a n d b e g i n t o g e n e r a t e
profits. Publix Supermarkets in Florida however,
is t h e o n l y c h a i n in t h e s u r v e y t o o w n its o w n
ATMs. For t h e m o s t part, t h e retailers are
c o n t e n t t o let t h e b a n k s o r t h i r d p a r t y n e t w o r k s
o w n t h e A T M s . Yet if t h e b a n k s o r n e t w o r k s d o
not p r o v i d e sufficient c u s t o m e r coverage, stores
w i l l p u r c h a s e t h e i r o w n m a c h i n e s . For instance,
in Mississippi, w h e r e t h e b a n k s have t h u s far
not c o l l a b o r a t e d , Carl Schauss of Jitney Jungle
Stores says " o w n i n g o u r o w n m a c h i n e s is a
m a j o r p o s s i b i l i t y if t h e b a n k s d o n ' t get w i t h it
( n e t w o r k formation) themselves." 2 3 Apparently,
A T M o w n e r s h i p is n o t critical t o t h e retailer
unless i n a d e q u a t e n e t w o r k c o v e r a g e exists.
A l t h o u g h r e d u c i n g t h e c h e c k v o l u m e is a
h o p e d for b y - p r o d u c t o f in-store A T M s , c h a i n s
s t a t e d t h a t t h e y d o u b t t h e n u m b e r of c h e c k s
c a s h e d w i l l d e c r e a s e . Joe L e t v e l t e r of PantryPride s u m s u p this a t t i t u d e : " w e d o n ' t feel t h a t
A T M s will reduce check c a s h i n g . . . From talking
to N C R a n d Publix(in Florida), t h e check v o l u m e
d o e s n ' t d e c r e a s e . . . t h e costs a s s o c i a t e d w i t h
check processing r e m a i n t h e same." 2 4 Certainly
this is c o n t r a r y t o t h e e x p e c t e d results. It is t o o
soon t o d e t e r m i n e a c c u r a t e l y w h a t e f f e c t s instore A T M s a c t u a l l y have o n c h e c k v o l u m e . Yet
e v e n if t h e y h a v e z e r o i m p a c t o n t h e n u m b e r of
c h e c k s cashed, t h e y w i l l still b e of v a l u e in
p r e v e n t i n g b a d c h e c k losses.
S e v e n o f t h e s u r v e y p a r t i c i p a n t s l i s t e d red u c t i o n of b a d c h e c k s as an o b j e c t i v e b e h i n d
" S t r a d a , "Converting FIG's Promise Into Power," B a n k N e t w o r k News,
Vol. 1 (May 11, 1983), p. 5
" C a r l Schauss, Jitney J u n g l e S t o r e s
24
Joe Letvelter, cash manager, Pantry Pride Ine, telephone interview,
August 23, 1983.

FEDERAL RESERVE B A N K O F A T L A N T A




installing ATMs. C o n v e n i e n c e stores e x p e r i e n c e
m i n i m a l b a d c h e c k losses b e c a u s e t h e y cash
f e w checks. Grocery stores, however, experie n c e e n o r m o u s b a d c h e c k losses. G i v e n this
fact, it is s o m e w h a t s u r p r i s i n g t h a t o n l y n i n e
companies r e p o r t e d any t y p e of electronic
c h e c k v e r i f i c a t i o n systems.
Several o t h e r p o t e n t i a l b e n e f i t s w e r e m e n t i o n e d in a s s o c i a t i o n w i t h i n - s t o r e A T M s . T w o
of t h o s e s u r v e y e d c i t e d i n c r e a s e d s e c u r i t y o f
cash as a result of d e c r e a s e d cash e x p o s u r e .
C o n v e n i e n c e stores in particular have a p r o b l e m
w i t h h o l d - u p s . A n d o n e p a r t i c i p a n t f e l t t h a t instore A T M s w o u l d r e d u c e t h e labor required
for c h e c k c a s h i n g a n d processing.

A Steppingstone to POS
Thus, i n c r e a s e d c u s t o m e r c o n v e n i e n c e is
t h e p r i m a r y m o t i v e for i n s t a l l i n g in-store A T M s .
Stores h o p e t h a t a r e d u c e d c h e c k v o l u m e w i l l
p r o d u c e v a r i o u s b e n e f i t s . These, h o w e v e r , are
o n l y t h e s h o r t - t e r m o b j e c t i v e s . In t h e l o n g run,
installing in-store A T M s m a y be an i n t e r m e d i a t e
s t e p in a c h a n g i n g retail p a y m e n t m e c h a n i s m .
In-store a u t o m a t e d t e l l e r m a c h i n e s r e p r e s e n t
o n e stage in t h e t r a n s i t i o n t o e l e c t r o n i c p o i n t of-sale (POS) registers.
U l t i m a t e l y , m o s t retailers h o p e t o h a v e POS
registers that electronically d e b i t t h e c u s t o m e r s
b a n k a c c o u n t at t h e c h e c k - o u t station. W h e n
asked if t h e y v i e w e d in-store A T M s as a steppingstone t o POS, seventeen of t h e survey participants
r e s p o n d e d yes. S o m e , s u c h as H a r r y W a d e of
Winn-Dixie, even i m p l i e d that A T M s w e r e
b e i n g i n s t a l l e d solely as a n i n t e r m e d i a r y step:
" A T M s are b e i n g i n s t a l l e d as a t r a i n i n g g r o u n d
t o get c u s t o m e r s t o use d e b i t cards. T h e y
( A T M s ) are a necessary e v i l . " 2 5 O t h e r s said t h a t
A T M s " g i v e us d e f i n i t i v e e x p e r i e n c e in cashf r e e t y p e s of t r a n s a c t i o n s . " 2 6 J o h n Polizzi of
S h o p - N - G o Inc. s u m s u p t h e general a t t i t u d e :
A T M s are g o i n g t o w o r k in c e r t a i n l o c a t i o n s
b u t w o n ' t have t h e i m p a c t t h a t POS will.
U l t i m a t e l y POS w i l l d o a w a y w i t h c h e c k
cashing. A T M s are s i m p l y a n o t h e r service w e
offer our customers.27
Obviously, strong s u p p o r t exists for t h e eventual
i m p l e m e n t a t i o n of POS registers.

" H a r r y Wade, director of work methods, Winn-Dixie, telephone interview,
August 22, 1983.
26
Ray Ayers. vice-president of real estate, Grand Union Company, telep h o n e interview, August 22, 1983.
' ' J o h n Polizzi, Shop & Go Inc.

39

List of Stores Surveyed

Louisiana
19. Schwegman Giant Super Stores New Orleans

Alabama
1. Bruno's Inc., Birmingham

*

20. Southland Corporation, Midsouth Division Baton Rouge

2. Warehouse Groceries Management - Gadsden

21. National Team Company (National Super-

3. Dixieland Food Stores - Geneva

markets) - Harahan (National Headquarters in

4. Delchamps, Inc. - Mobile

Rosemont, IL)

Florida

Mississippi
5. Winn-Dixie - Jacksonville
22. Jitney Jungle Stores of America - Jackson

6. Publix - Lakeland

23. Sunflower Stores Inc. - Indianola

7. Pantry Pride Inc. - Fort Lauderdale
*

8. Shop & Go, Inc. - Mango

*

9. Little General Stores - Tampa

*

North Carolina
24. Food Town Stores, Inc. - Salisbury
25. Harris-Teeter Supermarkets Inc. - Charlotte

10. Sunshine Jr. Stores Inc. - Panama City
11. Albertson's - Orlando (Southco Division

*

27. Ingle's Market, Inc. - Swannanoa

Headquarters)

28. Lowe's Food Stores - Wilkesboro

Georgia
12. Great Atlanta & Pacific Tea Co. - National
Headquarters in Montvale, New Jersey

26. The Pantry Inc. - Sanford

*

30. Fast Fare, Inc. - Henderson

South Carolina

13. Food Giant/Big Apple Supermarkets - Atlanta

31. Bi-Lo Inc. - Mauldin

*

15. Munford, Inc. - Atlanta

32. Community Cash Stores, Inc. - Spartanburg

*

16. National Convenience Stores (Stop-n-Go) -

Tennessee
33. The Red Food Stores, Inc. - Chattanooga

Decatur (National Headquarters In Houston)

34. Malone & Hyde, Inc. - Memphis

17. Grand Union Company (Colonial and Big Star

35. The White Stores, Inc. - Knoxille

Food Stores - Decatur)

36. Kroger Company - Nashville

18. Kroger - Atlanta Division
' I n d i c a t e s convenience store chains.
The t w o different divisions of Kroger are c o u n t e d as one company,
leading to a total of 3 5 survey participants

W h i l e m o s t retailers c o n c e d e that a trans i t i o n t o POS is i n e v i t a b l e — i n d e e d , t h e y w e l c o m e such a transition—few have m a d e any
c o n c r e t e m o v e s in t h a t d i r e c t i o n . In fact, o u t o f
35 surveyed, only three have any definite plans
r e g a r d i n g POS. S e v e n c l a i m e d t o h a v e v a g u e
plans.
Naturally, t h e same benefits resulting f r o m
r e d u c e d c h e c k v o l u m e after in-store A T M install a t i o n w i l l a l s o a c c r u e f r o m POS registers. For
40




instance, o n e s u p e r m a r k e t c h a i n in Texas f o u n d
t h a t it c o u l d " s a v e o n e - s i x t h o f l a b o r c o s t s a t
check-out d u e to the t i m e saved by directd e b i t transaction."28 A n d , w i t h o u t a d o u b t , this
is t h e m o s t e f f e c t i v e w a y t o p r e v e n t c h e c k
f r a u d o r b a d c h e c k losses. Even m o r e i m p o r t a n t
a r e t h e savings in c h e c k h a n d l i n g costs.

28

"Texas POS Rekindles a Fiery Network Feud," B a n k N e t w o r k News, VoL
2 (June 25, 1983), p. 4

JANUARY 1984, E C O N O M I C REVIEW

F

C u r r e n t l y e s t a b l i s h e d POS systems charge
t r a n s a c t i o n fees a v e r a g i n g 2 0 cents. T h e superm a r k e t s a n d c o n v e n i e n c e stores d o n o t have
any transaction costs b u t m u s t pay for installation
and maintenance.(lt should be n o t e d that whereas m o s t in-store A T M s are b a n k or n e t w o r k
o w n e d , a l m o s t all stores p l a n t o p u r c h a s e t h e i r
o w n POS registers.) A c c o r d i n g t o a 1 9 8 0 survey,
t h e h a n d l i n g c o s t o f a retail cash t r a n s a c t i o n is
45 cents. 2 9 T h u s POS is p r o v i n g t o b e m o r e
e c o n o m i c a l t h a n cash.

t h e 75 p e r c e n t s a t u r a t i o n of t h e d e b i t cardh o l d i n g m a r k e t b e l i e v e d essential for an econ o m i c a l POS s y s t e m . Extensive local n e t w o r k s ,
in c o n j u n c t i o n w i t h increasing c o n s u m e r awareness of e l e c t r o n i c p a y m e n t systems, are p a v i n g
t h e w a y f o r e l e c t r o n i c p o i n t - o f - s a l e . Thus, t h e
c u r r e n t installation of in-store A T M s — i n furt h e r i n g t h e d e v e l o p m e n t of a n e l e c t r o n i c infras t r u c t u r e a n d in f a m i l i a r i z i n g c u s t o m e r s w i t h
a u t o m a t e d b a n k i n g services—is a k e y f a c t o r in
t h e u p c o m i n g transition.

T h e a d v a n t a g e s t o retailers of POS systems
are obvious. But w e m u s t n o t forget that t h e
grocery i n d u s t r y is c o n s u m e r - d r i v e n . POS w i l l
be i m p l e m e n t e d if a n d o n l y if t h e c o n s u m e r
finds it beneficial. T h e r e f o r e , t h e q u i c k e r checko u t t i m e s of POS registers m a y b e a d e c i s i v e
factor in its favor.
A c c o r d i n g t o a 1983 Food M a r k e t i n g Institute
survey, 3 9 p e r c e n t of c o n s u m e r s p l a c e greatest
p r i o r i t y o n a q u i c k c h e c k - o u t L o w prices rank
s e c o n d . 3 0 A t y p i c a l POS t r a n s a c t i o n t a k e s t e n
t o f i f t e e n s e c o n d s , cash t r a n s a c t i o n s r e q u i r e 2 7
seconds, a n d c h e c k s r e q u i r e e v e n longer. T h u s
POS registers t r a n s a c t p a y m e n t w i t h m a x i m a l
speed. A t Dahl's, an I o w a s u p e r m a r k e t t h a t
p i o n e e r e d t h e use of POS registers, t h e a d d e d
convenience alone c o n v e r t e d 10-15 percent
of c h e c k w r i t e r s t o POS w i t h o u t any p r o m o t i o n
or f i n a n c i a l i n c e n t i v e s . This 10-15 percent c o m pensated for installation costs. 31 Thus consumers
face a t r a d e o f f b e t w e e n increased c o n v e n i e n c e
or r e l i n q u i s h e d check f l o a t Evidence suggests
t h a t a s u b s t a n t i a l p o r t i o n of c o n s u m e r s w i l l o p t
for q u i c k e r c h e c k - o u t s . T h o s e u n w i l l i n g t o give
u p float w i l l have t o b e l u r e d w i t h e c o n o m i c
i n c e n t i v e s a n d p r o p e r m a r k e t i n g strategies.

W e f o u n d a d e f i n i t e t r e n d t o w a r d t h e installation of i n - s t o r e A T M s in s u p e r m a r k e t a n d
c o n v e n i e n c e s t o r e c h a i n s in t h e Southeast. T h e
p r i m a r y m o t i v a t i o n lies in i n c r e a s i n g c u s t o m e r
convenience, w h i c h retailers h o p e w i l l increase
c u s t o m e r t r a f f i c t h r o u g h t h e i r stores. C o n sequently, grocery stores are b e g i n n i n g t o insist
t h a t local b a n k s c o o p e r a t e in f o r m i n g r e g i o n a l
n e t w o r k s ; o n l y in t h i s m a n n e r w i l l a g i v e n
store's A T M be available t o a sufficient q u a n t i t y of
consumers t o increase c o n v e n i e n c e significantly.

Conclusion
In t h e foreseeable future, t h e i m p l e m e n t a t i o n
of e l e c t r o n i c p o i n t - o f - s a l e registers w i l l transform t h e retail p a y m e n t mechanism. N u m e r o u s
grocery stores are installing electronic scanning
e q u i p m e n t at t h e c h e c k - o u t station, thus greatly
f a c i l i t a t i n g t h e c o n v e r s i o n t o e l e c t r o n i c POS
registers. In a d d i t i o n , t h e o n g o i n g f o r m a t i o n of
shared r e g i o n a l b a n k - c a r d n e t w o r k s is c r e a t i n g

" " C o s t of a Cash Transaction Put at 45 Cents," EFT Report, Vol. 6 (January
3, 1983), p. 5.
30
" Do Shoppers Want POS? FMI Study Gives Clue," B a n k N e t w o r k News,
Vol. 2 (June 25, 1983), p. 5.
3
'"Why Iowa's POS Test Remains in a Pilot Mode,' B a n k N e t w o r k News,
Vol. 1 (February 8, 1983), p. 6.

FEDERAL RESERVE B A N K O F A T L A N T A




As l o n g as t h e b a n k s p r o v e fairly c o o p e r a t i v e
in establishing these shared networks, t h e superm a r k e t s a n d c o n v e n i e n c e stores s h o u l d h a v e

"Evidence suggests that a
substantial portion of consumers
will opt for quicker check-outs.
Those unwilling to give up float will
have to be lured with economic
incentives and proper marketing
strategies."

little i n c l i n a t i o n t o o w n t h e A T M s or t o o p e r a t e
t h e electronic switch. Their concern appears
n o t t o b e w i t h c o n t r o l l i n g t h e p a y m e n t system,
b u t r a t h e r w i t h m o d e r n i z i n g t r a d i t i o n a l paym e n t mechanisms.
Indeed, t h e traditional retail p a y m e n t system
has b e c o m e a b u r d e n . S u p e r m a r k e t c h a i n s
spend exorbitant sums o n check processing
costs; t h e sheer v o l u m e of checks supermarkets
process r e n d e r s t h e s y s t e m i n e f f i c i e n t . Across
t h e board, grocery industry m a n a g e m e n t agrees
o n t h e n e c e s s i t y of r e d u c i n g t h e c h e c k v o l u m e .
M a n y of the survey participants h o p e that
c u s t o m e r s w i l l o b t a i n cash f r o m in-store A T M s ,
c u t t i n g d o w n o n t h e n u m b e r of c h e c k s w r i t t e n
b o t h for groceries a n d f o r cash at c o u r t e s y
41

desks. H o w e v e r , e v e n if t h e A T M s d o n o t
s u b s t a n t i a l l y r e d u c e t h e v o l u m e o f checks,
they acclimate the c o n s u m e r t o the idea of
e l e c t r o n i c a l l y d e b i t i n g his c h e c k i n g a c c o u n t at
t h e grocery store. In t h e future, d e b i t i n g accounts
b y a n e l e c t r o n i c POS register m a y n o t s e e m
such a s u d d e n , drastic c h a n g e .
Hence, in-store ATMs, w h i l e generating benefits in a n d of t h e m s e l v e s , u l t i m a t e l y d e r i v e
t h e i r greatest v a l u e as a s t e p p i n g s t o n e t o POS.
Electronic POS registers will dramatically r e d u c e
t h e v o l u m e a n d costs o f c h e c k processing. POS
also is an e f f e c t i v e w a y o f m i n i m i z i n g b a d
check losses. In addition, electronic POS registers
greatly s p e e d u p t h e c h e c k - o u t process, w h i c h
seems t o b e t h e most critical factor in i m p r o v i n g
c u s t o m e r c o n v e n i e n c e . Thus, e l e c t r o n i c POS
h o l d s m u l t i p l e b e n e f i t s f o r retailers a n d consumers.
I n d e e d , m a n y retailers eagerly w e l c o m e t h e
a p p e a r a n c e of e l e c t r o n i c POS systems. As Leo
C o n l a n o f S o u t h C a r o l i n a ' s Bi-Lo Stores e m p h a sizes, " b a n k s a n d retailers w a n t t o e n c o u r a g e
c o n s u m e r s t o q u i t u s i n g c h e c k s . . . It is a b o u t
t i m e it (POS) is c o m i n g t o this part of t h e
c o u n t r y . " 3 2 S o m e legal m a t t e r s r e m a i n t o b e
clarified, b u t f o r t h e m o s t part, POS t e c h n o l o g y
has b e e n r e f i n e d a n d s e e m s a b o u t t o c o m e o f
age.

" L e o Conlan, Financial Vice President Bi-Lo Inc., telephone interview,
August 19, 1983.

42




The spreading electronic infrastructure, accomp a n i e d b y t h e f o r m a t i o n o f large r e g i o n a l networks, provides the b a c k d r o p for the c o m i n g
of electronic retail payments. The grocery industry—experiencing acute problems with check
p r o c e s s i n g — w i l l u n d o u b t e d l y b e t h e first t o
m a k e t h e t r a n s i t i o n t o e l e c t r o n i c POS, j u s t as it
has b e e n t h e first t o i m p l e m e n t w i d e - s c a l e
A T M installation. O t h e r retailers w i l l c o n v e r t
m o r e slowly.
G e n e r a l l y , t h e size o f t h e retail business is
directly p r o p o r t i o n a l t o t h e v o l u m e of checks
cashed, w h i c h in t u r n d i r e c t l y relates t o t h e
n e e d t o c o n v e r t t o POS. In o t h e r w o r d s , larger
retail businesses, s u c h as m a j o r d e p a r t m e n t
stores, will likely f i n d it a d v a n t a g e o u s t o c o n v e r t
t o e l e c t r o n i c POS t e r m i n a l s as fast as possible.
Small s p e c i a l t y stores, o n t h e o t h e r h a n d , m a y
never experience any p r o b l e m s w i t h t h e existing
check-collection system. Thus, t h e rate at w h i c h
t h e t r a n s i t i o n t o e l e c t r o n i c POS occurs w i l l vary
greatly. Yet, t h e b u r d e n of c h e c k p r o c e s s i n g o n
s o m e retailers has b e c o m e so great t h a t a n e w
retail p a y m e n t m e c h a n i s m seems t o b e in order.
Electronic point-of-sale appears t o be t h e most
likely candidate; indeed, t h e growing popularity
o f in-store A T M s i n d i c a t e s t h a t t h e t r a n s i t i o n
m a y a l r e a d y be u n d e r w a y .

— Helen Stacey
and W i l l i a m N. Cox

JANUARY 1984, E C O N O M I C REVIEW

F|

Deposit Insurance Reform:
The Insuring Agencies'
Proposals
T h e t h r e e f e d e r a l g o v e r n m e n t agencies t h a t
insure t h e p u b l i c ' s d e p o s i t s h a v e b r o u g h t remarkable stability t o the financial sector of the
U n i t e d States e c o n o m y , b u t recent d e v e l o p m e n t s
have p r o m p t e d a r e e x a m i n a t i o n of t h e i r role.
A p p r o x i m a t e l y 50 p e r c e n t o f all b a n k s a n d 25
p e r c e n t of all savings a n d l o a n associations f a i l e d
b e t w e e n 1 9 3 0 a n d t h e c r e a t i o n o f t h e Federal
D e p o s i t I n s u r a n c e C o r p o r a t i o n in 1 9 3 3 a n d t h e
Federal Savings a n d Loan I n s u r a n c e C o r p o r a t i o n
in 1 9 3 4 . T h e f a i l u r e rate a m o n g b a n k s a n d
savings a n d loans d u r i n g t h e past c o u p l e of
d e c a d e s has s l o w e d t o an average of less t h a n 1
p e r c e n t a year. 1

R e s p o n d i n g to a c o n g r e s s i o n a l mandate, t h r e e
regulatory a g e n c i e s recently p r o p o s e d reforms
in t h e way public d e p o s i t s are insured. The
agencies, w h o s e p r o p o s a l s ranged over s u c h
t o p i c s as variable rate deposit insurance,
increased use of private insurance, d i s c l o s u r e of
supervisory actions, a n d c o n s o l i d a t i o n of t h e
insuring agencies, o c c a s i o n a l l y a g r e e d w i t h
e a c h other.

T h e agencies' role, h o w e v e r , is b e i n g c a l l e d
i n t o q u e s t i o n b y changes in t h e e c o n o m i c environm e n t a n d b y c h a n g e s in t h e f i n a n c i a l services
i n d u s t r y . T h e d r a m a t i c rise in m a r k e t i n t e r e s t
rates in t h e 1 9 7 0 s a n d early 1 9 8 0 s left m a n y S& Ls
w i t h a negative net worth. The deregulation of
interest rates o n deposits a n d increasing pressure
f r o m u n i n s u r e d c o m p e t i t o r s have f o r c e d i n s u r e d
i n s t i t u t i o n s t o b e c o m e m o r e aggressive. O n e
i n e v i t a b l e result of this i n c r e a s e d c o m p e t i t i o n is
a g r o w i n g f a i l u r e rate a m o n g i n s u r e d i n s t i t u t i o n s
a n d i n c r e a s e d c o n c e r n o v e r t h e i r safety. Furtherm o r e , s o m e b a n k s are d e m a n d i n g f r e e d o m t o
expand into n e w nonbank ventures that some
b e l i e v e are far riskier t h a n t r a d i t i o n a l b a n k i n g
activities.
In r e s p o n s e t o c h a n g e s in t h e f i n a n c i a l services
i n d u s t r y , Congress passed t h e Carn-St G e r m 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 A c t o f 1 9 8 2 . A m o n g its
m a n y provisions, this act a u t h o r i z e d i n s u r e d
institutions to offer a m o n e y market deposit
a c c o u n t w i t h n o legal restrictions o n t h e rate o f

'Supervisory assisted mergers of troubled institutions are included with
actual bankruptcies in this definition of failure.

FEDERAL RESERVE B A N K O F A T L A N T A




43

interest paid a n d a u t h o r i z e d t h e insuring agencies
to offer net w o r t h certificates t o institutions w i t h
w e a k c a p i t a l p o s i t i o n s . In this act, Congress also
recognized t h e n e e d to reevaluate t h e current
s y s t e m o f d e p o s i t insurance. Congress b e g a n
t h i s r é é v a l u a t i o n b y d i r e c t i n g e a c h of t h e t h r e e
d e p o s i t i n s u r a n c e agencies t o s t u d y s e v e n imp o r t a n t p o i n t s a n d r e l a t e d issues.
T h e t h r e e agencies are t h e Federal D e p o s i t
I n s u r a n c e C o r p o r a t i o n ( F D I C ) , w h i c h insures
c o m m e r c i a l a n d m u t u a l savings banks; t h e Federal
Savings a n d Loan Insurance C o r p o r a t i o n (FSLIC),
w h i c h insures savings a n d loans a n d s o m e m u t u a l
savings banks, a n d t h e N a t i o n a l C r e d i t U n i o n
Share I n s u r a n c e Fund ( N C U S I F ) , w h i c h insures
c r e d i t u n i o n s . Congress d i r e c t e d t h e agencies t o
study:
1. t h e c u r r e n t s y s t e m o f d e p o s i t i n s u r a n c e a n d
its i m p a c t o n t h e s t r u c t u r e a n d o p e r a t i o n s of
depository institutions;
2. t h e f e a s i b i l i t y o f a l l o w i n g d e p o s i t o r s t o purchase a d d i t i o n a l i n s u r a n c e c o v e r i n g d e p o s i t s
in excess of t h e general l i m i t p r o v i d e d b y l a w
and t h e capabilities of the private insurance
system, e i t h e r d i r e c t l y o r t h r o u g h reinsurance,
t o p r o v i d e risk c o v e r a g e in excess of t h e
general s t a t u t o r y limit;
3. t h e f e a s i b i l i t y of b a s i n g d e p o s i t i n s u r a n c e
p r e m i u m s o n t h e risk p o s e d b y e i t h e r t h e
i n s u r e d i n s t i t u t i o n or b y its c a t e g o r y or size
r a t h e r t h a n o n t h e p r e s e n t flat rate system;
4. t h e i m p a c t of e x p a n d i n g coverage of insured
d e p o s i t s o n t h e o p e r a t i o n s of t h e i n s u r a n c e
funds, i n c l u d i n g t h e p o s s i b i l i t y o f i n c r e a s e d or
u n d u e risk t o t h e f u n d s ;
5. t h e feasibility of revising t h e deposit insurance
s y s t e m t o p r o v i d e e v e n greater p r o t e c t i o n f o r
smaller depositors w h i l e fostering a greater
d e g r e e of d i s c i p l i n e w i t h r e s p e c t t o large
depositors;
6. t h e a d e q u a c y of e x i s t i n g p u b l i c d i s c l o s u r e
regarding t h e c o n d i t i o n a n d business practices
of i n s u r e d d e p o s i t o r y i n s t i t u t i o n s t o assess
changes t h a t m a y b e n e e d e d t o assure p u b l i c
disclosure;
7. t h e f e a s i b i l i t y of c o n s o l i d a t i n g t h e t h r e e ins u r a n c e funds; a n d
8. r e l a t e d issues.
T h e agencies t o o k t w o d i f f e r e n t a p p r o a c h e s t o
t h e c o n g r e s s i o n a l d i r e c t i v e . T h e Federal D e p o s i t
I n s u r a n c e C o r p o r a t i o n a n d t h e Federal H o m e
Loan Bank Board ( w h i c h runs t h e Federal Savings
a n d Loan I n s u r a n c e C o r p o r a t i o n ) t o o k a b r o a d
44




i n t e r p r e t a t i o n of t h e request, w h i l e t h e N a t i o n a l
C r e d i t U n i o n A d m i n i s t r a t i o n ( w h i c h runs t h e
N a t i o n a l C r e d i t U n i o n Share I n s u r a n c e Fund)
l i m i t e d its r e p o r t t o t h e p o i n t s raised b y Congress.
T h e F D I C r e p o r t , e n t i t l e d Deposit Insurance in a
Changing Environment, a n d t h e FHLBB r e p o r t ,
e n t i t l e d Agenda For Reform, b o t h r e v i e w d e p o s i t
i n s u r a n c e ' s role in o u r f i n a n c i a l s y s t e m a n d t h e
respective agencies' ideas o n reform. Both reports
c o n t a i n a p p e n d i c e s t h a t e x p l o r e key aspects of
d e p o s i t i n s u r a n c e in s o m e detail. M a n y o f t h e
r e c o m m e n d a t i o n s are c o n t r o v e r s i a l , b u t t h e y
p r o v i d e a v a l u a b l e s t a r t i n g p o i n t f o r t h o s e int e r e s t e d in r e f o r m i n g d e p o s i t insurance.
In c o n t r a s t , t h e N a t i o n a l C r e d i t U n i o n Adm i n i s t r a t i o n ( N C U A ) d i d n o t a n a l y z e t h e role of
c r e d i t u n i o n i n s u r a n c e in t h e f i n a n c i a l s y s t e m or
t h e r e f o r m s n e e d e d t o i m p r o v e t h e system. The
report appears to b e trying t o detail w h a t insurance
has d o n e f o r c r e d i t u n i o n s a n d h o w it can be
m o d i f i e d t o serve c r e d i t u n i o n s b e t t e r . I n d e e d ,
m o s t of t h e research c o n d u c t e d for this r e p o r t
a p p e a r s t o h a v e b e e n a s u r v e y of c r e d i t u n i o n
officials' o p i n i o n s o n share ( d e p o s i t ) insurance.
T h e r e p o r t ' s u s e f u l n e s s is l i m i t e d b y its p a r o c h i a l
perspective.
This a r t i c l e w i l l s u m m a r i z e t h e m o r e i m p o r t a n t
aspects of t h e s e t h r e e r e p o r t s b y t o p i c area. T h e
M a r c h issue of t h e Economic Review w i l l c o n t a i n
a c r i t i q u e of t h e r e p o r t s a n d s o m e a l t e r n a t i v e
r e f o r m proposals.

Goals of Deposit Insurance
T h e first s t e p in r e e v a l u a t i n g d e p o s i t i n s u r a n c e
is d e t e r m i n i n g w h y w e n e e d s u c h p r o t e c t i o n .
T h e FDIC, FHLBB a n d N C U A discuss a v a r i e t y
o f reasons f o r p r o v i d i n g i n s u r a n c e t o t h e instit u t i o n s t h e y insure.
First, t h e agencies say d e p o s i t i n s u r a n c e prot e c t s t h e f i n a n c i a l s y s t e m a n d t h e U.S. e c o n o m y
f r o m t h e h a r m s of b a n k failure. T h e y n o t e t h a t
f a i l u r e can h a v e serious c o n s e q u e n c e s b e c a u s e
b a n k s are a n essential e l e m e n t in t h e p a y m e n t
s y s t e m a n d b e c a u s e o f t h e p o t e n t i a l f o r a sharp
c o n t r a c t i o n in t h e m o n e y s u p p l y if t h e p u b l i c
w e r e t o " s t a m p e d e " f r o m d e p o s i t s t o cash. The
FHLBB p r o v i d e s an i n t e r e s t i n g analysis o f w h y
d e p o s i t i n s u r a n c e is n e e d e d t o p r o t e c t t h e financial system. It n o t e s t h a t t h e w a v e o f b a n k
failures in t h e 1 9 3 0 s c o u l d have b e e n p r e v e n t e d
if t h e Federal Reserve had p r o v i d e d a d e q u a t e

JANUARY 1984, E C O N O M I C REVIEW

F

l i q u i d i t y t o t h e b a n k i n g system. 2 T h e FHLBB
argues t h a t t h e e x p e r i e n c e o f t h e 1 9 3 0 s d e m o n strates t h e f a i l u r e o f " a s y s t e m w i t h d i s c r e t i o n as
its critical e l e m e n t " Thus, it i m p l i c i t l y argues t h a t
t h e U n i t e d States n e e d s d e p o s i t i n s u r a n c e t o
protect t h e financial system because the deposit
i n s u r a n c e a u t h o r i t i e s lack d i s c r e t i o n d u r i n g a
financial crisis.
S e c o n d , t h e F D I C a n d FHLBB say d e p o s i t
i n s u r a n c e p r o t e c t s small, u n s o p h i s t i c a t e d depositors f r o m losing t h e i r m o n e y . T h e F D I C
argues t h a t small d e p o s i t o r s are " i n e f f e c t c o m p e l l e d t o use b a n k i n g facilities," y e t t h e y " h a v e
little a b i l i t y t o p r o t e c t t h e m s e l v e s against t h e risk
of a b a n k ' s closing." A t h i r d reason m e n t i o n e d b y
t h e t w o a g e n c i e s is t h a t d e p o s i t i n s u r a n c e protects small institutions. That is, s o m e depositors
b e l i e v e large i n s t i t u t i o n s are safer t h a n small
ones and, w i t h o u t deposit insurance, s o m e small
i n s t i t u t i o n s w o u l d b e f o r c e d t o m e r g e w i t h larger
i n s t i t u t i o n s . N e i t h e r t h e F D I C n o r t h e FHLBB
argues t h a t p r o t e c t i n g small banks is an i m p o r t a n t
reason f o r c o n t i n u i n g d e p o s i t insurance.
W h i l e t h e s e j u s t i f i c a t i o n s are g i v e n f o r d e p o s i t
i n s u r a n c e in general, t h e FHLBB n o t e s t h a t t h e
p r i m a r y r e a s o n savings a n d loans r e c e i v e d deposit i n s u r a n c e was t o m a i n t a i n a f l o w o f f u n d s t o
t h e m o r t g a g e m a r k e t . It n o t e s t h a t S&Ls, u n l i k e
banks, d i d n o t fail in t h e 1 9 3 0 s b e c a u s e o f
liquidity p r o b l e m s , b u t rather because of defaults
o n t h e i r m o r t g a g e loans. T h e FSLIC was c r e a t e d
t o reestablish p u b l i c c o n f i d e n c e in S&Ls so t h e y
c o u l d c o n t i n u e t o m a k e m o r t g a g e loans. T h e
r e p o r t says t h r i f t i n s t i t u t i o n s c u r r e n t l y face large
risks if t h e y try t o use s h o r t - t e r m d e p o s i t s t o f u n d
l o n g t e r m f i x e d rate mortgages, g i v e n t h e v o l a t i l e
i n t e r e s t rates o f t h e past f e w years. Thus, t h e
FSLIC c o n c e d e s t h a t S&Ls w i l l h a v e t o r e d u c e

2

Many of the banks that failed in the early 1 9 3 0 s failed because they were
illiquid even t h o u g h they were solvent. That is, many banks failed w h e n
depositors tried to withdraw more money than the bank had on hand.
Banks did not (and still d o not) have sufficient cash to instantly redeem all
their deposits because many of the deposits are invested in relatively
illiquid l o a n s Banks make the assumption that their customers will not
need most of their money on any given day a n d that new deposits will
largely offset withdrawals. This assumption is a reasonable one during
ordinary times, but it is not valid if depositors think that the bank will fail. If
depositors fear such a failure (even if the fear is not justified) then they will
withdraw their money because that eliminates all risk of loss if the bank
should fail. If e n o u g h deposits are withdrawn, t h e n the bank will run out of
cash a n d it will fail. The Federal Reserve System could have prevented
these solvent but illiquid banks from failing by making a short term loan to
the bank to cover depositors' withdrawals. The banks could then have
repaid the Fed's loan w h e n depositors see that the bank will not fail a n d
they redeposit their money in the bank. Many banks did fail in the 1 9 3 0 s
because at that time the Federal Reserve did not believe it had a duty to
preserve banks' liquidity.

FEDERAL RESERVE B A N K O F A T L A N T A




t h e i r role in t h e m o r t g a g e m a r k e t a n d w i l l have t o
b e g i n o p e r a t i n g m o r e like t r a d i t i o n a l banks. T h e
FHLBB p o i n t s o u t t h a t t h i s c h a n g e in roles w i l l
r e d u c e t h e o r i g i n a l j u s t i f i c a t i o n f o r i n s u r i n g S&Ls.
T h e r e p o r t notes, h o w e v e r , t h a t if t h r i f t s " b e c o m e an i n t e g r a l part of t h e t r a n s a c t i o n s o r
e x c h a n g e p r o c e s s " t h e n t h e reason f o r i n s u r i n g
t h e m w i l l b e t h e s a m e as f o r i n s u r i n g banks.
T h e N C U A discusses t h e o r i g i n o f share ins u r a n c e a n d its b e n e f i t s f o r c r e d i t u n i o n s in its
first s e c t i o n , " I m p a c t of I n s u r a n c e o n C r e d i t
U n i o n s . " 3 T h e N C U A says t h a t " C o n g r e s s d i d n ' t
feel t h a t ( c r e d i t u n i o n ) i n s u r a n c e was n e e d e d ,
rather it w a n t e d t o r e w a r d c r e d i t u n i o n s f o r a j o b
w e l l d o n e a n d p r o v i d e p a r i t y in i n s u r a n c e w i t h
o t h e r f i n a n c i a l i n s t i t u t i o n s . " 4 Also, several c r e d i t
unions said d e p o s i t insurance helps in c o m p e t i t i o n
f o r f u n d s , is i n e x p e n s i v e , r e q u i r e s a m i n i m u m
level o f c o m p e t e n c e , a n d r e d u c e s s p o n s o r i n g
o r g a n i z a t i o n s ' h e s i t a n c y in c r e a t i n g a n e w c r e d i t
u n i o n . 5 It also a l l o w s c r e d i t u n i o n s t o e n g a g e in
n e w a c t i v i t i e s s e c u r e in t h e k n o w l e d g e " t h a t
should something unforeseen happen, the big
i n s u r a n c e f u n d in W a s h i n g t o n , D.C. w i l l c o m e t o
t h e rescue," a c c o r d i n g t o t h e N o r t h C a r o l i n a
C r e d i t U n i o n League. O n e reason c i t e d f o r
d e p o s i t i n s u r a n c e at b a n k s a n d S&Ls is t h e
desirability of p r o t e c t i n g small depositors. The
N C U A r e p o r t i m p l i c i t l y calls i n t o q u e s t i o n t h e
applicability of this rationale t o credit unions,
observing that their m e m b e r s rarely lost m o n e y
p r i o r t o t h e c r e a t i o n o f d e p o s i t insurance. 6

The Need for Reform
T h e F D I C a n d t h e FHLBB d e s c r i b e t h e n e e d
f o r r e f o r m similarly. T h e t w o a g e n c i e s say d e p o s i t
i n s u r a n c e s i g n i f i c a n t l y r e d u c e s t h e f i n a n c i a l markets' i n c e n t i v e t o discipline banks because a l m o s t
all d e p o s i t o r s r e c o v e r t h e i r m o n e y if an i n s u r e d
i n s t i t u t i o n fails. T h e risk of loss f a c i n g c r e d i t o r s in
m o s t businesses is carried b y t h e insuring agencies
for insured d e p o s i t o r y institutions. The insuring
agencies say t h e y c o u l d t r y t o l i m i t t h e i r risk in
o n e o f t w o ways: t h r o u g h r e g u l a t i o n o f b a n k
activities a n d c o m p e t i t i o n , or t h r o u g h risk-related

3

l n the Table of Contents the report sections are given short titles, but in
the body of the paper the relevant part of the congressional directive is
quoted.
4
The NCUA was c r e a t e d in 1971, unlike both the FDIC a n d FSLIC, w h i c h
were created during the Depression.
a
Pages 1 - 2 0 through 1 - 2 1
6
Pages 1 - 1 0 through 1 - 1 1 .

45

d e p o s i t i n s u r a n c e p r e m i u m s . T h e agencies historically have relied o n regulation to control bank
risk, c h a r g i n g o n l y o n e rate for d e p o s i t i n s u r a n c e
regardless of i n d i v i d u a l banks' riskiness.
T h e F D I C a n d FH LBB n o t e t h a t r e c e n t d e r e g u latory measures have w e a k e n e d their ability t o
influence insured institutions' riskand that m a n y
proposed measures w o u l d further w e a k e n their
i n f l u e n c e . If d e p o s i t i n s u r a n c e is n o t r e f o r m e d ,
t h e s e a g e n c i e s c o u l d face s u b s t a n t i a l losses.
Thus, t h e y c o n c l u d e t h a t d e p o s i t i n s u r a n c e m u s t
b e r e f o r m e d t o give i n s u r e d i n s t i t u t i o n s m o r e o f
an i n c e n t i v e t o l i m i t t h e i r risk. T h e t w o a g e n c i e s
suggest t h a t t h e p r i v a t e s e c t o r b e g i v e n m o r e
i n c e n t i v e t o i n f l u e n c e i n s u r e d i n s t i t u t i o n s ' risk o r
t h a t t h e agencies start c h a r g i n g risk-related ins u r a n c e p r e m i u m s or b o t h .
The N C U A report contends that credit unions
w e r e r u n m o r e p r u d e n t l y p r i o r t o t h e c r e a t i o n of
f e d e r a l share i n s u r a n c e in 1 9 7 1 a n d t h a t s t r o n g
credit unions were m o r e willing to help their
w e a k e r cousins. It q u o t e s i n d u s t r y officials as
saying t h a t m a n y c r e d i t u n i o n s n o w feel t h e
N C U A will take responsibility for any mistakes
t h e y m a k e . 7 T h e r e p o r t urges t h a t s o m e w a y
should be f o u n d to make credit unions more
responsible while maintaining the benefits they
r e c e i v e f r o m f e d e r a l share insurance.

Desirability of Risk-Related
Insurance Premiums
T h e congressional d i r e c t i v e asked t h e agencies
t o l o o k at t h e f e a s i b i l i t y of b a s i n g i n s u r a n c e
p r e m i u m s o n t h e i n s t i t u t i o n s ' risk, o r t h e i r category or size. M o s t o f t h e d i s c u s s i o n is f o c u s e d o n
risk-based p r e m i u m s . T h e FDIC thinks risk-based
p r e m i u m s are d e s i r a b l e b e c a u s e t h e y are m o r e
e q u i t a b l e , b u t t h e a g e n c y d o u b t s t h a t t h e y can
fully replace regulation and m a r k e t discipline.
T h e FHLBB also s u p p o r t s risk-based p r e m i u m s
a n d argues t h a t t h e y can b e u s e d t o i n f l u e n c e
s o m e t y p e s of risk w h i l e r e g u l a t i o n c o n t r o l s o t h e r
t y p e s o f risk. T h e N C U A is o p p o s e d t o riskr e l a t e d p r e m i u m s p r i m a r i l y b e c a u s e it b e l i e v e s
t h e y w o u l d increase t h e g o v e r n m e n t ' s role in t h e
f i n a n c i a l sector.

T h e F D I C says t h a t t h e " i d e a l s y s t e m " in w h i c h
p r e m i u m s are c l o s e l y t i e d t o t h e i n s t i t u t i o n ' s risk
is n o t feasible. It f i n d s little e m p i r i c a l e v i d e n c e
demonstrating the need for a comprehensive
risk-based i n s u r a n c e s y s t e m a n d says a s y s t e m
b a s e d o n t h e FDIC's p e r c e p t i o n s o f risk is u n d e sirable b e c a u s e t h e a g e n c y is t h e o n l y s o u r c e of
i n s u r a n c e for banks. T h e F D I C s u p p o r t s riskb a s e d i n s u r a n c e p r e m i u m s o n l y as a m e a n s of
p r o v i d i n g e q u i t y t o banks t h a t are n o t excessively
risky, a n d it d o e s n o t w a n t s u c h p r e m i u m s t o be
t h e p r i m a r y i n f l u e n c e o n b a n k risk positions.
The FHLBB argues that t h e risk p r e m i u m structure
n e e d not b e ideal to reduce insured institutions'
risk. It n o t e s t h a t r e g u l a t i o n can c o n t r o l risks t h a t
are n o t p r i c e d . T h e FHLBB also argues that,
w h e r e feasible, i n f l u e n c i n g risks t h r o u g h insurance
p r e m i u m s r a t h e r t h a n r e g u l a t i o n is d e s i r a b l e
because regulation establishes an arbitrary cutoff
for risk-taking a n d because supervisory sanctions
t e n d t o b e i m p o s e d a f t e r t h e fact.
T h e N C U A b r i e f l y discusses t h e a d v a n t a g e s of
b a s i n g i n s u r a n c e p r e m i u m s o n risk b u t t h e n
p r o c e e d s t o argue against it. T h e N C U A a c k n o w ledges t h a t s o m e b e l i e v e risk r a t i n g is m o r e
e q u i t a b l e a n d t h a t it w i l l r e d u c e r i s k t a k i n g . But it
cites a r g u m e n t s against d e p o s i t i n s u r a n c e b y
t h o s e in t h e c r e d i t u n i o n i n d u s t r y w h o say risk
r a t i n g c o u l d p r o v o k e runs o n c r e d i t u n i o n s a n d
c o u l d h u r t a l r e a d y a i l i n g c r e d i t u n i o n s . T h e y also
say t h e risk r a t i n g m i g h t n o t b e fair, t h a t a n y r a t i n g
w o u l d have t o i n c l u d e an analysis of t h e s t r e n g t h
of t h e c r e d i t u n i o n ' s s p o n s o r a n d t h a t s u c h r a t i n g
w o u l d increase g o v e r n m e n t i n f l u e n c e in t h e
f i n a n c i a l sector. 8

Implementing Risk-Related Premiums
All t h r e e agencies' r e p o r t s i n c l u d e s o m e discussion of h o w t h e y w o u l d i m p l e m e n t risk-related
p r e m i u m s . T h e F D I C p r o v i d e s a fairly s p e c i f i c
b l u e p r i n t of h o w it m i g h t set u p a p r e m i u m
s t r u c t u r e . T h e FHLBB discusses t h e g e n e r a l princ i p l e s t h a t s h o u l d b e u s e d in s e t t i n g u p riskrelated premiums, b u t provides f e w details o n

8

'This part of the NCUA report reinforces the FDIC a n d F H L B B position that
the current deposit insurance system encourages insured institutions to
take on more risk

46




The NCUA highlights the last argument, that risk rating w o u l d increase
goverment influence in the financial sector, in effect arguing that it
demonstrates a fundamental flaw in risk based premiums. What this
argument ignores, however, is that the current system has a dramatic but
perverse effect on t h e activities of insured institutions, including credit
u n i o n s A more persuasive argument is that risk rating w o u l d have a w o r s e
effect on the private sector than do risk independent p r e m i u m s

JANUARY 1984, E C O N O M I C REVIEW

F|

t h e s y s t e m it w o u l d prefer. W h i l e t h e N C U A is
o p p o s e d t o s u c h p r e m i u m s , it i n c l u d e s a proposal t h a t is in effect a risk-based insurance plan
(albeit w i t h o n l y a single, c r u d e m e a s u r e o f risk).
T h e F D I C ' s p r o p o s a l is b a s e d o n t h e i n s u r a n c e
rebates it pays a n n u a l l y t o i n s u r e d banks. T h e
a g e n c y c u r r e n t l y gives b a n k s a n a s s e s s m e n t
credit at t h e e n d o f e a c h year, u s u a l l y e q u a l t o 6 0
percent of the difference b e t w e e n each bank's
gross a s s e s s m e n t a n d its o p e r a t i n g e x p e n s e s a n d
insurance losses. T h e F D I C says it w o u l d assign
each b a n k t o o n e o f t h r e e risk categories: n o r m a l
risk, h i g h risk a n d v e r y h i g h risk. Banks in t h e
n o r m a l risk c a t e g o r y w o u l d r e c e i v e a full assessm e n t c r e d i t , b a n k s in t h e h i g h risk w o u l d r e c e i v e
50 p e r c e n t o f t h e c r e d i t , a n d t h o s e in t h e v e r y
high risk c a t e g o r y w o u l d r e c e i v e n o c r e d i t . T h e
FDIC e x p e c t s t h a t t h e " v a s t m a j o r i t y " o f b a n k s
w o u l d fall i n t o t h e n o r m a l category.
T h e F D I C w o u l d l o o k at several criteria in
assigning b a n k s t o t h e risk categories. O n e is t h e
bank's capital. T h e F D I C r e c o g n i z e s t h a t c a p i t a l
a d e q u a c y d e p e n d s o n e a c h b a n k ' s risk p o s i t i o n ,
b u t it a c k n o w l e d g e s t h a t it c a n n o t m e a s u r e risk
precisely. T h e F D I C favors a 5 p e r c e n t c a p i t a l
s t a n d a r d b u t will, at least initially, u s e a 3 p e r c e n t
standard. 9 That is, a n y b a n k t h a t d o e s n o t h a v e
capital e q u a l t o at least 3 p e r c e n t of its assets w i l l
a u t o m a t i c a l l y b e p l a c e d in t h e highest risk category. This s t a n d a r d w o u l d a p p l y o n l y t o d e p o s i t
i n s u r a n c e a n d p r o b a b l y w o u l d b e raised t o 5
p e r c e n t in a f e w years a c c o r d i n g t o t h e FDIC.
A n o t h e r c a t e g o r y t h e F D I C w i l l c o n s i d e r is
c r e d i t risk. T h e F D I C p r o p o s e s t o use classified
assets (substandard loans plus 0.5 times d o u b t f u l
loans) f o r this s t a n d a r d . 1 0 If classified assets
e x c e e d 7 0 p e r c e n t o f a b a n k ' s capital, t h e n its
c r e d i t risk is c o n s i d e r e d u n a c c e p t a b l y high. T h e
F D I C a d m i t s t h a t this s t a n d a r d is j u d g m e n t a l a n d
that t h e 70 p e r c e n t standard may be changed
based o n o n g o i n g research. (See, for e x a m p l e ,
the special issue o n c o m m e r i c a l bank surveillance,
this Review, N o v e m b e r 1 9 8 3 . )

' T h e FDIC a c k n o w l e d g e s that s o m e people do not agree that banks
should have 5 percent capital, a n d that a number ot large banks are
operating at lower capital levels.
'"Bank examiners review each b a n k s asset portfolio as a part of their
examination. As a part of this review, the examiners place w e a k loans into
one of three categories: loss, doubtful, a n d substandard. The FDIC
presumes that all loss loans a n d 50 percent of doubtful loans will be
charged to loan losses. The FDiC proposes to include the remaining
weak loans in its evaluation of a bank's asset quality.

FEDERAL RESERVE B A N K O F A T L A N T A




A t h i r d t y p e o f r i s k t h a t t h e F D I C w i l l e v a l u a t e is
i n t e r e s t rate risk. T h e a g e n c y is c o n s i d e r i n g
c o m p u t i n g t h e e f f e c t o f a 2 5 0 basis p o i n t c h a n g e
in i n t e r e s t rates o n a b a n k ' s c u m u l a t i v e earnings
f o r e a c h of f o u r p e r i o d s : t h r e e m o n t h risk, sixm o n t h risk, o n e - y e a r risk a n d f i v e - y e a r risk. If
such c h a n g e in i n t e r e s t rates w o u l d d e c r e a s e t h e
p r e s e n t v a l u e of assets in excess o f 2 0 p e r c e n t o f
capital o v e r a year o r less t i m e h o r i z o n a n d in
excess of 5 0 p e r c e n t o f c a p i t a l o v e r t h e f i v e year
h o r i z o n , t h e n t h e b a n k is d e e m e d t o have
u n a c c e p t a b l y h i g h i n t e r e s t rate risk. T h e F D I C
a d m i t s t h a t m a n y t h r i f t s w o u l d fail t h i s test. T h e
a g e n c y notes, h o w e v e r , t h a t it p r o b a b l y w o u l d
t a k e a c o u p l e o f years t o i m p l e m e n t t h i s riskbased insurance program, and expresses h o p e
t h a t m a n y t h r i f t s w o u l d r e d u c e t h e i r i n t e r e s t rate
risk b y t h e n . T h e F D I C also w o u l d like t o base t h e
ratings o n m o r a l h a z a r d risk a n d l i q u i d i t y risk b u t
d o u b t s t h a t this is c u r r e n t l y feasible.
T h e F D I C also l o o k s at t h e r e l a t i o n s h i p bet w e e n b a n k size a n d risk a n d c o n c l u d e s that,
" O n b a l a n c e , it is n o t clear t h a t s m a l l e r b a n k s
w i t h e s t a b l i s h e d t r a c k r e c o r d s are s i g n i f i c a n t l y

"The two agencies say deposit
insurance significantly reduces the
financial markets' incentive to
discipline banks because almost all
depositors recover their money if
an insured institution fails."

r i s k i e r t h a n large banks, a n d r e l a t i n g p r e m i u m s t o
t h e size of t h e b a n k d o e s n o t s e e m a p p r o p r i a t e . "
(See t h e special issue o n e c o n o m i e s o f scale in
b a n k i n g , this Review, N o v e m b e r 1 9 8 2 . ) T h e
FDIC does note, however, that m o r e conservative
standards s h o u l d be a p p l i e d t o n e w banks a n d
banks w i t h u n p r o v e n management.
T h e F D I C is i n s i s t e n t t h a t U n i f o r m I n t e r a g e n c y
Bank Rating S y s t e m ratings ( c o m m o n l y k n o w n as
C A M E L ratings—measuring capital adequacy,
asset quality, m a n a g e m e n t earnings, a n d liquidity),
based on examiners' review of a bank, s h o u l d n o t
b e u s e d f o r risk-rating banks. T h e F D I C n o t e s
t h a t s u c h a use of t h e C A M E L ratings w o u l d
cause b a n k e r s t o b e m o r e g u a r d e d a b o u t t h e i r
p r o b l e m s . If b a n k e r s b e c o m e less o p e n , t h e
F D I C says, t h e e x a m i n a t i o n p r o c e s s w o u l d h a v e
t o b e e x p a n d e d significantly. T h e a g e n c y also

47

n o t e s t h a t t h e c u r r e n t C A M E L ratings a r e inf l u e n c e d h e a v i l y b y s u b j e c t i v e factors. If t h e
ratings w e r e used t o d e t e r m i n e risk-based p r e
miums, banks w o u l d challenge them, eventually
f o r c i n g t h e a g e n c i e s t o use a s y s t e m b a s e d o n l y
o n statistics. Such a c h a n g e w o u l d r e d u c e t h e
r e l i a b i l i t y o f t h e rating. T h e F D I C f u r t h e r argues
t h a t s o m e b a n k s are assigned n e w C A M E L ratings
only during on-site examinations, and that a
three-year gap m a y occur b e t w e e n such examinations. 1 1
T h e FHLBB's " i d e a l s t r u c t u r e " f o r r i s k - r e l a t e d
p r e m i u m s w o u l d m e e t several criteria:
the
prices c h a r g e d s h o u l d r e f l e c t t h e risk t o t h e
FDIC, t h e p r e m i u m s s h o u l d b e b a s e d o n t h e
institution's capital position, a n d the p r e m i u m
s t r u c t u r e s h o u l d b e easy f o r m a n a g e r s t o u n d e r stand and should m i n i m i z e t h e n e e d for nonp r i c e r e g u l a t i o n . T h e Bank Board's r e p o r t discusses t w o g e n e r a l w a y s o f e v a l u a t i n g risks:
overall risk indicators a n d i n d i v i d u a l risk measures.
T h e FH LBB e v a l u a t e s several s p e c i f i c m e t h o d s in
b o t h categories, b u t it m a k e s n o d e t a i l e d r e c o m m e n d a t i o n s s u c h as t h o s e c o n t a i n e d in t h e F D I C
r e p o r t . O n e o v e r a l l risk i n d i c a t o r r e j e c t e d b y t h e
FHLBB is e x a m i n a t i o n ratings, w h i c h it d e s c r i b e s
as s u b j e c t i v e a n d s o m e t i m e s s i m p l y w r o n g . 1 2 It
rejects a s e c o n d o v e r a l l risk i n d i c a t o r , o n e b a s e d
o n a f i n a n c i a l ratio, b e c a u s e m o d e l s are a d h o c
a n d b e c a u s e ratios b o t h r e f l e c t t h e past a n d
p r e d i c t t h e f u t u r e . T h e FHLBB w o u l d p r e f e r t h a t
t h e indicator only predicted t h e future. Another
p o s s i b l e i n d i c a t o r w o u l d b e past d u e loans a n d
s e c u r i t y losses, b u t t h e Bank B o a r d q u e s t i o n s t h i s
m e a s u r e b e c a u s e it also r e f l e c t s past p r o b l e m s . A
f o u r t h i n d i c a t o r c o n s i d e r e d is t h e past level a n d
v o l a t i l i t y of earnings. T h e r e p o r t suggests t h a t this
m e a s u r e c o u l d b e u s e d if it w e r e c o r r e l a t e d w i t h
m a r k e t - d e t e r m i n e d d e f a u l t risk p r e m i u m s a n d
t h e i n c i d e n c e o f d e f a u l t at savings a n d loans. 1 3
T h e last i n d i c a t o r c o n s i d e r e d b y t h e FHLBB is t h e
interest-rate risk p r e m i u m o n u n i n s u r e d liabilities.
It rejects t h i s m e a s u r e b e c a u s e m a n y i n s t i t u t i o n s

" T h e third argument can be made, however, against the FDIC's use of
classified a s s e t s The FDIC g e t s a r o u n d the problem by annual loan
inspections.
,2
The F H L B B n o t e d one major oversight on the part of the FSLIC
examiners in the past: t h e y missed the interest rate risk at savings a n d
loans
,3
The FHLBB's consideration of this indicator is hard to understand given
that they have rejected t w o other indicators on the grounds that the
indicators reflected the past a n d not the future. Financial ratios a n d past
due loans both provide at least s o m e indication of the future health of an
institution. Empirical estimates of the level a n d volatility of earnings can
only reflect historical results

48




lack s i g n i f i c a n t u n i n s u r e d liabilities, b e c a u s e t h e
p r o c e d u r e s u s e d t o h a n d l e f a i l e d S&Ls o f t e n
p r o v i d e 1 0 0 percent d e facto insurance, and
b e c a u s e o f p r o b l e m s in s e p a r a t i n g risk, m a r k e t ability and regional influences o n t h e interest
rate paid.
T h e FH LBB t h i n k s t h r e e t y p e s of risk s h o u l d be
e v a l u a t e d in s e t t i n g m a r k e t - b a s e d risk p r e m i u m s :
i n t e r e s t rate risk, c r e d i t risk a n d m a n a g e m e n t
risk. It d r a w s n o c o n c l u s i o n s as t o h o w t h e FSLIC
w o u l d m e a s u r e a n y o f t h e s e risks in a risk-based
insurance p r e m i u m program, but explores a
c o u p l e of p o s s i b i l i t i e s f o r i n t e r e s t a n d c r e d i t rate
risk. T h e r e p o r t discusses t h e use o f d u r a t i o n a n d
m a t u r i t y gap analysis t o m e a s u r e i n t e r e s t - r a t e
risk. It argues t h a t d u r a t i o n offers a b e t t e r measure
of an i n s t i t u t i o n ' s risk, b u t t h a t m a t u r i t y gap
analysis is m o r e f a m i l a r t o S&Ls. 14
T h e r e p o r t suggests t h a t t h e c r e d i t risk o n a
savings a n d loan's asset portfolio c o u l d be measured
b y t h e risk p r e m i u m o n its assets o r b y historic
l o a n losses, b u t it f i n d s fault w i t h b o t h . It says t h e
t r u e risk p r e m i u m o n loans c a n n o t b e m e a s u r e d
b e c a u s e t h e r e is n o s e c o n d a r y m a r k e t f o r loans.
Also, h i s t o r i c l o a n losses d o n o t d e t e r m i n e t h e
size o f t h e p r e m i u m t o b e c h a r g e d f o r c u r r e n t
c r e d i t risk. T h e FH LBB also says t h a t t h e diversific a t i o n o f t h e i n s t i t u t i o n ' s p o r t f o l i o is i m p o r t a n t ,
b u t it is u n c e r t a i n h o w t o m e a s u r e diversification.
M a n a g e m e n t risk is s e e n as an i m p o r t a n t f a c t o r
in t h e riskiness of an institution, b u t is characterized
as a l m o s t i m p o s s i b l e t o m e a s u r e . T h e r e p o r t also
n o t e s t h a t if e x a m i n e r s t r y t o m e a s u r e m a n a g e
m e n t risk t h e y w i l l h a v e t o s e c o n d guess e a c h
institution's m a n a g e m e n t , w h i c h w o u l d run
c o u n t e r t o the purpose of deregulation.
T h e N C U A m a y b e o p p o s e d t o risk-based
p r e m i u m s , b u t it d o e s f i n d m e r i t in b e i n g a b l e t o
t i e r its p r e m i u m s t o t h e size of a d e p o s i t . T h e
a g e n c y n o t e s t h a t m o s t c r e d i t u n i o n a c c o u n t s are
small, u n d e r $ 5 0 , 0 0 0 , b u t t h a t a f e w i n s t i t u t i o n s h a v e s o u g h t larger a c c o u n t s aggressively
b y p a y i n g h i g h i n t e r e s t rates. T h e N C U A b e l i e v e s
t h a t m a n y c r e d i t u n i o n s s e e k i n g larger a c c o u n t s
are a c q u i r i n g assets t h a t have h i g h r e t u r n s a n d
h i g h risks t o m e e t i n t e r e s t p a y m e n t s o n t h e large
a c c o u n t s . T h e N C U A w o u l d like t o b e a b l e t o tier

'"Duration is a measure of the effective term to maturity of an asset or
liability. The duration measure discussed in the study has s o m e flaws that
are not discussed in the study, but it is still superior to the g a p analysis
discussed by the F H L B B See Cooper (1) for a discussion of s o m e of
duration's limitations.

JANUARY 1984, E C O N O M I C REVIEW

F|

its p r i c i n g s y s t e m b a s e d o n a c c o u n t size so
aggessive c r e d i t u n i o n s w o u l d pay h i g h e r risk
premiums.

Reducing Deposit Insurance Coverage
D e p o s i t s at i n s u r e d i n s t i t u t i o n s legally are
insured up t o $ 1 0 0 , 0 0 0 , b u t b o t h t h e FDIC and
FSLIC n o t e t h a t t h e i r c u r r e n t m e t h o d o f h a n d l i n g
failures o f t e n p r o v i d e s 1 0 0 p e r c e n t i n s u r a n c e t o
all d e p o s i t o r s . T h e agencies usually use t h e
purchase a n d a s s u m p t i o n m e t h o d f o r h a n d l i n g
failed institutions. T h a t m e t h o d involves a m e r g e r
between the failed institution and a healthy one,
w i t h t h e a c q u i r i n g i n s t i t u t i o n a s s u m i n g all t h e
failed o n e ' s d e p o s i t s . This m i n i m i z e s t h e insuring
agencies' cash o u t f l o w a n d d i s r u p t i o n in t h e
failed i n s t i t u t i o n ' s c o m m u n i t y . T h e p r o b l e m is
that d e p o s i t o r s w i t h o v e r $ 1 0 0 , 0 0 0 d o n o t feel
their f u n d s are at risk, so t h e y d o n o t m o n i t o r t h e
d e p o s i t o r y i n s t i t u t i o n s ' risk. O b v i o u s l y , t h e r e can
be n o p r i v a t e s e c t o r d i s c i p l i n e o v e r b a n k risk
t a k i n g unless d e p o s i t o r s b e l i e v e t h e i r f u n d s are
in danger. T h e FDIC, FHLBB a n d N C U A s u p p o r t
measures t o increase t h e risk b o r n e b y depositors. 1 5
T h e F D I C suggests o n e of t w o c h a n g e s t o
m a k e u n i n s u r e d d e p o s i t o r s share in t h e risk of
failure. O n e of t h e s e changes, c a l l e d m o d i f i e d
payout, w o u l d i n v o l v e i m m e d i a t e f u l l p a y m e n t
of i n s u r e d a c c o u n t s a n d a n a d v a n c e t o r e m a i n i n g
claimants e q u a l t o t h e e s t i m a t e d recoveries. This
p r o c e d u r e c o u l d b e i m p l e m e n t e d e v e n if t h e
FDIC a r r a n g e d a m e r g e r b e t w e e n t h e f a i l e d
institution and a healthy one, w i t h the healthy
institution assuming only the insured accounts
and t h e FDIC's a d v a n c e t o o t h e r creditors.16 The
FDIC says t h a t w h i l e c o n g r e s s i o n a l a c t i o n m a y
facilitate t h e m o d i f i e d p a y o u t m e t h o d , t h e agency
has t h e a u t h o r i t y t o f o l l o w t h i s a p p r o a c h o n its
own.
T h e F D I C also c o n s i d e r s a v a r i a t i o n o n t h e
m o d i f i e d p a y o u t a p p r o a c h , w h i c h it calls c o i n surance. C o i n s u r a n c e w o u l d w o r k like m o d i f i e d

" A l l three agencies also mentioned the possibility ot increasing the level of
government insurance but none of the three s u p p o r t e d such an increase.
The FDIC believes such an increase w o u l d be a bad step unless it could
price coverage to cover each institution's risk. The FDIC does not believe
such pricing is possible as is n o t e d above. The NCUA flatly rejects an
increase in the limits.
,6
lf a bank failed and was acquired by another b a n k under this proposal the
acquiring bank w o u l d acquire all of the insured deposits of the failed
bank. The acquiring bank w o u l d also assume s o m e uninsured liabilities,
with the amount a s s u m e d by the acquirer dependent on the amount the
FDIC expects t o collect w h e n it liquidates the failed bank.

payout except that uninsured depositors might
b e g u a r a n t e e d 75 p e r c e n t o f t h e i r u n i n s u r e d
deposits, f o r e x a m p l e , w h e n t h e institution failed.
T h e r e m a i n i n g 25 p e r c e n t a n d t h e c l a i m s of all
o t h e r c r e d i t o r s w o u l d b e satisfied as t h e f a i l e d
b a n k ' s assets w e r e l i q u i d a t e d . B o t h m o d i f i e d
payout a n d coinsurance w o u l d place uninsured
parties' f u n d s at risk a n d give t h e m a reason f o r
m o n i t o r i n g i n s u r e d i n s t i t u t i o n s ' risk p o s i t i o n . If
depositors t h o u g h t a given insured institution
w a s m o r e risky t h a n a n o t h e r , t h e y c o u l d d e m a n d
a h i g h e r risk p r e m i u m o r w i t h d r a w t h e i r m o n e y .
Either a c t i o n w o u l d d i s c o u r a g e t h e i n s t i t u t i o n ' s
m a n a g e r s f r o m t a k i n g e x c e s s i v e risks. T h e F D I C
argues t h a t t h e c o i n s u r a n c e s c h e m e w o u l d h a v e
t h e advantage of r e d u c e d uncertainty a n d possible
c o n t r o v e r s y a s s o c i a t e d w i t h t h e e s t i m a t e d recoveries. C o i n s u r a n c e also w o u l d g u a r a n t e e uninsured depositors a high p r o p o r t i o n of their
f u n d s , w h i c h w o u l d lessen t h e i n c e n t i v e f o r b a n k
runs.
W i l l i a m M . Isaac, t h e C h a i r m a n o f t h e FDIC,
a n n o u n c e d in D e c e m b e r 1 9 8 3 t h a t t h e F D I C
w o u l d s o o n start u s i n g t h e m o d i f i e d p a y o u t
m e t h o d o f h a n d l i n g b a n k failures (The American
Banker, D e c 7, 1 9 8 3 ) . H e said t h a t t h e F D I C
w o u l d begin by using the m o d i f i e d payout t o
h a n d l e small b a n k failures b u t t h a t t h e m e t h o d
w o u l d b e e x t e n d e d t o large b a n k s if it p r o v e d
feasible. If t h e m o d i f i e d p a y o u t m e t h o d is n o t
feasible, t h e n Isaac said t h a t t h e F D I C w o u l d
consider urging Congress t o i m p o s e m i n i m u m
capital standards w i t h s u b o r d i n a t e d d e b t eligible t o
m e e t a p o r t i o n o f t h e standards.
The FDIC notes t w o counterarguments: these
proposals w o u l d not place many private depositors
at risk, b u t t o t h e e x t e n t t h e y d o t h e s e p r o p o s a l s
c r e a t e an i n c e n t i v e f o r b a n k runs. T h e r e p o r t
argues t h a t since s m a l l e r i n s t i t u t i o n s a l r e a d y
have a h i g h p r o p o r t i o n o f t h e i r d e p o s i t s in
insured accounts, these proposals c o u l d i n f l u e n c e
their behavior only modestly. Intermediate and
regional b a n k s c o u l d r e d u c e t h e i r u n i n s u r e d
deposits substantially by relying o n brokers w h o
b r e a k large d e p o s i t s i n t o $ 1 0 0 , 0 0 0 packages a n d
deposit these packages in separate banks. Finally,
t h e F D I C says t h a t s o m e argue t h a t " u n t i l a
m u l t i b i l l i o n d o l l a r i n s t i t u t i o n is actually closed,
t h e p o s s i b i l i t y w o u l d have l i m i t e d c r e d i b i l i t y so
that t h e effect of i m p l e m e n t i n g t h e proposal
m i g h t a c t u a l l y b e t o increase t h e a d v a n t a g e o f
t h e v e r y large b a n k . " If m a n y d e p o s i t o r s d o f e e l
t h e y h a v e s i g n i f i c a n t d e p o s i t s at risk, h o w e v e r ,
they may w i t h d r a w their funds from banks w i t h
49

FEDERAL RESERVE B A N K O F A T L A N T A




even relatively m o d e s t problems. These depositors
m a y b e l i e v e t h a t t h e y have little t o gain a n d a lot
t o lose b y s t i c k i n g w i t h a p r o b l e m i n s t i t u t i o n . T h e
FDIC does not dispute that these proposals
w o u l d p l a c e f e w d e p o s i t o r s at risk, b u t it d o e s
d e n y t h a t t h e proposals w o u l d lead t o b a n k runs.
T h e F D I C also w a r n s t h a t t h e p r i v a t e m a r k e t a n d
b a n k s c o u l d o v e r r e a c t t o t h e s e measures a n d
banks c o u l d b e c o m e o v e r l y conservative.
The FHLBB discusses t h e prospects of increasing
market discipline through reduced coverage a n d
* h e n details s o m e m e t h o d s for increasing m a r k e t
discipline. It generally is negative t o w a r d r e d u c i n g
t h e a m o u n t i n s u r e d per d e p o s i t o r . T h e FHLBB
says such a c u t w o u l d e n c o u r a g e t h e use of
b r o k e r e d funds, c o u l d cause losses f o r investors,
a n d c o u l d increase i n c e n t i v e s f o r runs o n instit u t i o n s b e l i e v e d t o be in financial d i f f i c u l t y . Such

"The FDIC...concludes that 'On
balance, it is not clear that smaller
banks with established track records
are significantly riskier than large
banks, and relating premiums to
the size of the bank does not seem
appropriate."
a c u t in coverage, a c c o r d i n g t o t h e FHLBB, w o u l d
p r o b a b l y r e d u c e d e p o s i t s at S&Ls since m o s t
d e p o s i t o r s d o n o t like t o m a k e u n i n s u r e d deposits at thrifts. 1 7
T h e FHLBB r e p o r t discusses a v a r i e t y of w a y s
of c u t t i n g e f f e c t i v e d e p o s i t insurance, b u t m a k e s
n o s p e c i f i c r e c o m m e n d a t i o n . T h e s i m p l e s t of
these proposals is t o d o nothing, a l l o w i n g inflation
a n d i n c r e a s e d w e a l t h t o increase t h e average
size of deposits and t h e n u m b e r of u n i n s u r e d
d e p o s i t o r s . T h e FHLBB also discusses proposals
similar t o t h e FDIC's m o d i f i e d p a y o u t a n d coins u r a n c e proposals. A n o t h e r proposal w o u l d cover
d e m a n d d e p o s i t s in f u l l b u t l i m i t i n s u r a n c e
coverage o n t i m e deposits. This proposal recognizes
that d e m a n d deposits can be w i t h d r a w n a n y t i m e
w i t h o u t loss, b u t t h a t t i m e d e p o s i t s can have
significant early w i t h d r a w a l penalties. Thus, holders
of t i m e d e p o s i t s are less likely t o w i t h d r a w t h e i r
f u n d s at t h e first sign of t r o u b l e .

" T h i s last point can be considered a disadvantage, an advantage or
irrelevant in analyzing a reduction, depending on one's perspective.

50




T h e N C U A e n d o r s e s t h e c r e a t i o n of a d e d u c t i ble in share insurance. T h a t is, e v e r y c r e d i t u n i o n
m e m b e r ' s first share at least s h o u l d b e u n i n s u r e d
t o m a k e m e m b e r s t a k e o n s o m e p r o p o r t i o n of
t h e risk. T h e N C U A n o t e s that, e x c e p t f o r a f e w
c o r p o r a t e c r e d i t u n i o n s , t h e average c r e d i t u n i o n
a c c o u n t is less t h a n $ 5 0 , 0 0 0 . Thus, a t t e m p t s t o
i m p o s e greater risks o n large d e p o s i t o r s m a y n o t
w o r k for most credit unions. The N C U A does not
a d v o c a t e a n y c h a n g e at this t i m e in t h e i n s u r a n c e
structure for corporate credit unions.

Private Deposit Insurance
A n o t h e r w a y of b r i n g i n g m o r e p r i v a t e sector
d i s c i p l i n e t o i n s u r e d d e p o s i t o r y i n s t i t u t i o n s is to
s u b s t i t u t e p r i v a t e i n s u r a n c e f o r p u b l i c insurance.
O p i n i o n s of this o p t i o n d e p e n d on w h a t each
a g e n c y t h i n k s its r e s p o n s i b i l i t i e s are a n d w h o it
insures. T h e F D I C insures m a n y b a n k s w i t h
assets in excess o f $1 b i l l i o n a n d feels a responsibility t o p r o t e c t t h e health of t h e nation's financial
system. This a g e n c y d o u b t s t h a t p r i v a t e firms
have t h e c a p a c i t y t o i n s u r e larger banks, a n d
does not see h o w t h e y c o u l d p r o t e c t t h e financial
system. T h e t y p i c a l c r e d i t u n i o n i n s u r e d b y t h e
N C U A is small, b y contrast, a n d t h e a g e n c y feels
n o r e s p o n s i b i l i t y t o p r o t e c t t h e f i n a n c i a l system,
Furthermore, over 3,000 credit unions already
are i n s u r e d b y parties o t h e r t h a n t h e f e d e r a l
g o v e r n m e n t . T h e N C U A s u p p o r t s t h e s e alternative insurance schemes a n d believes t h a t federal
credit unions s h o u l d have t h e o p t i o n of substituting
o n e o f t h e m for f e d e r a l insurance. T h e FHLBB
-supports p r i v a t e d e p o s i t i n s u r a n c e b u t d o u b t s
t h a t it can r e p l a c e f e d e r a l i n s u r a n c e c o m p l e t e l y .
T h e F D I C argues t h a t n e i t h e r b a n k self insurance nor private insurance c o m p a n i e s offer
an a d e q u a t e substitute for g o v e r n m e n t insurance,
T h e FDIC argues that self insurance is i n a d e q u a t e
b e c a u s e it c o u l d c r e a t e a " d o m i n o e f f e c t " in
t i m e s of financial distress. T h e F D I C argues that
p r i v a t e i n s u r a n c e c o m p a n i e s are i n a d e q u a t e :
b e c a u s e t h e y lack t h e financial c a p a c i t y t o insure
banks. T h e F D I C n o t e s t h a t t h e aggregate capital
o f all d o m e s t i c p r o p e r t y a n d l i a b i l i t y insurers \s\
a p p r o x i m a t e l y $ 6 8 b i l l i o n a n d t h a t m o s t have!
legal l i m i t a t i o n s of 10 p e r c e n t o n e x p o s u r e t o ai
single e v e n t . 1 8 F u r t h e r m o r e , if all f a c t o r s are

i
,
i

|
i
I
|
;

f
t
f
f
t
\
f
I
f
I;
1
f

'"The FDIC says in a footnote that it limits its analysis t o domestic insurance
companies because most foreign insurers either can not or do not
underwrite financial g u a r a n t e e s

J A N U A R Y 1 9 8 4 , E C O N O M I C REVIEW

F|

taken i n t o c o n s i d e r a t i o n , t h e m o s t d o m e s t i c
private insurance w o u l d insure any o n e institution
for w o u l d b e $1 b i l l i o n t o $2 b i l l i o n . 1 9 T h e F D I C
t h e n n o t e s t h a t " t w o r e l a t i v e l y large N e w Y o r k
City b a s e d c o m m e r c i a l b a n k s each h o l d m o r e
than $15 billion in uninsured d o m e s t i c deposits." It
further argues t h a t " n u m e r o u s s m a l l i n s t i t u t i o n s "
also h a v e u n i n s u r e d d e p o s i t levels t h a t w o u l d
appear t o e x c e e d t h e t o t a l c a p a c i t y of t h e
domestic insurance industry.
The F D I C also p o i n t s o u t t h a t private insurance
c o m p a n i e s m a i n t a i n t h e right t o a c c e p t o r r e j e c t
a p p l i c a n t s a n d insist o n t h e right t o c a n c e l
insurance w i t h o u t g i v i n g a cause. T h e F D I C
believes t h a t rejection or cancellation of insurance
w o u l d b e d e s t a b i l i z i n g in t h e b a n k i n g i n d u s t r y .
O t h e r p r o b l e m s w i t h p r i v a t e i n s u r a n c e are discussed b y t h e FDIC. It n o t e s t h a t t h e f e d e r a l
g o v e r n m e n t has b e t t e r access t o t h e necessary
data, t h a t a p r i v a t e i n s u r e r w o u l d h a v e t o b e
relatively large t o insure a r e g i o n a l l y d i v e r s i f i e d
group o f banks, t h a t private insurance c o m p a n i e s
invest in less l i q u i d a n d m o r e risky assets t h a n
t h e FDIC, a n d t h a t p r i v a t e i n s u r a n c e m a y n o t
h a n d l e failures as q u i c k l y as t h e f e d e r a l governm e n t . T h e F D I C c o n c l u d e s b y saying in e f f e c t
that it has n o o b j e c t i o n t o p r i v a t e i n s u r a n c e f o r
u n i n s u r e d a c c o u n t s , b u t t h a t it d o e s n o t s u p p o r t
a major g o v e r n m e n t c o m m i t m e n t t o t h e d e v e l o p m e n t o f p r i v a t e s e c t o r insurance.
The FHLBB says a c o m p l e t e s u b s t i t u t i o n o f
private f o r p u b l i c i n s u r a n c e is i m p r a c t i c a l b u t
that s o m e s u b s t i t u t i o n w o u l d b e b e n e f i c i a l . T h e
FHLBB b e l i e v e s t h a t p r i v a t e i n s u r a n c e c o u l d
p r o d u c e several benefits: private regulation w o u l d
s u b s t i t u t e for p u b l i c r e g u l a t i o n t o s o m e e x t e n t ,
t h e p r i c i n g of p r i v a t e i n s u r a n c e w o u l d e l i m i n a t e
t h e p e r v e r s e i n c e n t i v e s in t h e c u r r e n t risk-indep e n d e n t pricing system, and substituting private
for p u b l i c i n s u r a n c e w o u l d i m p r o v e e c o n o m i c
e f f i c i e n c y a n d r e d u c e t h e d r a i n o n f e d e r a l assets
w h e n i n s t i t u t i o n s fail. Its r e p o r t c o n t e n d s t h a t
private i n s u r a n c e can c o v e r t h r e e of t h e f o u r
hazards f a c e d b y banks: t h e risk o f r o b b e r y a n d
f r a u d b y o u t s i d e r s , t h e risk of m i s a p p r o p r i a t i o n
by insiders a n d t h e risk o f m a n a g e m e n t failure.
The o n l y risk p r i v a t e f i r m s c o u l d n o t c o v e r is a
failure of n a t i o n a l m a c r o e c o n o m i c policies.

' 9 The other factors taken into consideration are domestic private reinsurance
corporations and self-imposed maximum exposure limitations of private
insurance c o r p o r a t i o n s

FEDERAL RESERVE B A N K O F A T L A N T A




T h e FH LBB discusses b o t h t h e b r o a d o u t l i n e of
a c o m b i n e d private and public insurance system
and some operational problems that such a
s y s t e m m i g h t e n c o u n t e r . T h e a g e n c y suggests
that the federal g o v e r n m e n t c o u l d guarantee
a c c o u n t s u p t o a c e r t a i n l e v e l a n d c o u l d also
p r o m i s e t o s t e p in t o l i m i t p r i v a t e losses in t h e
case o f a m a c r o e c o n o m i c p o l i c y failure. Private
i n s u r a n c e c o m p a n i e s w o u l d c o v e r d e p o s i t s in
excess of t h e f e d e r a l g u a r a n t e e s u b j e c t t o a
l i m i t a t i o n o n t h e i r losses in t h e e v e n t o f a
national catastrophe.
Several o p e r a t i o n a l p r o b l e m s c o u l d o c c u r in a
m i x e d system, a c c o r d i n g t o t h e FHLBB. O n e
p r o b l e m w o u l d b e e s t a b l i s h i n g rules t o p r o t e c t
t h e agencies' d i s c r e t i o n o n c l o s i n g i n s t i t u t i o n s
w h i l e p r o t e c t i n g p r i v a t e insurers f r o m s u f f e r i n g
large losses o n i n s o l v e n t i n s t i t u t i o n s t h a t are n o t
p r o m p t l y closed. A n o t h e r p r o b l e m is t h e regulation
o f private insurers. T h e FHLBB says t h a t insurance
c o u l d be o f f e r e d b y existing insurance c o m p a n i e s
or t h r o u g h n e w m u t u a l i n s u r a n c e agencies set u p
b y i n s u r e d i n s t i t u t i o n s . In e i t h e r case s o m e sort
o f r e g u l a t i o n w o u l d b e r e q u i r e d b u t t h e FHLBB
w o u l d p r e f e r t h a t s u c h r e g u l a t i o n c l o s e l y parallel
regulation of existing insurance companies. The
FHLBB n o t e s a p o t e n t i a l p r o b l e m of a d v e r s e
s e l e c t i o n for b o t h t h e insurers a n d t h e i n s u r e d .
T h e p r o b l e m is t h a t i n s t i t u t i o n s m a y w i s h t o b e
insured only during times of e c o n o m i c trouble,
while insurance companies may be willing t o
offer insurance only during times of prosperity.
T h e r e p o r t says t h a t t h e insurers' p r o b l e m m a y
b e a v o i d e d b y r e q u i r i n g f e d e r a l l y i n s u r e d instit u t i o n s t o s e e k p r i v a t e insurance. T h e p r o b l e m s
of the insured firms c o u l d be resolved w h i l e
giving private insurers t h e right t o cancel insurance
b u t r e q u i r i n g t h e i n s u r i n g f i r m s t o r e m a i n at risk
during a specified cancellation period.

Other Means of Increasing
Private Sector Discipline
B o t h t h e F D I C a n d t h e FSLIC suggest w a y s t h a t
p r i v a t e sector d i s c i p l i n e c o u l d b e i n c r e a s e d
w i t h o u t r e d u c i n g d e p o s i t i n s u r a n c e c o v e r a g e or
r e l y i n g o n p r i v a t e insurance. I n s u r e d i n s t i t u t i o n s
c o u l d use m o r e s u b o r d i n a t e d d e b t , f o r instance.
T h e F D I C talks a b o u t t h e use of s u b o r d i n a t e d
d e b t in t h e c o n t e x t o f r e v i s e d c a p i t a l standards.
T h e a g e n c y m a i n t a i n s t h a t s u b o r d i n a t e d d e b t is
not a substitute for e q u i t y capital because d e b t
c a n n o t a b s o r b losses in a g o i n g c o n c e r n . T h e

51

F D I C is i n t e r e s t e d , h o w e v e r , in r e q u i r i n g greater
use o f s u b o r d i n a t e d d e b t b e c a u s e it can a b s o r b
t h e a g e n c y ' s losses w h e n a b a n k fails. T h e F D I C
d o e s n o t say it w i l l use s u b o r d i n a t e d d e b t at t h i s
t i m e , b u t it d o e s say t h e i d e a " a p p e a r s t o w a r r a n t
c o n s i d e r a t i o n in a d d i t i o n to, or in lieu of, t h e risksharing proposals considered above."20
In a d d i t i o n t o discussing i n c r e a s e d use o f
s u b o r d i n a t e d n o t e s b y savings a n d loans, t h e
FH LBB also discusses t h e n e e d f o r S&L o w n e r s t o
e x e r t greater c o n t r o l s . T h r e e p r i v a t e g r o u p s h a v e
a n i n c e n t i v e t o m o n i t o r a t h r i f t ' s risk b e h a v i o r :
t h e i n s t i t u t i o n ' s c r e d i t o r s , its o w n e r s a n d its
managers. In m u t u a l o r g a n i z a t i o n s o w n e r s h i p is
t o o diffuse t o exercise effective control, a n d t h e
o w n e r s h a v e n o i n c e n t i v e t o m o n i t o r t h e organization's risk p o s i t i o n b e c a u s e t h e y w i l l n o t necessarily lose a n y t h i n g if it fails. 2 1 Also, s t o c k organiz a t i o n s can o f f e r t h e i r m a n a g e r s s t o c k o p t i o n s ,
w h i c h m a y r e d u c e t h e i n c e n t i v e f o r t a k i n g risks
because these options ultimately d e p e n d on the
S&L's l o n g - r u n value. T h e FHLBB c o n c l u d e s b y
a r g u i n g t h a t S&Ls w i l l b e s u b j e c t t o greater
m a r k e t d i s c i p l i n e if t h e y a r e c o n v e r t e d f r o m
m u t u a l t o stock organizations.

t h e g e n e r a l p u b l i c has n o n e e d t o e x a m i n e a
bank's f i n a n c i a l c o n d i t i o n . It says s o m e supp o s e d l y s o p h i s t i c a t e d users, like smaller corporations a n d g o v e r n m e n t a l units, d o n o t use
c u r r e n t l y a v a i l a b l e data. T h e F D I C b e l i e v e s t h a t
a n y d i s c l o s u r e s h o u l d b e g e a r e d t o t h e n e e d s of
t h o s e w h o w i l l use t h e i n f o r m a t i o n . A d d r e s s i n g
c o n c e r n s t h a t f i n a n c i a l d i s c l o s u r e m i g h t cause
t h e p u b l i c t o o v e r r e a c t a n d trigger b a n k panics,
t h e F D I C asserts t h a t d i s c l o s u r e is b e t t e r f o r w e l l
r u n b a n k s t h a n an e n v i r o n m e n t o f r u m o r s a n d
half-truths.
T h e F D I C p r e s e n t s results o f d i s c u s s i o n s w i t h
s o p h i s t i c a t e d b a n k c u s t o m e r s w h o are using
c u r r e n t l y a v a i l a b l e data. T h e s e c u s t o m e r s suggested t h a t banks s h o u l d disclose m o r e consistent

"The FDIC, F H L B B and NCUA
support measures to increase the
risk borne by depositors."

Assuring a d e q u a t e financial disclosure t o the
p u b l i c is essential in g e n e r a t i n g m o r e p r i v a t e
sector discipline over insured institutions. All
t h r e e agencies a c k n o w l e d g e t h e i m p o r t a n c e of
financial disclosure, b u t t h e y s e e m generally
satisfied w i t h t h e c u r r e n t s y s t e m o f d i s c l o s u r e .
Furthermore, the FDIC and N C U A believe the
primary responsibility for a d e q u a t e disclosure
rests w i t h i n d i v i d u a l i n s t i t u t i o n s . ( F o r a f u r t h e r
d i s c u s s i o n of d i s c l o s u r e issues, see t h e s p e c i a l
issue o n c o m m e r c i a l b a n k s u r v e i l l a n c e , t h i s
Review, N o v e m b e r 1 9 8 3 . )

d a t a o n loan q u a l i t y a n d c o m p l a i n e d a b o u t t h e
length of t i m e b e t w e e n the e n d of the reporting
p e r i o d a n d t h e t i m e t h e b a n k ' s r e p o r t s are
disclosed to the public.
The FDIC believes that the reports of examin a t i o n o f b a n k s c o n d u c t e d b y b a n k supervisors
s h o u l d r e m a i n c o n f i d e n t i a l , b u t t h a t t h e results
o f a d m i n i s t r a t i v e a c t i o n s t a k e n s h o u l d b e disc l o s e d in t h e Federal Register. It n o t e s that, w h i l e
a d e q u a t e d i s c l o s u r e t o t h e p u b l i c is desirable,
t h e F D I C a n d its sister b a n k r e g u l a t o r y agencies
lack t h e a u t h o r i t y t o m a n d a t e s u c h disclosure. 2 2
F u r t h e r m o r e , t h e F D I C says it w i l l n o t s e e k such
p o w e r because it believes that p r o v i d i n g a d e q u a t e
d i s c l o s u r e is t h e b a n k s ' r e s p o n s i b i l i t y .

T h e F D I C says t h a t financial disclosure e n h a n c e s
market discipline and helps protect depositors
a n d o t h e r c u s t o m e r s f r o m b a n k failure. T h e F D I C
t h e n n o t e s t h a t r e p o r t i n g i n f o r m a t i o n can be a
c o s t l y b u r d e n t o a b a n k , p a r t i c u l a r l y if it is
r e q u i r e d t o d i s c l o s e i n f o r m a t i o n it w o u l d n o t
o t h e r w i s e g a t h e r f o r m a n a g e m e n t ' s use. T h e
FDIC notes that w i t h $ 1 0 0 , 0 0 0 insurance coverage,

T h e FHLBB's d i s c u s s i o n o f d i s c l o s u r e argues
that insured depositors d o not need to k n o w a
bank's financial c o n d i t i o n because they will not
use t h e i n f o r m a t i o n . T h e r e p o r t also n o t e s t h a t
"uninsured" depositors will not examine the
f i n a n c i a l c o n d i t i o n o f a n i n s u r e d i n s t i t u t i o n if
t h e y believe t h e y are receiving d e facto insurance.
T h e r e p o r t a c k n o w l e d g e s that financial disclosure

Financial Disclosure

20

The reference to proposals considered above is an apparent reference to
the modified payout a n d coinsurance proposals previously discussed in
this paper.
21
The o w n e r s of mutual organizations are their d e p o s i t o r s

52




" T h e other agencies are the Office of the Comptroller of the Currency and
the Federal Reserve System. The three agencies do have the power t o
gather information n e e d e d for their supervisory functions and any effect
they have on bank disclosure is a result of this power.

JANUARY 1984, E C O N O M I C

REVIEW

1

1

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1

1

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[

I
5

s
s

can w e a k e n s o m e marginal institutions b y causing
t h e p u b l i c t o w i t h d r a w d e p o s i t s . Y e t it argues
that d i s c l o s u r e t o t h e u n i n s u r e d w i l l s t r e n g t h e n
t h e e n t i r e s y s t e m b y d i s c o u r a g i n g e x c e s s i v e risk
taking. T h e r e p o r t says t h a t d i s c l o s u r e t o an
i n s t i t u t i o n ' s s h a r e h o l d e r s can result in greater
m a r k e t d i s c i p l i n e if t h e s h a r e h o l d e r s are risk
averse, b u t n o t e s t h a t s u c h d i s c i p l i n e c a n n o t
exist at m u t u a l o r g a n i z a t i o n s . T h e FHLBB says
that, in general, a n y i n f o r m a t i o n n e e d e d t o s e e k
risk-based i n s u r a n c e p r e m i u m s s h o u l d b e disclosed t o t h e p u b l i c . It is r e l u c t a n t t o d i s c l o s e
results of g o v e r n m e n t e x a m i n a t i o n s a n d a d m i n i strative a c t i o n s b e c a u s e it b e l i e v e s t h e m a r k e t
s h o u l d f o r m its o w n o p i n i o n o f an i n s t i t u t i o n ' s
health, a n d fears disclosure of g o v e r n m e n t o p i n i o n s
m i g h t have an u n d u e e f f e c t
The N C U A notes t h a t federally-chartered credit
unions m u s t d i s c l o s e a b a l a n c e sheet, a year-todate i n c o m e a n d e x p e n s e s t a t e m e n t a n d a
summary of d e l i n q u e n t loan a m o u n t s o n a m o n t h l y
basis, w h i l e o t h e r insured institutions n e e d report
only o n a q u a r t e r l y o r s e m i - a n n u a l basis. T h e
r e p o r t also notes t h a t c r e d i t u n i o n m e m b e r s serve
on b o a r d s o f d i r e c t o r s a n d o t h e r c o m m i t t e e s .
The N C U A b e l i e v e s t h e p r i m a r y r e s p o n s i b i l i t y
for a d e q u a t e d i s c l o s u r e m u s t rest w i t h i n d i v i d u a l
credit unions a n d their m e m b e r s . T h e o n l y change
c o n t e m p l a t e d b y t h e N C U A is t h e d e v e l o p m e n t
of a p e e r r a t i n g s y s t e m t h a t w i l l a l l o w i n d i v i d u a l
c r e d i t u n i o n s t o see h o w t h e y stack u p against
others.

Adequacy of the Insurance Funds
s

i
5
a
1

t
f
-

Along w i t h considering h o w to control bank
risk e x p o s u r e , t h e r e p o r t s also d e a l w i t h a c o u p l e
of a d m i n i s t r a t i v e issues: t h e a d e q u a c y o f indiv i d u a l i n s u r a n c e funds, a n d c o n s o l i d a t i o n of t h e
d i f f e r e n t agencies t h a t insure a n d regulate insured
financial i n s t i t u t i o n s . T h e c o n g r e s s i o n a l d i r e c t i v e
asked t h e i n s u r i n g a g e n c i e s o n l y t o r e v i e w t h e
risks t o t h e m of an increase in d e p o s i t i n s u r a n c e ,
but all t h r e e agencies also a n a l y z e d t h e a d e q u a c y
of t h e i r f u n d s g i v e n t h e i r e x i s t i n g e x p o s u r e ,
T h e F D I C b e l i e v e s its f u n d is a d e q u a t e . T h e
FHLBB d o e s n o t e x p r e s s an o p i n i o n o n its f u n d ' s
a d e q u a c y , b u t it d o e s discuss several w a y s o f
eliminating any " p e r c e i v e d inadequacy." The
N C U A b e l i e v e s its f u n d s h o u l d b e e x p a n d e d ,
a n d it p r o p o s e s a s p e c i f i c p l a n f o r d o i n g so.
T h e r e is n o s c i e n t i f i c basis for e s t a b l i s h i n g an
a p p r o p r i a t e f u n d size a c c o r d i n g t o t h e F D I C T h e

ratio of t h e f u n d t o i n s u r e d d e p o s i t s u n d e r s t a t e s
the fund's adequacy because the FDIC typically
arranges f o r a h e a l t h y b a n k t o a c q u i r e t h e deposits of its f a i l e d banks. In a n o t h e r sense,
h o w e v e r , i n s u r e d d e p o s i t s are an i n c o m p l e t e
measure of t h e f u n d s receiving d e facto insurance
since m o s t failures are h a n d l e d t h r o u g h purchase
a n d a s s u m p t i o n . Thus, a n increase in t h e d e j u r e
coverage may not affect t h e fund's adequacy.
T h e F D I C also n o t e s t h a t it can l i m i t its losses b y
c l o s i n g a b a n k b e f o r e its e c o n o m i c w o r t h bec o m e s s u b s t a n t i a l l y negative. H i s t o r i c a l l y , t h e
F D I C has e x p e r i e n c e d losses e q u a l t o 4 p e r c e n t
of failed banks' assets (9 p e r c e n t after consideration
of f o r e g o n e interest) b u t it e x p e c t s f u t u r e losses
t o run 9 t o 10 p e r c e n t o f s u c h assets. T h e F D I C
r e b a t e s o v e r 50 p e r c e n t o f its n e t a s s e s s m e n t
i n c o m e b e f o r e t h e c r e d i t so t h a t , s h o u l d econ o m i c t i m e s c h a n g e , t h e F D I C c o u l d increase its
resources w i t h o u t d i p p i n g i n t o t h e f u n d .
T h e f u n d ' s l i q u i d i t y is also i m p o r t a n t T h e F D I C
m i n i m i z e s its i n i t i a l cash f l o w t h r o u g h t h e use o f
p u r c h a s e a n d a s s u m p t i o n h a n d l i n g of f a i l e d
b a n k s a n d t h r o u g h p r o m i s e s of f u t u r e cash
o u t l a y s t o t h e p u r c h a s e r s o f f a i l e d banks. It also
has r e l i e d o n t h e d i s c o u n t w i n d o w at Federal
R e s e r v e Banks f o r l i q u i d i t y p r i o r t o f a i l u r e ,
e s p e c i a l l y in t h e Franklin N a t i o n a l case.
M o s t of t h e F D I C ' s r e c o m m e n d e d c h a n g e s in
t h i s area are t e c h n i c a l c h a n g e s in t h e base u s e d
for calculating d e p o s i t insurance premiums. O n e
m a j o r c h a n g e s u g g e s t e d is t h a t t h e F D I C ' s a b i l i t y
t o b o r r o w in an e m e r g e n c y f r o m t h e Treasury b e
raised f r o m t h e c u r r e n t $3 b i l l i o n t o w h a t e v e r
a m o u n t t h e FDIC chairman a n d t h e Secretary of
t h e T r e a s u r y agree u p o n . T h e o t h e r s i g n i f i c a n t
r e c o m m e n d a t i o n is t h a t t h e i n s u r a n c e o f f o r e i g n
banks' U.S. b r a n c h e s b e r e c o n s i d e r e d . T h e F D I C
is n o t in a p o s i t i o n t o assess t h e o v e r a l l c o n d i t i o n
of t h e s e b a n k i n g o r g a n i z a t i o n s a n d d o u b t s t h a t it
c o u l d p r e v e n t t h e r e m o v a l of assets f r o m t h e s e
b r a n c h e s in t i m e s of p o l i t i c a l d i f f i c u l t y . Furtherm o r e , t h e F D I C says its r e c o m m e n d a t i o n s f o r
v a r i a b l e rate d e p o s i t i n s u r a n c e a n d its a t t e m p t s
to obtain adequate disclosure should be applied
t o t h e entire b a n k i n g organization t o b e effective.
T h e FH LBB n o t e s t h a t e v e n t h o u g h t h e cost of
assistance g r e w d r a m a t i c a l l y in 1 9 8 1 a n d 1 9 8 2 ,
t h e FSLIC f u n d i n c r e a s e d in size. T h e FH LBB runs
t w o s i m u l a t i o n s t o e x a m i n e t h e a d e q u a c y o f its
f u n d for 1 9 8 3 a n d 1 9 8 4 . T h e u n f a v o r a b l e scenario
assumes t h e Treasury bills y i e l d e d 13.5 p e r c e n t
a n d t h a t t h e p r i m e rate is 1 7 . 2 5 p e r c e n t d u r i n g
1983 and 1984. Given these assumptions, 1,290
53

FEDERAL RESERVE B A N K O F A T L A N T A




savings a n d loans w i t h assets o f a p p r o x i m a t e l y
$ 2 8 4 b i l l i o n w o u l d fail. T h e FHLBB n o t e s t h a t its
f u n d is i n a d e q u a t e t o h a n d l e this e v e n if t h e
FSLIC's losses w e r e a s m a l l f r a c t i o n o f t h e assets
o f t h e f a i l e d banks. T h e o t h e r s c e n a r i o f o l l o w s
O f f i c e of M a n a g e m e n t a n d Budget ( O M B ) f o r e
casts o f 9 p e r c e n t Treasury b i l l rates a n d a p r i m e
rate o f 1 1 . 7 5 p e r c e n t . U n d e r this s c e n a r i o t h e
savings a n d loan i n d u s t r y as a w h o l e w o u l d
r e t u r n t o p r o f i t a b i l i t y in t h e s e c o n d q u a r t e r o f
1 9 8 3 , a n d f e w e r t h a n 2 0 0 S&Ls, w i t h assets o f
less t h a n $ 4 0 b i l l i o n , w o u l d fail. T h e FHLBB says
it has t h e resources t o h a n d l e e x p e c t e d failures
under the O M B assumptions.23
T h e FHLBB n o t e s t h a t FSLIC losses can b e
m i n i m i z e d if an i n s t i t u t i o n is c l o s e d w h e n its
e c o n o m i c n e t w o r t h r e a c h e s zero. H o w e v e r , t h e
current accounting system does n o t p r o v i d e an
e s t i m a t e of t h e i n s t i t u t i o n ' s n e t w o r t h , o n l y a n
e s t i m a t e o f its h i s t o r i c value. W h i l e t h e FHLBB
w o u l d like current value accounting data t o help
it d e t e r m i n e w h e n t o c l o s e a n i n s t i t u t i o n , it d o e s
n o t necessarily b e l i e v e t h a t i n s t i t u t i o n s s h o u l d
automatically be closed w h e n their net w o r t h
falls t o zero. T h e r e p o r t argues t h a t " m a n y S&Ls
w i t h n e g a t i v e n e t w o r t h can b e e x p e c t e d t o b e
p r o f i t a b l e in t h e f u t u r e , o n t h e basis o f y i e l d s a n d
costs c u r r e n t l y p r e v a i l i n g in t h e m a r k e t , g i v e n
t h e i r existing location, organization a n d managem e n t " 2 4 It n o t e s t h a t if e v e r y S&L w i t h n e g a t i v e
w o r t h w e r e c l o s e d t h e n " n e a r l y all" w o u l d h a v e
b e e n c l o s e d in t h e last f e w years.
T h e FHLBB r e p o r t p r e s e n t s n i n e d i f f e r e n t
w a y s a n y " p e r c e i v e d i n a d e q u a c y " in t h e f u n d
c o u l d b e e l i m i n a t e d , a n d f o c u s e s o n t h e disadvantages o f t w o r e f o r m s : i n c r e a s e d r e g u l a t i o n
a n d d e c r e a s e d FSLIC coverage. T h e r e p o r t also
says t h a t w h i l e t h e FSLIC c o u l d b e m a d e m o r e
a d e q u a t e if t h e f u n d u s e d f u t u r e s t o h e d g e
i n t e r e s t rate changes, i n d i v i d u a l S&Ls are in a
b e t t e r p o s i t i o n t o h e d g e . T h e a g e n c y lists f i v e
o t h e r reforms, several of w h i c h are r e c o m m e n d e d

" T h e O M B projections have been reasonably accurate to date. Both the
Treasury Bill a n d prime rates are slightly below O M B projections in
November 1983.
24

The report does not say whether it is referring to S&Ls with negative book
net worth or negative e c o n o m i c net worth. If the report is referring to
S&Ls with negative book value then the F H L B B may have a good point.
Savings and loans that have a negative book value but that will earn
profits based on existing market conditions probably have positive economic
net worth. An S&L with positive economic net worth should not be closed.
If the report is referring t o S&Ls with negative economic net worth then
the F H L B B argument is weak. Failing to close these savings a n d loans in
effect allows them to g a m b l e on recovery with government money. If the
S&L d o e s not b e c o m e profitable, t h e n the government absorbs all of the
economic losses

54




e l s e w h e r e in its r e p o r t . T h e f i v e m e a s u r e s are:
i n c r e a s e d c a p i t a l a d e q u a c y f o r savings a n d loans,
i m p r o v e d i n f o r m a t i o n o n S&Ls' e c o n o m i c v a l u e ,
g r e a t e r f l e x i b i l i t y in t h e p r o c e d u r e s f o r h a n d l i n g
f a i l e d i n s t i t u t i o n s , risk-sensitive p r e m i u m s , a n d
i n c r e a s e d p r e m i u m levels. T h e n i n t h p r o p o s a l ,
t h a t t h e f u n d r e d u c e t h e m a t u r i t y o f its assets,
has a l r e a d y b e e n i m p l e m e n t e d a n d t h e r e p o r t
suggests t h a t t h e f u n d c o n t i n u e t h a t r e d u c t i o n .
T h e N C U A n o t e s that, w h i l e t h e F D I C a n d
FSLIC r e c e i v e d an initial c a p i t a l c o n t r i b u t i o n
f r o m t h e f e d e r a l g o v e r n m e n t , t h e N C U A was
f o r m e d w i t h n o initial capital. W h e n t h e N C U A
was f o r m e d , it w a s h o p e d t h a t l o w losses a n d t h e
f u n d ' s i n c o m e w o u l d e x p a n d it t o o n e p e r c e n t of
credit u n i o n shares. This, in f a c t has n o t h a p p e n e d
a n d t h e f u n d has d e c r e a s e d in e a c h o f t h e last
t h r e e years. T h e N C U A r e c o m m e n d s t h a t " i n
c o n s u l a t i o n w i t h t h e i n d u s t r y , c r e d i t u n i o n s be
given the chance to capitalize their f u n d w i t h a
o n e t i m e a s s e s s m e n t o f i n s u r e d shares o f o n e
percent"

Agency Consolidation
T h e t h r e e a g e n c i e s all a s s u m e t h a t a n y c o n s o l i d a t i o n w o u l d leave t h e F D I C as t h e s u r v i v i n g
agency. N o t t o o surprisingly, t h e F D I C likes this
idea, w h i l e t h e FSLIC a n d N C U A are less e n t h u siastic.
T h e F D I C suggests t h a t t h e FSLIC b e m e r g e d
i n t o t h e F D I C b u t t h a t t h e N C U A a n d its f u n d b e
left as is, " a t least at this t i m e . " T h e F D I C argues
t h a t b o t h i n s u r a n c e f u n d s o p e r a t e in a similar
m a n n e r , h a v e similar d u t i e s , a n d h a v e " d i r e c t
examination a n d supervisory authority o r a close
a n d c o n t i n u o u s l i n k t o t h o s e agencies w i t h
primary supervisory responsibility." The report
argues t h a t r e m o v i n g c e r t a i n d i f f e r e n c e s in t h e
w a y t h e f u n d s levy i n s u r a n c e p r e m i u m s w o u l d
b e an a d v a n t a g e of m e r g i n g t h e f u n d s . A c c o r d i n g
t o t h e FDIC, t h e b a n k i n g i n d u s t r y a n d S&L
i n d u s t r y are b e c o m i n g m o r e a n d m o r e alike, a n d
m e r g i n g t h e f u n d s w o u l d c r e a t e a less c o n f u s i n g
f r a m e w o r k for t h e p u b l i c . It says t h a t d e p o s i t
i n s u r a n c e r e f o r m s , s u c h as greater risk s h a r i n g b y
large d e p o s i t o r s , s h o u l d b e i m p l e m e n t e d f o r
b o t h types of institutions. A n o t h e r advantage
c l a i m e d f o r m e r g i n g t h e f u n d s is t h a t b o t h w i l l b e
strengthened through the diversification of their
risks. T h e F D I C n o t e s t h a t m o s t S&L p r o b l e m s a r e
a t t r i b u t a b l e t o c h a n g e s in i n t e r e s t rates, n o t t o
s i g n i f i c a n t loan losses. Banks, o n t h e o t h e r h a n d ,

J A N U A R Y 1984, E C O N O M I C

REVIEW

have s i g n i f i c a n t l o a n losses b u t r e l a t i v e l y little
e x p o s u r e t o i n t e r e s t rate risk. 2 5 A c c o r d i n g t o t h e
agency, t h e c o m b i n e d f u n d w o u l d b e larger a n d
less l i k e l y t o call f o r d i r e c t g o v e r n m e n t s u b s i d i zation. It also n o t e s t h a t C i t i c o r p has a c q u i r e d
Fidelity Federal Savings a n d Loan of San Francisco
and t h a t t h e c u r r e n t " f r a c t i o n a l i z e d " s u p e r v i s o r y
system is inefficient for d e a l i n g w i t h organizations
t h a t i n c l u d e b o t h b a n k s a n d thrifts.
T h e F D I C r e v i e w s several a r g u m e n t s against
m e r g i n g t h e f u n d s b u t c o n c l u d e s t h a t n o n e of
t h e m is valid. 2 6 O n e a r g u m e n t against c o m b i n i n g
t h e f u n d s is t h a t it w o u l d c o n f l i c t w i t h o t h e r
p u b l i c policies. T h e F D I C c o u n t e r s t h a t t h e o n l y
o b j e c t i v e of an i n s u r i n g a g e n c y s h o u l d b e a
stable f i n a n c i a l system, a n d t h a t o t h e r g o v e r n mental entities can be created t o p r o m o t e specific
causes. T h e F D I C d e n i e s t h a t m e r g i n g t h e f u n d s
w o u l d result in a loss o f i n d u s t r y o r i e n t a t i o n b y
arguing t h a t t h e i n d u s t r i e s are r a p i d l y b e c o m i n g
m o r e alike. It also n o t e s t h e a r g u m e n t t h a t
c o m b i n i n g t h e f u n d s w o u l d b e u n f a i r t o banks,
w h o w o u l d in e f f e c t b e a s k e d t o s u b s i d i z e S&Ls.
According t o t h e agency, t h e merger c o u l d be
p h a s e d in t o c o i n c i d e w i t h t h e d e v e l o p m e n t o f a
risk-related p r e m i u m i n s u r a n c e s c h e m e in w h i c h
strong institutions w o u l d n o t b e asked t o subsidize
w e a k i n s t i t u t i o n s . 2 7 T h e last a r g u m e n t t h e F D I C
d i s p u t e s is t h a t t h e m e r g e r c o u l d w e a k e n p u b l i c
c o n f i d e n c e in t h e d e p o s i t i n s u r a n c e system,
countering that such a merger w o u l d strengthen
d e p o s i t i n s u r a n c e a n d result in a less c o n f u s i n g
and d i s r u p t i v e i n s u r a n c e system.
T h e F D I C argues f o r r e f o r m of t h e b a n k supervisory f r a m e w o r k a n d says it is t h e a g e n c y t h a t
s h o u l d survive a n y a g e n c y c o n s o l i d a t i o n . A m o n g
t h e F D I C ' s a r g u m e n t s are t h a t it is t h e largest a n d
strongest f u n d , a n d t h a t it a l r e a d y insures m o s t of
the institutions and deposits that w o u l d be
i n s u r e d a f t e r a merger. U n d e r t h e c u r r e n t supervisory f r a m e w o r k , t h e states a n d t h e O f f i c e o f t h e
C o m p t r o l l e r of t h e C u r r e n c y ( O C C ) charter banks,
w h i l e t h e states, t h e F D I C , t h e O C C a n d t h e
Federal Reserve System all e x a m i n e a n d supervise
banks. T h e F D I C w o u l d like t o a l l o w t h e states

a n d a n e w federal a g e n c y t o charter a n d supervise
b a n k s a n d thrifts, w h i l e t h e F D I C t o o k o v e r all
federal responsibility for examinations a n d for
h a n d l i n g p r o b l e m situations. T h e F D I C p r o p o s a l
w o u l d r e m o v e t h e Federal Reserve S y s t e m f r o m
b a n k supervision a n d regulation, b u t w o u l d a l l o w
o n e m e m b e r of the FDIC b o a r d t o c o m e f r o m
t h e B o a r d o f G o v e r n o r s o f t h e Federal Reserve
System. The FDIC notes that t h e Board of Governors
believes t h a t t h e System n e e d s s o m e supervisory
p o w e r o v e r large b a n k s a n d b a n k h o l d i n g c o m panies t o c o n d u c t a n e f f e c t i v e m o n e t a r y p o l i c y .
T h e F D I C r e s p o n d s t h a t this a r g u m e n t is n o t
persuasive a n d that s o m e observers believe
t h e r e is a serious p o t e n t i a l f o r c o n f l i c t b e t w e e n
bank supervision a n d the c o n d u c t of m o n e t a r y
policy.28
The FHLBB addresses t h e issue of c o n s o l i d a t i n g ,
t h e f u n d s at several p o i n t s in its r e p o r t a n d t h e
t o n e o f its r e c o m m e n d a t i o n s is slightly d i f f e r e n t

"The three agencies all assume
that any consolidation would leave
the FDIC as the surviving agency.
Not too surprisingly, the FDIC likes
this idea, while the FSLIC and
NCUA are less enthusiastic."
in e a c h s e c t i o n . 2 9 In t h e s e c t i o n e n t i t l e d " B a n k
B o a r d A g e n d a f o r R e f o r m : R e c o m m e n d a t i o n s of
t h e Federal H o m e Loan Bank B o a r d " t h e FHLBB
a p p e a r s t o b e r e j e c t i n g a m e r g e r of t h e i n s u r a n c e
funds. T h e report argues that t h e greatest regulatory
costs a r e t h o s e t h a t s t e m f r o m i n e f f i c i e n c i e s it
causes in t h e m a r k e t place a n d t h a t a d m i n i s t r a t i v e
costs arising f r o m r e g u l a t o r y d u p l i c a t i o n are
small. The FHLBB believes t h a t its current structure,
w h i c h c o m b i n e s m a n y o f t h e f u n c t i o n s t h a t are
in t h e t h r e e d i f f e r e n t b a n k r e g u l a t o r y agencies, is
" h i g h l y effective" for addressing the broad implications of regulatory action a n d for i m p l e m e n t i n g
regulatory reform.
T h e discussion, e n t i t l e d " F r a m i n g t h e Issues"
e x p a n d s o n t h e advantages of having o n e agency,

25

The FDIC d o e s not discuss the covariance b e t w e e n these two risks.
" T h e report does not cite any of the sources for these arguments against
merging the f u n d s
" T h i s argument may be valid under s o m e risk-related premium plans, but
not under the plan s u g g e s t e d by the FDIC. The FDIC's plan is based on
the return on assessment income in excess of e x p e n s e a If the FDIC has
higher expenses as a result of thrift losses, then the size of the
assessment credit w o u l d be c u t which will reduce the credit received by
strong institutions

FEDERAL RESERVE B A N K O F A T L A N T A




J8

The FDIC does not cite any specific arguments on this issue nor d o e s it
cite the sources that convinced the FDIC that the Federal Reserve does
not need supervisory powers to effectively conduct monetary policy.
29
The FHLBB report was written while Mr. Richard T. Pratt was itsChairman.
Mr. Edwin J. Gray has subsequently b e c o m e Chairman and he is
unambiguously opposed to consolidating the insurance funds. See
'Keep Agencies Separate—Gray 1 in the N a t i o n a l T h r i f t N e w s (5).

55

s u c h as t h e FHLBB, p e r f o r m t h e r e g u l a t i o n ,
e x a m i n a t i o n , supervision, insurance a n d provision
o f l i q u i d i t y f u n c t i o n s f o r its m e m b e r i n s t i t u t i o n s .
T h e Bank B o a r d also n o t e d t h a t s u b s t a n t i a l
d i f f e r e n c e s w i l l c o n t i n u e t o exist f o r m a n y years
b e t w e e n S&Ls, b a n k s a n d c r e d i t u n i o n s . T h u s a n y
f u n d m e r g e r s w o u l d r e m o v e little d u p l i c a t i o n
b e t w e e n t h e a g e n c i e s ( a n d w o u l d save little
m o n e y ) . This s e c t i o n c o n c l u d e s t h a t a n y c o n s o l i d a t i o n " s h o u l d n o t b e i n i t i a t e d w i t h o u t first
r a t i o n a l i z i n g t h e f u n c t i o n s o f t h e f i n a n c i a l regulators."30
In S e c t i o n V I , " R e t h i n k i n g R e g u l a t o r y Struct u r e , " t h e a g e n c y discusses a r g u m e n t s against
c o n s o l i d a t i n g t h e F D I C a n d FSLIC, b u t it also
c o n t a i n s s o m e analysis t h a t s e e m s t o f a v o r c o n s o l i d a t i o n . T h e FHLBB n o t e s t h a t c o n f l i c t s can
arise b e t w e e n f o s t e r i n g c o m p e t i t i o n a n d p r o m o t i n g soundness for financial institutions. T h e
r e p o r t takes t h e p o s i t i o n t h a t it is easier f o r o n e
agency t o achieve the public's desired tradeoff
t h a n it is f o r t w o a g e n c i e s w i t h c o n f l i c t i n g goals.
This s e c t i o n of t h e r e p o r t also m i n i m i z e s t h e
potential for agency consolidation to reduce
a d m i n i s t r a t i v e costs o f d e p o s i t insurance.
S e c t i o n V I m a k e s several a r g u m e n t s t h a t s e e m
t o favor consolidation. O n e concerns t h e potential
p r o b l e m s o f c o m p e t i n g r e g u l a t o r y agencies. T h e
FH LBB p o i n t s o u t t h a t s o m e f a v o r " c o m p e t i t i o n "
b e t w e e n - t h e regulators, w h i l e o t h e r s c o n d e m n
this as " c o m p e t i t i o n in laxity." It c o n c l u d e s t h a t
having d i f f e r e n t agencies regulate t h e same types
of f i n a n c i a l i n s t i t u t i o n s results in u n d e s i r a b l e
" a m b i g u i t y in t h e e x e c u t i o n of g o v e r n m e n t policy."
T h e FHLBB also n o t e s t h a t c o n s o l i d a t i o n o f t h e
i n s u r i n g agencies w i l l b e c o m e i n c r e a s i n g l y desirable as b a n k s a n d t h r i f t s c o m e t o b e o w n e d b y
one parent company. A third argument that
a p p e a r s t o f a v o r c o n s o l i d a t i o n is t h a t t h e issues
of a g e n c y c o n s o l i d a t i o n h a v e b e e n e x t e n s i v e l y
d e b a t e d a n d are r i p e f o r i m m e d i a t e a c t i o n .
S e c t i o n V I d e v o t e s a l m o s t 2 0 pages t o d i s c u s s i n g
t h e r e p o r t s of n u m e r o u s r e f o r m g r o u p s t h a t h a v e
a n a l y z e d t h e f i n a n c i a l r e g u l a t o r y s t r u c t u r e ext e n s i v e l y . It c o n c l u d e s t h a t a d e c i s i o n o n reorganizing the system " m u s t " be m a d e n o w o n
t h e basis o f a v a i l a b l e e v i d e n c e . It t h e n goes o n t o
argue t h a t w e a k n e s s e s in t h e e x i s t i n g r e g u l a t o r y
s c h e m e w i l l increase a n d its a d v a n t a g e s w i l l f a d e
in i m p o r t a n c e as d e r e g u l a t i o n continues. 3 1 G i v e n

30

Page 4 8 of the F H L B B report.

56




t h i s last a r g u m e n t o n e m i g h t e x p e c t t h e r e p o r t t o
c o n c l u d e t h a t t h e b a n k r e g u l a t o r y agencies a n d
t h e FSLIC s h o u l d b e m e r g e d p r o m p t l y . Instead,
it argues t h a t t h e f i n a n c i a l regulators' f u n c t i o n s
should be rationalized before t h e insurance
f u n d s are c o n s o l i d a t e d . T h e r e p o r t t h e n says t h a t
a n y r e o r g a n i z a t i o n n e e d n o t b e " r a d i c a l or imm e d i a t e " b e c a u s e " t r a n s i t i o n issues l o o m large."
T h e N C U A flatly rejects a merger of t h e insuring
f u n d s . T h e a g e n c y argues t h a t s u c h a m e r g e r
w o u l d " c r e a t e a concentration of e n o r m o u s
e c o n o m i c consequence and political p o w e r "
a n d w o u l d force " h o m o g e n i z a t i o n " of t h e insured
i n s t i t u t i o n s . T h e N C U A argues t h a t s u b s t a n t i a l
d i f f e r e n c e s b e t w e e n banks, t h r i f t s a n d c r e d i t
u n i o n s j u s t i f y d i f f e r e n t insurers. F u r t h e r m o r e ,
the N C U A believes that deregulation will reward
d i f f e r e n c e s in i n s t i t u t i o n s a n d n o t u n i f o r m i t y .
A c c o r d i n g t o t h e agency, c r e d i t u n i o n s pay for
t h e c o s t of t h e i n s u r a n c e f u n d a n d t h e r e f o r e
s h o u l d b e e n t i t l e d t o w e i g h a n y cost savings
against t h e d i s a d v a n t a g e s o f m e r g i n g t h e funds.
A poll of federal credit unions f o u n d that 69
percent of the credit unions d o not support
c o n s o l i d a t i o n o f t h e i n s u r a n c e funds. T h e N C U A
also c l a i m s t h a t c r e d i t u n i o n s ' u n i q u e n e e d s
w o u l d get lost in an a g e n c y g e a r e d t o serve
p r i m a r i l y b a n k s a n d thrifts.

Summary
Congress r e c o g n i z e d t h a t e v e n t h o u g h d e p o s i t
i n s u r a n c e has p r o v i d e d s o m e v a l u a b l e b e n e f i t s
t o t h e U n i t e d States, t h e role of d e p o s i t insurance
in a d e r e g u l a t e d f i n a n c i a l s y s t e m s h o u l d be
r e v i e w e d . T h e Garn-St G e r m a i n A c t a s k e d t h e
FDIC, FHLBB, a n d t h e N C U A t o r e v i e w d e p o s i t
insurance and report back w i t h their recommendations. All three g o v e r n m e n t deposit insurance
a g e n c i e s b e l i e v e t h a t d e p o s i t i n s u r a n c e still perf o r m s a v a l u a b l e f u n c t i o n , b u t e a c h argues t h a t
s o m e r e f o r m s in d e p o s i t i n s u r a n c e are d e s i r a b l e .
T h e F D I C favors several d i f f e r e n t reforms. It
supports variable rate d e p o s i t insurance p r o v i d e d
b y t h e g o v e r n m e n t t o i n t r o d u c e e q u i t y across
banks t o t h e d e p o s i t insurance p r e m i u m schedule,
b u t it d o e s n o t e x p e c t its p r o p o s a l t o a f f e c t b a n k
risk e x p o s u r e significantly. T h e F D I C also favors a
r e d u c t i o n in t h e d e f a c t o d e p o s i t i n s u r a n c e g i v e n
large d e p o s i t o r s t o i n c r e a s e d t h e i r i n c e n t i v e s t o

31

Page 3 4 1 of the report.

J A N U A R Y 1984, E C O N O M I C R E V I E W

F|

m o n i t o r insured institutions' risks. The FDIC w o u l d
like t o d i s c l o s e s u p e r v i s o r y actions taken against
i n d i v i d u a l banks. T h e a g e n c y also b e l i e v e s it
s h o u l d have f u l l r e s p o n s i b i l i t y f o r e x a m i n i n g a n d
insuring all b a n k s a n d thrifts.
T h e FHLBB s u p p o r t s v a r i a b l e rate d e p o s i t
i n s u r a n c e a n d t h e use o f p r i v a t e i n s u r a n c e t o
e n c o u r a g e t h r i f t s t o r e d u c e risk e x p o s u r e . It also
believes t h r i f t s s h o u l d h a v e m o r e c a p i t a l a n d
that t h e i r o w n e r s a n d d i r e c t o r s s h o u l d t a k e a
m o r e a c t i v e role in c o n t r o l l i n g t h e i r i n s t i t u t i o n ' s
risk e x p o s u r e . T h e FHLBB favors r a t i o n a l i z i n g t h e
bank r e g u l a t o r y a g e n c i e s b e f o r e t h e i n s u r a n c e
f u n d s are c o n s o l i d a t e d .

T h e N C U A b e l i e v e s c r e d i t u n i o n s ' risk c o u l d
b e r e d u c e d if t h o s e t h a t a t t r a c t large a c c o u n t s
(over $50,000) w o u l d pay m o r e for their insurance
a n d if t h e first share o f e v e r y m e m b e r w e r e n o t
i n s u r e d . T h e N C U A w o u l d give f e d e r a l c r e d i t
unions the o p t i o n of substituting private for
p u b l i c insurance. It favors a o n e t i m e o n e p e r c e n t
a s s e s s m e n t o f c r e d i t u n i o n shares t o increase
c a p i t a l i z a t i o n of t h e N C U A ' s f u n d . T h e N C U A is
o p p o s e d t o c o n s o l i d a t i n g its i n s u r a n c e f u n d w i t h
t h o s e of t h e o t h e r t w o i n s u r i n g agencies.

— Larry D. W a l l

BIBLIOGRAPHY

1. Cooper, Ian. "Asset Changing Interest Rates a n d Duration," J o u r n a l of
F i n a n c i a l a n d Q u a n t i t a t i v e Analysis, (December 1977) pp. 701-723.
2. D e p o s i t I n s u r a n c e in a C h a n g i n g E n v i r o n m e n t . A study submitted to
Congress by the Federal Deposit Insurance Corporation, Washington,
DC.
3 A g e n d a for Reform: A Report o n Deposit Insurance t o the Congress
f r o m t h e F e d e r a l H o m e L o a n B a n k B o a r d . Washington, D C. (March
1983.

4. C r e d i t U n i o n S h a r e I s s u a n c e : A R e p o r t t o t h e C o n g r e s s . Prepared by
the National Credit Union Administration, Washington, D.C. (April 1983)
1983.
5. " K e e p Agencies S e p a r a t e - G r a y . " N a t i o n a l T h r i f t News, (November
21, 1983) pages 1 a n d 10.

57
FEDERAL RESERVE B A N K O F A T L A N T A




"Financial Crises" and the Role
of the Lender of Last Resort
The w o r l d n o w appears t o be recovering f r o m
o n e o f its m o s t severe recessions in 5 0 years.
Prospects f o r s i g n i f i c a n t a n d s u s t a i n a b l e real
o u t p u t g r o w t h for t h e i n d u s t r i a l i z e d n a t i o n s o f
t h e W e s t have s u b s t a n t i a l l y i m p r o v e d , t h o u g h
r e d u c t i o n s in u n e m p l o y m e n t rates are e x p e c t e d
t o lag b e h i n d t h e increased p r o d u c t i o n .
E c o n o m i c g r o w t h in
t h e industrialized countries is particularly imp o r t a n t t o t h e lessd e v e l o p e d countries.
In s o m e of t h e m , heavy
d e b t b u r d e n s are imp o s i n g severe f i n a n c i a l
pressure. Such g r o w t h
would promote export
earnings
of
lessdeveloped countries
(LDCs) and, conseq u e n t l y , w o r k t o improve
the
incomegenerating
capacity
of
these
countries.
M a n y investments w e r e
undertaken
in
these
countries w i t h t h e belief
that c o n t i n u e d comm o d i t y price inflation
w o u l d generate steadily
rising e x p o r t earnings. D u r i n g t h e r e c e s s i o n in
the industrialized countries, however, s l u m p i n g
c o m m o d i t y prices p r e v e n t e d s o m e LDCs f r o m
generating a n t i c i p a t e d foreign exchange revenue
from exports to cover imports and meet debt
payments. Since m u c h of t h e d e b t carries floating

i n t e r e s t rates, rising real i n t e r e s t rates in t h e
industrialized countries further aggravated the
b a l a n c e of p a y m e n t s p r o b l e m s o f t h e less-develo p e d c o u n t r i e s . C o n s e q u e n t l y , c o m m o d i t y price
stabilization ( w o r l d c o m m o d i t y prices have ceased
t h e i r t w o - y e a r d e s c e n t ) , g r o w t h of real i n c o m e in
t h e industrialized count r i e s a n d l o w e r real
i n t e r e s t rates in t h e industrialized countries
are necessary t o reduce
the swollen currenta c c o u n t deficits of these
less-developed countries. U l t i m a t e l y , o n l y
these circumstances will
e n a b l e t h e less-develo p e d c o u n t r i e s t o better manage their d e b t
burden.
U n t i l these developm e n t s take place, however, t h e i m m e d i a t e
p r o b l e m of h o w t o deal
w i t h t h e existing debt
remains. M e x i c o , Argentina, a n d Brazil have
already rescheduled
s o m e o f t h e i r d e b t repayments, while many
o t h e r c o u n t r i e s are
d o i n g t h e same. 1 W h i l e m o s t analysts agree t h a t
t h e s e c o u n t r i e s ' d e b t p r o b l e m s m a y h a v e an

'Even the East European countries of Poland a n d Romania, w h o s e loans
were a s s u m e d to be g u a r a n t e e d by the Soviet Union, have postponed
s o m e debt repayments.

Stable monetary policies and reliable domestic lenders of last resort provide
considerable protection against liquidity crises. But does the world also need an
international lender of last resort?

58




JANUARY 1984, E C O N O M I C R E V I E W

F|

i m p a c t o n t h e i n d u s t r i a l i z e d nations, o p i n i o n s
vary w i d e l y as t o t h e role o f a l e n d e r o f t h e last
resort in easing t h i s b u r d e n . T h e role of t h e
I n t e r n a t i o n a l M o n e t a r y F u n d ( I M F ) in p a r t i c u l a r
is s c r u t i n i z e d in t h i s light. S o m e analysts c o n sider that e v e n rescheduling efforts m a y b e insufficient t o p r e v e n t massive loan defaults, a n d
therefore t h e y advocate increased financial assistance by t h e IMF.2
W i t h o u t s u c h assistance, s o m e p r o p o n e n t s
argue, an international financial crisis m i g h t ensue.
D e b t - r i d d e n LDCs might b e forced t o default,
sending shock waves t h r o u g h o u t industrialized
c o u n t r i e s as large c o m m e r c i a l b a n k s w r i t e o f f t h e
d e f a u l t e d loans, m a k i n g t h e b a n k s t e c h n i c a l l y
insolvent If their fears w e r e realized, shareholders
and u n i n s u r e d d e p o s i t o r s w o u l d face t h e prospect o f s i z a b l e losses. Because of t h e p o t e n t i a l
threat p o s e d b y t h e c u r r e n t d e b t p r o b l e m s o f
less-developed countries, industrialized nations
are s e e k i n g s o l u t i o n s t o h e l p ease t h e b u r d e n of
indebted countries while keeping their o w n
banks s o l v e n t .
O t h e r analysts, h o w e v e r , d i s p u t e t h i s r a t i o n a l e
for assisting d e b t - r i d d e n c o u n t r i e s . W h i l e t h e y
agree t h a t s o m e c o u n t r i e s m a y d e f a u l t o n t h e i r
o b l i g a t i o n s if f u r t h e r f i n a n c i a l assistance is n o t
f o r t h c o m i n g , t h e y c o n t e n d t h a t t h i s is natural in
free m a r k e t l e n d i n g r e l a t i o n s — s o m e loans d o
i n d e e d t u r n sour. That is w h y lenders are r e w a r d e d
for assuming risk in free capital markets. Providing
financial assistance t o l e s s - d e v e l o p e d c o u n t r i e s
c o n s t i t u t e s s u p p o r t t o t h e large l e n d i n g banks,
t h e y argue. I n c r e a s e d assistance w o u l d m a k e
existing p r i v a t e loans m o r e secure, as w e l l as
p r o v i d e greater l a t i t u d e t o t h e l e s s - d e v e l o p e d
c o u n t r i e s in d e a l i n g w i t h t h e i r b a l a n c e of payments difficulties. A c c o r d i n g t o this view, foreign
d e f a u l t s s h o u l d n o t p o s e serious t h r e a t s t o t h e
U.S. e c o n o m y b e c a u s e o n e role of t h e Federal
Reserve (as t h e U.S. " l e n d e r o f last r e s o r t ' ) is t o
prevent external shocks f r o m disrupting the
d o m e s t i c f i n a n c i a l system.
This a r t i c l e w i l l a n a l y z e t h e n a t u r e o f f i n a n c i a l
crises, t h e i r r e l a t i o n s h i p t o c e n t r a l b a n k p o l i c y ,
a n d t h e l e n d e r of last resort f u n c t i o n o f t h e
c e n t r a l b a n k as w e l l as t h e role of t h e IMF. T h e
e m p h a s i s is less o n t h e c u r r e n t i n t e r n a t i o n a l d e b t

Also involved In the efforts to provide additional financial assistance t o
the Third World countries are the World Bank, the Swiss-based Bank for
International Settlements, individuaf central banks, a n d some large a n d
already involved private commercial banks.

FEDERAL RESERVE B A N K O F A T L A N T A




s i t u a t i o n t h a n o n t h e g e n e r a l p r o b l e m of financial
crises a n d t h e role of l e n d e r s o f last resort in
curtailing their destructive effects o n t h e d o m e s t i c
e c o n o m y . T h e q u e s t i o n is i m p o r t a n t b e c a u s e
i n t e r v e n t i o n is l i k e l y t o c h a n g e t h e w a y f u t u r e
international financial transactions are c o n d u c t e d
a n d will establish p r e c e d e n t s for g o v e r n m e n t
i n v o l v e m e n t in f u t u r e crises.
T h e a r t i c l e is o r g a n i z e d as f o l l o w s : T h e n e x t
section briefly describes t h e nature of d o m e s t i c
financial crises. T h e r e l a t i o n s h i p o f d o m e s t i c t o
i n t e r n a t i o n a l f i n a n c i a l crises is t h e n d e l i n e a t e d ,
f o l l o w e d b y an analysis of t h e role of t h e d o m e s t i c

"Industrialized nations are seeking
solutions to help ease the burden
of indebted countries while
keeping their own banks solvent."

l e n d e r o f last resort. Finally, w e p r e s e n t s o m e
alternative v i e w s regarding an international lender
o f last r e s o r t

What Causes Domestic
Financial Crises?
T h e reason f i n a n c i a l crises can d e v e l o p o u t o f
stable e c o n o m i c c i r c u m s t a n c e s is f o u n d in t h e
n a t u r e of p o r t f o l i o i n v e s t m e n t itself. I n v e s t o r s
base p o r t f o l i o decisions o n e x p e c t a t i o n s of f u t u r e
earnings. Because p o t e n t i a l e a r n i n g s w i l l b e
d e t e r m i n e d b y f u t u r e events that can b e p r e d i c t e d
o n l y w i t h v a r y i n g d e g r e e s o f u n c e r t a i n t y , t h e r e is
an e l e m e n t of risk i n h e r e n t in all i n v e s t m e n t
decisions.
In a l l o c a t i n g w e a l t h , a rational i n v e s t o r w i l l
c o m p a r e t h e relative e x p e c t e d returns o n various
assets, i n c o r p o r a t i n g p e r c e p t i o n s o f t h e assets'
relative s u s c e p t i b i l i t y t o d e c r e a s e s in value. T h e
riskier t h e asset, t h e greater h e w i l l e x p e c t its
r e t u r n t o b e t o c o m p e n s a t e f o r t h e a d d i t i o n a l risk.
P e r c e p t i o n s o f p o t e n t i a l risk versus p o t e n t i a l
return of any given asset are based o n expectations
of f u t u r e e v e n t s t h a t w i l l a f f e c t t h a t asset's value.
C h a n g e s in p o t e n t i a l returns o n assets versus
t h e i r p o t e n t i a l risks w i l l i n d u c e t h e i n v e s t o r t o
a l t e r t h e p o r t f o l i o o f assets h e w i s h e s t o h o l d .
C o n c e r n a b o u t b o t h e x p e c t e d r e t u r n a n d risk
necessarily i m p l i e s a t t e n t i o n t o f u t u r e events,
such as p o s s i b l e g o v e r n m e n t actions, w h i c h
59

m i g h t a f f e c t t h e r e t u r n relative t o t h e risk of t h o s e
assets. A rational individual will t h e n alter p o r t f o l i o
d e c i s i o n s b a s e d o n his e x p e c t a t i o n s of f u t u r e
events. O f c o u r s e , e x p e c t a t i o n s are b a s e d o n
i n c o m p l e t e and costly i n f o r m a t i o n a n d t h u s are
n o t a l w a y s correct. I n d i v i d u a l perceptions o f risk
t h e r e f o r e b e c o m e an i m p o r t a n t d e t e r m i n a n t of
f u t u r e f i n a n c i a l events.
Historically, m o s t d o m e s t i c financial crises have
o c c u r r e d w h e n investors shifted asset preferences
d u e t o a p e r c e i v e d increase in risk. Such a shift
has n o r m a l l y t a k e n t h e f o r m o f a p r e f e r e n c e f o r
l o w e r risk, h i g h e r q u a l i t y , m o r e l i q u i d assets s u c h
as cash (legal t e n d e r ) , gold, or h i g h q u a l i t y
d e p o s i t s . Bank runs h a v e o c c u r r e d w h e n m a n y
depositors a t t e m p t e d to w i t h d r a w their funds
f r o m a c o m m e r c i a l bank simultaneously because
they feared that the bank might be unable to
h o n o r t h e i r d e p o s i t s . W h e n i n d i v i d u a l s have
a n t i c i p a t e d t h a t this m i g h t b e t h e case, t h e y h a v e
tried t o convert their deposits into currency.
Given fractional reserve banking, however, c o m m e r c i a l b a n k s c o u l d n o t h o n o r all s u c h r e q u e s t s
i m m e d i a t e l y b e c a u s e o n l y a small p o r t i o n o f
t h e i r assets is in t h e f o r m o f c u r r e n c y ; t h e
r e m a i n i n g p o r t i o n is in ( l o n g e r - m a t u r i t y ) loans
a n d securities. 3 Banks s c r a m b l i n g t o sell o f f loans
a n d securities t o o b t a i n t h e c u r r e n c y d e m a n d e d
b y d e p o s i t o r s o f t e n w e r e f o r c e d t o sell such assets
at a s u b s t a n t i a l loss. W h e n t h e s e losses w e r e b i g
e n o u g h t o cause i n s o l v e n c y , s o m e b a n k s w e r e
f o r c e d t o close t h e i r doors.
If t h e b a n k s h a d b e e n m i s m a n a g e d , c l o s u r e
m i g h t have b e e n appropriate. A w i d e s p r e a d run,
h o w e v e r , has f o r c e d e v e n w e l l - m a n a g e d b a n k s
i n t o ruin. In o t h e r w o r d s , a b a n k ' s assets m i g h t
h a v e e x c e e d e d its liabilities, b u t y e t it m i g h t h a v e
b e e n u n a b l e t o c o n v e r t all of its d e p o s i t liabilities
i n t o c u r r e n c y o n d e m a n d . Bank runs thus have
created liquidity problems t o o e n o r m o u s for
even w e l l - m a n a g e d banks t o h a n d l e successfully.
Again, t h i s m a y have b e e n b e c a u s e i n d i v i d u a l s
d e c i d e d t h a t t h e risk of n o t b e i n g a b l e t o c o n v e r t
$1 in d e p o s i t s i n t o $1 in c u r r e n c y o n d e m a n d
had i n c r e a s e d s u f f i c i e n t l y for t h e m t o a t t e m p t t o
m a k e t h e c o n v e r s i o n i m m e d i a t e l y . Thus, w h e n
individuals have believed banks have limited
capability to honor their c o m m i t m e n t s , they

3

Actually, banks today hold reserves in cash or on deposit at Federal
Reserve B a n k s The reserves or deposits at Federal Reserve Banks,
however, can be e x c h a n g e d for currency at any time.

60




h a v e a t t e m p t e d t o b e first t o r e m o v e t h e i r
deposits.4
Thus, in a w o r l d of uncertainty, individuals
base i n v e s t m e n t decisions o n e x p e c t e d returns
versus p e r c e i v e d risk. As p e r c e p t i o n s o f risk
relative t o e x p e c t e d returns change, individuals
m o d i f y asset h o l d i n g s a c c o r d i n g l y , p e r h a p s
a b r u p t l y a n d substantially. A f i n a n c i a l crisis or
b a n k run m a y result f r o m s u c h b e h a v i o r , b u t
t h e b e h a v i o r itself is n o t irrational. It is t h e
natural c o n s e q u e n c e of m a k i n g decisions u n d e r
c o n d i t i o n s of u n c e r t a i n t y , t h a t is, w i t h less t h a n
c o m p l e t e and perfect information.
A r a t i o n a l i n d i v i d u a l a c t i o n , h o w e v e r , may
a f f e c t t h e b e h a v i o r of others. In t h e 1930s,
i n d i v i d u a l b a n k runs h e l p e d t o trigger a c h a i n

"A financial crisis is the natural
consequence of making decisions
under conditions of uncertainty,
that is, with less than complete and
perfect information."

r e a c t i o n of b a n k closings t h r o u g h o u t t h e e c o n o m y . Such a r e a c t i o n has several i m p o r t a n t
results. First, t h e i n t e r m e d i a t i o n f u n c t i o n of
b r i n g i n g t o g e t h e r savers a n d investors m a y be
s e v e r e l y h a m p e r e d , r e s u l t i n g in h i g h e r real
i n t e r e s t rates a n d / o r c r e d i t r a t i o n i n g a n d t h u s
less overall i n v e s t m e n t 5 Second, t h e a t t e m p t e d
c o n v e r s i o n o f d e m a n d deposits i n t o currency,
g i v e n a f r a c t i o n a l reserve b a n k i n g system, m a y
result in a s h a r p c o n t r a c t i o n of t h e m o n e y
s u p p l y . 6 Finally, d u r i n g p e r i o d s of b a n k runs
and c o n s e q u e n t bank failures, transactors sometimes refuse t o accept checks, causing a breakd o w n of t h e p a y m e n t s system. This b r e a k d o w n
causes financial loss a n d d i s r u p t i o n t o businesses
and individuals not directly related to the

"An important attraction ot currency relative to d e m a n d deposits is that it
alone is legal tender, making it the most liquid of all assets. Also, it may
readily be e x c h a n g e d abroad for purchases of g o o d s or foreign currency.
6
For a recent a n d informative analysis of the importance of this particular
factor, see Ben S. Bernanke, " N o n m o n e t a r y Effects of the Financial Crisis
in the Propagation of the Great Depression," A m e r i c a n E c o n o m i c
Review, J u n e 1983, pp. 257-276.
6
See, a m o n g others, Barry L. Anderson a n d James L. k u t k i e w i c z , " M o n e y ,
Spending, a n d the Great Depression," S o u t h e r n E c o n o m i c J o u r n a l ,
October 1980, pp. 3 8 8 - 4 0 3 .

JANUARY 1984, E C O N O M I C REVIEW

F

affected institutions,7 p r o v i d i n g a rationale for
g o v e r n m e n t i n v o l v e m e n t as t h e l e n d e r o f last
resort.

What Is the Relationship between
International and Domestic
Financial Crises?
Financial crises are n o t e x c l u s i v e l y d o m e s t i c
in n a t u r e ; c u r r e n t i n t e r n a t i o n a l f i n a n c i a l p r o b lems p e r v a d e n e w s p a p e r s a n d business a n d
e c o n o m i c s literature. F r e q u e n t l y this l i t e r a t u r e
contains r e f e r e n c e s t o an " i n t e r n a t i o n a l l e n d e r
of last resort." 8 T o assess t h e v a l i d i t y of t h e s e

"After all, one country's balance of
payments deficit is another country's
balance of payments surplus."

proposals, it is i m p o r t a n t t o e x a m i n e t h e f u n c t i o n
of t h e l e n d e r of last resort. First, h o w e v e r , a
brief d e s c r i p t i o n of international financial crises
and t h e i r r e l a t i o n s h i p t o d o m e s t i c f i n a n c i a l
crises is in o r d e r .
N o t all i n t e r p r e t a t i o n s of t h e t e r m " i n t e r national f i n a n c i a l crisis" c o i n c i d e . A n
extreme h y p o t h e t i c a l e x a m p l e of an international
crisis is o n e in w h i c h , given w i d e s p r e a d fractional
reserve b a n k i n g , i n c r e a s e d w o r l d d e m a n d f o r
i n t e r n a t i o n a l reserves u n d e r a f i x e d e x c h a n g e
rate r e d u c e s t h e s u p p l y o f w o r l d m o n e y , c a u s i n g
a severe l i q u i d i t y crisis a n d a s s o c i a t e d b a n k
failures, as in t h e d o m e s t i c case. Such a m o n e t a r y

'See, for e x a m p l e , O . M . W . S p r a g u e , H i s t o r y o f C r i s e s U n d e r t h e N a t i o n a l
B a n k i n g S y s t e m , 1 9 1 0 , p. 75; a n d V e r a Smith, T h e R a t i o n a l e o f C e n t r a l
B a n k i n g , p. 155.
"See, for example, C h a r l e s P. Kindleberger, M a n i a s , P a n i c s , a n d C r a s h e s ,
Basic Books, N.Y. 1 9 7 8 . C h a p t e r 10, pp. 1 8 2 - 2 0 9 ; D . E M o g g r i d g e ,
•Financial C r i s e s a n d L e n d e r s of Last Resort; Policy in t h e C r i s e s of 1 9 2 0
and 1929,' J o u r n a l o f E u r o p e a n H i s t o r y , V o l u m e 10, No. 1 S p r i n g 1 9 8 1 ;
Franklin E d w a r d s , " F i n a n c i a l I n s t i t u t i o n s a n d R e g u l a t i o n s in t h e 2 1 s t
Century: A f t e r t h e Crash," M i m e o g r a p h , C o l u m b i a U n i v e r s i t y ( 1 9 8 0 ) ; a n d
J a c k G u t t e n t a g a n d R i c h a r d H e r r i n g , " T h e Lender-of-Last-Resort Function
in a n I n t e r n a t i o n a l C o n t e x t " E s s a y s i n I n t e r n a t i o n a l F i n a n c e , No. 1 5 1 ,
May 1 9 8 3 , I n t e r n a t i o n a l F i n a n c e S e c t i o n , P r i n c e t o n University.

c o n t r a c t i o n a n d f i n a n c i a l b r e a k d o w n w o u l d severely disrupt trade and the domestic economy.
M o r e frequently, however, the term "intern a t i o n a l f i n a n c i a l crisis" is a p p l i e d t o b a l a n c e
o f p a y m e n t s ( o r e x c h a n g e rate) a d j u s t m e n t s .
Yet such a d j u s t m e n t s are part of t h e e q u i l i b r a t i o n
process b e t w e e n c o u n t r i e s a n d , as such, d o n o t
in themselves qualify as an " i n t e r n a t i o n a l crisis."
A f t e r all, o n e c o u n t r y ' s b a l a n c e o f p a y m e n t s
deficit (or exchange rate depreciation) is another
c o u n t r y ' s b a l a n c e of p a y m e n t s s u r p l u s (or exc h a n g e rate a p p r e c i a t i o n ) . This is p a r t i c u l a r l y
t r u e o n a l i m i t e d basis; e v e n s e v e r e b a l a n c e o f
p a y m e n t s p r o b l e m s in s m a l l c o u n t r i e s d o n o t
c o n s t i t u t e " a n i n t e r n a t i o n a l crisis."
C u r r e n t l y , t h e phrase " i n t e r n a t i o n a l f i n a n c i a l
crisis" is l o o s e l y a s s o c i a t e d w i t h t h e large d e b t
b u r d e n s o f several l e s s - d e v e l o p e d c o u n t r i e s .
Concern that these countries may default on
t h e i r d e b t o b l i g a t i o n s , m a n y o f w h i c h are o w e d
t o large U. S. c o m m e r c i a l banks, is w i d e s p r e a d .
If d e f a u l t w e r e t o o c c u r , t h e s e b a n k s w o u l d
i n c u r i m m e d i a t e losses o n t h e s e loans a n d
c o u l d face t h e p r o s p e c t of i n s o l v e n c y . Since
f e d e r a l d e p o s i t i n s u r a n c e c o v e r s o n l y a b o u t 62
p e r c e n t of all d e p o s i t s , w i t h t h e d e p o s i t s at t h e
large b a n k s m o s t h e a v i l y e x p o s e d , d e p o s i t o r s
also are concerned. 9 In addition, federal d e p o s i t
insurance guarantees deposits only up t o
$ 1 0 0 , 0 0 0 per account, aggravating large depositors' c o n c e r n s a b o u t t h e s o l v e n c y of t h e i r
banks, a n d i n c r e a s i n g t h e p e r c e p t i o n o f risk o n
d e p o s i t s relative t o returns. 1 0 O n e w a y t o a v o i d
such a crisis in c o n f i d e n c e , s o m e observers contend, is t o provide "extraordinary" financial assistance
q u i c k l y t o t h e a f f e c t e d less-developed countries.
O t h e r s q u e s t i o n t h e n e c e s s i t y of e x t r a assist a n c e , e v e n t e m p o r a r i l y . This g r o u p c o n t e n d s
t h a t l o a n d e f a u l t s a n d a f e w b a n k failures m a y
e v e n b e d e s i r a b l e . 1 1 T h e s e analysts r e c o g n i z e

« " C o m m e r c i a l b a n k s h a v e m a n y d e p o s i t a c c o u n t s that are not i n s u r e d in
full, w i t h u n i n s u r e d d e p o s i t s a c c o u n t i n g for a b o u t 3 8 p e r c e n t of t o t a l b a n k
deposits-Further, c o m m e r c i a l b a n k s h a v e a s i z a b l e a m o u n t of n o n d e p o s i t
liabilities t h a t a r e not insured.' S e e A g e n d a f o r R e f o r m , F e d e r a l H o m e
L o a n B a n k Board, W a s h i n g t o n , D C., M a r c h 1983, p. 92.
,0

T h i s is e s p e c i a l l y t r u e s i n c e P e n n S q u a r e N a t i o n a l B a n k w a s p e r m i t t e d t o
fail in 1 9 8 2 . Prior t o this, t h e g e n e r a l p r a c t i c e of t h e F D I C w a s t o a r r a n g e
m e r g e r s o r l i q u i d a t i o n s s o t h a t n o d e p o s i t o r lost any funds. In effect, all
d e p o s i t s w e r e g u a r a n t e e d . T h e r e is c u r r e n t l y g r e a t e r u n c e r t a i n t y a b o u t
t h e s t a t u s of d e p o s i t s . Interestingly, i n t e r e s t r a t e s p a i d o n large C D s n o w
vary a c r o s s banks, r e f l e c t i n g c o n c e r n a b o u t t h e s h a k y f o r e i g n l o a n s
m a d e by s o m e banks. As of t h i s writing, h o w e v e r , risk s p r e a d s h a v e
n a r r o w e d s u b s t a n t i a l l y s i n c e t h e s u m m e r of 1 9 8 2 .
" S e e , for e x a m p l e , A D a l e Tussing, " T h e C a s e for B a n k Failures," J o u r n a l
o f L a w a n d E c o n o m i c s 1 9 6 5 , V o l u m e X; a n d T h o m a s Mayer, " S h o u l d
Large B a n k s B e A l l o w e d t o Fail?' J o u r n a l o f F i n a n c i a l a n d Q u a n t i t a t i v e
Analysis, November 1975.

61
FEDERAL RESERVE B A N K O F A T L A N T A




t h a t t h e risks of i n t e r n a t i o n a l l e n d i n g m a y
e x c e e d t h e risks a s s o c i a t e d w i t h d o m e s t i c
l e n d i n g b e c a u s e (a) t h e costs o f a c q u i r i n g
i n f o r m a t i o n o n b o r r o w e r s are h i g h e r , ( b ) borr o w e r s m a y h a v e t r o u b l e c o n v e r t i n g local currencies i n t o l o a n t r a n s a c t i o n c u r r e n c i e s , (c)
t h e r e is i n t e r n a t i o n a l p o l i t i c a l uncertainty, a n d
(d) t h e r e is e x p o s u r e t o f o r e i g n e x c h a n g e
risk. 1 2 T h e s e factors n e e d t o t o b e i n c o r p o r a t e d
in c o m m e r c i a l b a n k l o a n e v a l u a t i o n a n d risk
a s s e s s m e n t p r o c e d u r e s . S i n c e b a n k s a r e rew a r d e d for successful l e n d i n g ventures, according
t o this p o i n t of view, t h e y m u s t accept responsib i l i t y f o r b a d l e n d i n g d e c i s i o n s as w e l l .
Since these analysts are less likely t o consider
t h e c u r r e n t s i t u a t i o n an " i n t e r n a t i o n a l f i n a n c i a l
crisis," t h e y d o n o t c o n s i d e r t h e s e p r o b l e m s
t h r e a t s t o i n t e r n a t i o n a l f i n a n c i a l stability. T h e y ,
t h e r e f o r e , are s k e p t i c a l o f t h e n e e d f o r an
i n t e r n a t i o n a l l e n d e r of last resort. In e v a l u a t i n g
these alternative arguments regarding assistance,
a d i s c u s s i o n o f t h e role o f t h e l e n d e r o f last
resort b e c o m e s e s p e c i a l l y p e r t i n e n t .

The Role of the Domestic
Lender of Last Resort
T h e call f o r a d o m e s t i c l e n d e r of last resort
arises because of t w o institutional characteristics,
n a m e l y , f r a c t i o n a l reserve b a n k i n g a n d t h e
g o v e r n m e n t m o n o p o l y of legal t e n d e r issuance. 13
As d i s c u s s e d earlier, f r a c t i o n a l reserve b a n k i n g
implies t h a t banks d o n o t k e e p e n o u g h currency
t o m e e t all d e p o s i t o r d e m a n d s s i m u l t a n e o u s l y .
G o v e r n m e n t m o n o p o l y of legal t e n d e r issuance
prevents banks a n d others f r o m creating curr e n c y t o satisfy t h e s e d e m a n d s . T h e role o f t h e
lender of last resort was established t o guarantee
banks' ability t o m e e t currency d e m a n d , thus
p r e c l u d i n g a p a n i c - i n d u c e d collapse of the
b a n k i n g system. By e n s u r i n g b a n k s ' a b i l i t y t o
m e e t d e p o s i t o r d e m a n d s , t h e l e n d e r of last
resort can h e l p p r e v e n t (a) t h e d i s r u p t i o n o f

f i n a n c i a l i n t e r m e d i a t i o n , (b) d i s r u p t i o n s o f t h e
p a y m e n t s system, a n d (c) c o n t r a c t i o n s of t h e
m o n e y stock, all w h i c h m a y o c c u r in t i m e s of
f i n a n c i a l panic.
S o m e analysts argue t h a t a d o m e s t i c l e n d e r
o f last resort is u n n e c e s s a r y b e c a u s e f e d e r a l
d e p o s i t i n s u r a n c e r e m o v e s t h e i n c e n t i v e s for
b a n k runs. 1 4 I n s u r e d d e p o s i t o r s f e e l c o n f i d e n t
t h a t n o m a t t e r h o w b a d l y m a n a g e d a b a n k is,
t h e y w i l l e v e n t u a l l y r e c e i v e t h e i r deposits.
M i n o r runs o n f i n a n c i a l i n s t i t u t i o n s s o m e t i m e s
d o o c c u r , s u c h as t h e run o n t h e A b i l e n e
N a t i o n a l Bank in 1 9 8 2 , b u t t h e s e e p i s o d e s pale
in c o m p a r i s o n t o t h o s e e x p e r i e n c e d d u r i n g t h e
1930s. As n o t e d earlier, however, de jure federal
d e p o s i t i n s u r a n c e c u r r e n t l y insures o n l y a b o u t
62 p e r c e n t o f all d e p o s i t s . F u r t h e r m o r e , the
Federal D e p o s i t I n s u r a n c e C o r p o r a t i o n p r i c i n g

"The role of the lender of last resort
was established to guarantee banks'
ability to meet currency demands."

s c h e m e m a y b e a l t e r e d in t h e n e a r f u t u r e t o
shift s o m e o f t h e risk b u r d e n b a c k t o large
d e p o s i t o r s . Finally, in t h e e v e n t of w i d e s p r e a d
b a n k failures t h a t d e p l e t e t h e f u n d s of f e d e r a l
d e p o s i t i n s u r a n c e , a l e n d e r of last resort m u s t
u l t i m a t e l y f u n c t i o n as a b a c k u p f o r f e d e r a l
d e p o s i t i n s u r a n c e itself.
In t h e early 1 9 0 0 s , p r i o r t o t h e e s t a b l i s h m e n t
of t h e Federal Reserve, s o m e of t h e f u n c t i o n s
of a l e n d e r of last resort w e r e s u p p l i e d by
private institutions. C u r r e n c y substitutes (script),
clearing house certificates, and " b a n k holidays"
w e r e mechanisms for dealing w i t h financial
crises. 1 5 If a b a n k run b e g a n t o d e v e l o p , m a n y
banks w o u l d refuse t o convert deposits into
currency o n d e m a n d . S o m e t i m e s banks declared
a " b a n k h o l i d a y , " c l o s i n g f o r business. This

l2

S e e Jack Guttentag a n d Richard Hering, "The Lender of Last Resort
Function in an International Context.' E s s a y s i n I n t e r n a t i o n a l F i n a n c e ,
No. 151, May 1983, p. 2.
13
100 percent reserve banking would eliminate bank runs. The fact that
other banks cannot issue legal tender m e a n s that only the issuer of legal
tender can meet an abnormal increase in the d e m a n d for legal tender.
Moreover, because of the g o v e r n m e n t (central bank) monopoly of legal
tender issuance, the central bank naturally becomes the central store of
bank reserves, the ultimate source of domestic liquidity, and, consequently, the "bankers' b a n k "

62




"•For an extremely insightful analysis of the relationship b e t w e e n deposit
insurance a n d bank runs, see Douglas W. Diamond and Philip H. Dybvig,
" B a n k Runs, Deposit Insurance, a n d Liquidity,' J o u r n a l of P o l i t i c a l
E c o n o m y , J u n e 1983, pp. 401-419.
l5
See, for example, Milton Friedman a n d Anna Scfiwartz, A M o n e t a r y
H i s t o r y of t h e U n i t e d S t a t e s (Princeton, Princeton University Press,
1 963).

JANUARY 1984, E C O N O M I C REVIEW

F|

e n a b l e d b a n k s t o a v o i d selling o f f massive
a m o u n t s o f assets at r e d u c e d prices, t h e r e b y
a v o i d i n g large losses a n d p o s s i b l e i n s o l v e n c y .
The l e n d e r o f last resort was c r e a t e d t o p r o v i d e
sufficient e m e r g e n c y liquidity in t i m e s of massive
deposit w i t h d r a w a l s t o k e e p t h e banking system
open. Because t h e lender of last resort guarantees
deposit-to-currency convertibility, individuals
have c o n f i d e n c e t h a t t h e y can always
convert
their d e p o s i t s i n t o c u r r e n c y o n d e m a n d , a n d
therefore do not " r u n " to w i t h d r a w deposits
w h e n a b a n k m i g h t a p p e a r in d a n g e r o f insolvency. Even a f t e r t h e i n s t i t u t i o n o f f e d e r a l
deposit insurance, t h e u l t i m a t e d e p o s i t protection r e s t e d w i t h t h e Federal Reserve Bank in its
role as l e n d e r o f last r e s o r t
Having t h e p o w e r t o issue legal t e n d e r implies
that central banks never exhaust their (domestic)

"In 1971, the Board of Governors
affirmed its commitment to assist
the financial system, but not
individual banks."

financial l i q u i d i t y a n d are t h e r e f o r e a b l e t o
lend w h e n o t h e r institutions are illiquid. Because
the l e n d e r of last resort is c o n c e r n e d w i t h t h e
health o f t h e o v e r a l l d o m e s t i c e c o n o m y , it
should assume this role o n l y w h e n b a n k insolvency p r o b l e m s threaten the e c o n o m y ; the
classical p o s i t i o n is t h a t it s h o u l d not act in t h e
interest o f a p a r t i c u l a r b a n k o r banks. 1 6 T h e
effective exercise of this liquidity responsibility
will p r e v e n t a rapid, w i d e s p r e a d call-in o f loans
and a d r a m a t i c fall (or collapse) o f asset prices.
Thus, b y s u p p o r t i n g t h e m a r k e t in l i q u i d i t y
e m e r g e n c i e s , t h e l e n d e r o f last resort e n s u r e s
that b a n k s w i l l n o t b e f o r c e d t o sell l i q u i d
assets at losses t h a t m i g h t o t h e r w i s e result in
i n s o l v e n c y a n d its c o n s e q u e n t a d v e r s e effects.
Ostensibly, t h e market will handle individual
bank crises. In a c o m p e t i t i v e f i n a n c i a l system,

' 6 See Thomas M Humphrey, The Classical Concept of the Lender of Last
Resort." E c o n o m i c Review, Federal Reserve Bank of Richmond,
January/February 1975.

FEDERAL RESERVE B A N K O F A T L A N T A




if a b a n k is f u n d a m e n t a l l y s o l v e n t b u t t e m p o rarily i l l i q u i d , o t h e r s can p r o f i t b y l e n d i n g t o i t
If a p a r t i c u l a r b a n k is i n s o l v e n t , h o w e v e r , its
real resources are r e l e a s e d t o f l o w i n t o m o r e
p r o d u c t i v e uses. N e i t h e r t h e case o f a s o l v e n t
nor of an insolvent bank involves the lender of
last resort. In 1 9 7 1 , t h e B o a r d of G o v e r n o r s o f
t h e Federal Reserve System a f f i r m e d its c o m m i t m e n t t o assist t h e f i n a n c i a l system,
but not
individual
banks. A s p e c i a l r e p o r t r e a p p r a i s i n g
t h e d i s c o u n t m e c h a n i s m stated:
" T h e (Federal Reserve) S y s t e m s h o u l d n o t
act t o p r e v e n t losses a n d i m p a i r m e n t o f
c a p i t a l of p a r t i c u l a r f i n a n c i a l i n s t i t u t i o n s . If
pressures d e v e l o p against a n d i m p a i r t h e
profitability of institutions w h o s e operations
have b e c o m e unstable, inappropriate to
changing e c o n o m i c conditions, or competit i v e l y d i s a d v a n t a g e d in t h e m a r k e t p l a c e , it is
n o t t h e Federal Reserve's r e s p o n s i b i l i t y t o
use its b r o a d m o n e t a r y p o w e r s in a b a i l - o u t
o p e r a t i o n . . . The System should intervene
in its c a p a c i t y as l e n d e r of last resort o n l y
w h e n l i q u i d i t y pressures t h r e a t e n t o e n g u l f
w h o l e classes of f i n a n c i a l i n s t i t u t i o n s w h o s e
s t r u c t u r e s are s o u n d a n d w h o s e o p e r a t i o n a l
i m p a i r m e n t w o u l d be seriously disruptive t o
the economy."17
M o r e o v e r , t h e f u n c t i o n of t h e l e n d e r o f last
resort is n o t t o p r e v e n t s h o c k s t h a t f r e q u e n t l y
a f f e c t t h e f i n a n c i a l s y s t e m or t o s t a b i l i z e t h e
business c y c l e b u t rather t o m i n i m i z e t h e
s e c o n d a r y r e p e r c u s s i o n s o f t h o s e shocks. In
essence, t h e p u r p o s e is t o m a i n t a i n c o n f i d e n c e
in t h e f i n a n c i a l s y s t e m so t h a t t h e r e w i l l b e n o
n e e d t o e x e r c i s e t h e l e n d e r o f last resort
function.
O n e of the most i m p o r t a n t functions of the
l e n d e r of last resort is t o assure t h e m a r k e t t h a t
s u p p o r t will be f o r t h c o m i n g if n e e d e d . C r e d i b l e
assurance o f t h e c e n t r a l b a n k ' s w i l l i n g n e s s t o
act in a crisis relieves uncertainty a n d stabilizes
expectations that might otherwise generate
d e p o s i t o r panics. 1 8 T o p r e v e n t e x c e s s i v e risktaking b y banks c o n f i d e n t of assistance, however,
t h e l e n d e r of last resort m u s t b e c e r t a i n t o
s p e c i f y t h a t in financial crises assistance will b e
a v a i l a b l e t o t h e m a r k e t , n o t t o p a r t i c u l a r banks.

" S t e e r i n g Committee, "Report of a System Committee, R e a p p r a i s a l of
t h e F e d e r a l Reserve D i s c o u n t M e c h a n i s m , Board of Governors of the
Federal Reserve System, Volume 1, August 1971, p.19
' " S e e Humphrey, op. cil.

63

How the Domestic Lender of
Last Resort Operates
T h e r e are t w o m a i n w a y s t h e l e n d e r o f last
resort s u p p l i e s l i q u i d i t y . T h e m o s t f a m i l i a r w a y
is t o l e n d f u n d s t h r o u g h t h e d i s c o u n t w i n d o w
t o c o m m e r c i a l b a n k s a n d o t h e r i n s t i t u t i o n s if
c o n d i t i o n s so w a r r a n t a n d if s u f f i c i e n t s o u n d
c o l l a t e r a l is available. T h e l e n d e r o f last resort
m u s t b e careful, h o w e v e r , t o e n s u r e t h a t loans
assist institutions c o p i n g w i t h liquidity problems,
not solvency problems. T h e rate of interest or
d i s c o u n t rate c h a r g e d o n s u c h loans s h o u l d b e
a p e n a l t y rate h i g h e n o u g h t o e n s u r e t h a t o t h e r
m a r k e t sources o f f u n d s h a v e b e e n e x h a u s t e d
a n d that banks b o r r o w f r o m t h e Federal Reserve
o n l y as a " l a s t resort." In t h e w o r d s o f W a l t e r
B a g e h o t in 1 8 7 3 : " L e n d f r e e l y at a h i g h rate."
W h e n t h e l e n d e r o f last resort f u n c t i o n w a s
d e v e l o p e d , d i s c o u n t l e n d i n g was t h e p r i m a r y
m o n e t a r y p o l i c y t o o l a n d t h u s w a s also t h e
p r i m a r y t o o l for m a k i n g last resort loans. Today,
m a n y e c o n o m i s t s still v i e w d i s c o u n t w i n d o w
l e n d i n g as t h e o n l y m e c h a n i s m b y w h i c h t h e
l e n d e r o f last resort can p r o v i d e l i q u i d i t y .
T h e s e c o n d , m o r e e f f i c i e n t , b u t lesser k n o w n
w a y t h a t t h e l e n d e r of last resort can p r o v i d e
l i q u i d i t y t o t h e m a r k e t is b y e n g a g i n g in o p e n
m a r k e t o p e r a t i o n s . By p u r c h a s i n g g o v e r n m e n t
securities in t h e marketplace, t h e Federal Reserve
i n j e c t s reserves i n t o t h e m a r k e t p l a c e , a l m o s t
i m m e d i a t e l y i n c r e a s i n g t h e reserves a v a i l a b l e
t o all i n s t i t u t i o n s b u t w i t h o u t allocating t h e m
a m o n g p a r t i c u l a r users. Federal Reserve o p e n
m a r k e t p u r c h a s e s p r o v i d e a m a r k e t f o r individuals, firms, a n d f i n a n c i a l i n s t i t u t i o n s s e l l i n g
securities t o m e e t t h e i r c u r r e n c y d e m a n d s .
W i t h o p e n market purchases t o stabilize t h e
s t o c k of b a n k d e p o s i t s , b a n k runs s h o u l d n o t
d e v e l o p since depositors k n o w that t h e b a n k i n g
s y s t e m w i l l n o t h a v e t o sell o f f its assets at a
c a p i t a l loss. T h e d i s c o u n t w i n d o w a n d o p e n
m a r k e t o p e r a t i o n s are t h e m e a n s b y w h i c h t h e
Fed provides liquidity in crisis periods t o ensure
t h a t b a n k s c a n r e a d i l y c o n v e r t assets i n t o cash
t o m e e t c u r r e n c y drains. C o n s e q u e n t l y , b o t h
m e t h o d s p r e v e n t b a n k runs a n d t h e p r o b l e m s
a s s o c i a t e d w i t h s u c h runs.
Provision o f l i q u i d i t y d u r i n g a crisis via o p e n
m a r k e t p u r c h a s e s is c o n s i s t e n t w i t h a n d a
crucial e l e m e n t of longer-run m o n e t a r y control.
P r o m p t a n d v i g o r o u s l e n d e r o f last resort a c t i o n
will stop panics long b e f o r e t h e m o n e y s u p p l y
64




strays far off c o u r s e The " l e n d e r of last resort"
f u n c t i o n is essentially a v e r y s h o r t - r u n f u n c t i o n
of a central bank that is activated o n l y during
t e m p o r a r y periods of emergency; t h e " m o n e t a r y
control" f u n c t i o n of a central bank is a c o n t i n u o u s
a n d l o n g e r - r u n f u n c t i o n . T h e l e n d e r o f last
resort acts t o prevent s u d d e n decreases (shocks)
in t h e m o n e y stock, a n d t h u s w o r k s t o r e i n f o r c e
stable m o n e t a r y control. Thus, m o n e t a r y control
a n d last resort l e n d i n g a r e c o m p l e m e n t a r y , n o t
conflicting.

A Role for an International
Lender of Last Resort?
T r a d i t i o n a l l y , d i s c u s s i o n s o f t h e l e n d e r o f last
resort h a v e r e l a t e d a l m o s t e n t i r e l y t o t h e
d o m e s t i c e c o n o m y w i t h little regard f o r international concerns. Current international financial
problems, however, have elicited calls t o e x t e n d
t h e l e n d e r o f last resort f u n c t i o n t o t h e intern a t i o n a l realm. I n d e e d , several e c o n o m i s t s

"The discount window and open
market purchases are the means
by which the Fed provides liquidity
in crisis periods to ensure that
banks can readily convert assets
into cash to meet currency drains."

c o n t e n d t h a t t h e I M F is a l r e a d y a s s u m i n g this
role. 1 9 Several p r o p o s a l s h a v e b e e n m a d e t o
c r e a t e an i n t e r n a t i o n a l l e n d i n g e n t i t y . 2 0
W h i l e t h e c o n c e p t o f a domestic
l e n d e r of
last resort is w e l l established, t h e role of a similar
international
lender remains unclear. Localized
i n t e r n a t i o n a l l i q u i d i t y p r o b l e m s r e l a t e d t o balance of p a y m e n t s (or exchange rate) adjustments
are c o m m o n b u t d o n o t r e q u i r e i n t e r v e n t i o n o f
a last resort lender. Balance of p a y m e n t s adjustm e n t s are i n h e r e n t e l e m e n t s o f a c o u n t r y ' s
t r a d e e q u i l i b r a t i n g process a n d d o n o t necessarily relate t o b a n k i n g crises. M o r e o v e r , w h e n
o n e c o u n t r y loses, a n o t h e r m u s t gain. T h e s e

,9

See; for example, James W. Dean a n d Ian H. Giddy, "Averting International Banking Crises," Monograph 1981-1, New York University, The
Monograph Series in Finance a n d Economics, 1981.
J0
See, for example, Charles Kindleberger, op. c/'f,; a n d Franklin Edwards, op.
cit.

JANUARY 1984, E C O N O M I C REVIEW

F|

adjustments, then, pertain only t o particular
c o u n t r i e s , a n d t h e r e f o r e d o n o t m e r i t t h e interv e n t i o n o f an i n t e r n a t i o n a l l e n d e r of last resort.
As o n t h e d o m e s t i c level, t h e n e e d f o r an
i n t e r n a t i o n a l l e n d e r o f last resort arises in part
f r o m f r a c t i o n a l reserve b a n k i n g a n d g o v e r n ments' exclusive c o n t r o l of legal t e n d e r issuance.
W h i l e n o g o v e r n m e n t issues international legal
t e n d e r , t h e r e are i n t e r n a t i o n a l m e d i u m s of
exchange, p a r t i c u l a r l y w h e n e x c h a n g e rates
are f i x e d . M a n y l e s s - d e v e l o p e d c o u n t r i e s p e g
their c u r r e n c i e s t o key c u r r e n c i e s s u c h as t h e
dollar. T h e role o f an i n t e r n a t i o n a l l e n d e r of last
resort w o u l d b e t o p r e v e n t severe disruptions
(especially m o n e t a r y contractions) of t h e w o r l d
m o n e t a r y system. U n d e r a f i x e d e x c h a n g e rate
regime, a f i n a n c i a l crisis m a y result f r o m an
increase in t h e p e r c e i v e d risk of a c o u n t r y ' s
currency relative t o its value. If foreign depositors s i m u l t a n e o u s l y a t t e m p t t o w i t h d r a w t h e i r
money, d e n o m i n a t e d in an international m e d i u m
of e x c h a n g e , f r o m t h e c o u n t r y ' s banks, a run o n

"In its current form, however, the
IMF cannot function as a lender of
last resort, as it cannot create
money or international reserves."

t h e c e n t r a l b a n k ' s i n t e r n a t i o n a l reserves m a y
result. If this c e n t r a l b a n k w i s h e s t o m a i n t a i n
a f i x e d e x c h a n g e rate, it m a y u l t i m a t e l y h a v e t o
b o r r o w an i n t e r n a t i o n a l m e d i u m of e x c h a n g e
from other central banks or f r o m an international
l e n d e r of last resort. U n d e r t h e s e p a r t i c u l a r
c i r c u m s t a n c e s an i n t e r n a t i o n a l l e n d e r of last
resort m a y have a v a l i d role. 2 1
If t h e c e n t r a l b a n k c a n n o t b o r r o w in an intern a t i o n a l m e d i u m of e x c h a n g e , it m a y go o f f t h e
fixed exchange rate system a n d allow its currency
t o d e p r e c i a t e . In t h e d o m e s t i c m a r k e t , b a n k s
are a/ways e x p e c t e d t o r e d e e m t h e i r liabilities
at par. In t h e i n t e r n a t i o n a l arena, h o w e v e r , a
c o u n t r y can d e p r e c i a t e its c u r r e n c y i n s t e a d o f

" S e e Ralph Hawtrey, T h e Art of C e n t r a l B a n k i n g , p. 2 2 8 and Robert
Aliber, "Bagehot, the Lender of Last Resort, a n d the International
Financial System," unpublished manuscript p. 26.

maintaining a fixed exchange value w i t h an
international m e d i u m of exchange. The ability
to allow currency to fluctuate t o a c c o m m o d a t e
crises provides LDCs w i t h a r e m e d y n o t available
t o t h e d o m e s t i c m a r k e t This d i f f e r e n c e b e t w e e n
domestic and international currency standards
suggests t h a t a l e n d e r of last resort m a y be less
n e c e s s a r y in t h e i n t e r n a t i o n a l t h a n in t h e
domestic context.22
.
By these standards, current international d e b t
p r o b l e m s d o n o t r e q u i r e t h e assistance of an
i n t e r n a t i o n a l l e n d e r o f last resort. C u r r e n t d a t a
indicate that w o r l d m o n e y a n d reserves c o n t i n u e
t o increase at m o d e r a t e rates. 2 3 D e v e l o p e d c o u n t r y b a n k s are l i q u i d a n d a b l e t o c o n t i n u e
l e n d i n g , i m p l y i n g t h a t n o serious
general
l i q u i d i t y crisis exists. 24
In s p i t e of t h e lack of a general l i q u i d i t y crisis,
s o m e analysts n e v e r t h e l e s s c o n t e n d t h a t an
i n t e r n a t i o n a l l e n d e r o f last resort is essential. 2 5
T o f u n c t i o n as a l e n d e r o f last resort, h o w e v e r ,
an international organization m u s t have authority
t o create m o n e y , i.e., p r o v i d e u n l i m i t e d liquidity
o n d e m a n d . U n l i k e o t h e r i n s t i t u t i o n s , f o r exa m p l e , a d o m e s t i c l e n d e r of last resort n e v e r
faces i l l i q u i d i t y o r i n s o l v e n c y since it is t h e
u l t i m a t e s o u r c e of legal t e n d e r or c u r r e n c y . A n

2-¡See, for example, Hawtrey, op. cit., p. 2 2 8 ; Aliber, op. cit, p. 27; a n d D. E.
Moggndge, "Financial Crises and Lender of Last Resort; Policy in the
Crises of 1 9 2 0 a n d 1929," J o u r n a l of E u r o p e a n History, Volume 10, No.
1 Spring 1981, p. 50. The above scenario describes a situation in which
demand increases for the conversion of deposits into international media
of exchange. The current international debt situation is quite different.
There is another important difference between domestic and international
financial c r i s e s Since the volume of international debt is often contracted
in t e r m s of a f o r e i g n c u r r e n c y , e x c h a n g e r a t e m o v e m e n t s a d d
risk to international debt not associated with the domestic c o u n t e r p a r t
Exchange rate risk translates into riskof governmental policy. That is, with
debt d e n o m i n a t e d in domestic currency, governmental policy makers
can prevent or forestall default by inflation or taxation. W h e n debt is
d e n o m i n a t e d in foreign currency, however, this option is closed. The
servicing of foreign debt requires conversion of domestic money into
foreign money at e x c h a n g e rates that reflect governmental policies.
Policies to prevent default, such as taxation or inflation, will merely raise
the cost of conversions into foreign currency. See Karl Brunner, et. ai„
"The International Debt Problem, Insolvency a n d Illiquidity A Policy
Proposal," Statement prepared by the Ad Hoc Committee on International
D e b t a n d US. Financial Policies, Distributed by The Center for Research in
Government Policy a n d Business Graduate School of Management,
University of Rochester, January 14, 1983, p. 6. Furthermore, actions to
prevent exchange rates from adiusting to reflect these governmental
policies will alter individuals' expectations of future developments a n d
thus their current portfolio decisions, w h i c h will only exacerbate the
situation, especially as the debt burden rises and the sustainability of the
existing policies w e a k e n s
__ „
,
" I n t e r n a t i o n a l F i n a n c i a l S t a t i s t i c s , supplement No. 5, S u p p l e m e n t o n
M o n e y and latest data in I n t e r n a t i o n a l F i n a n c i a l S t a t i s t i c s , November
1983
" T h i s is not to say that no problem exists. As s o m e point out, in attempting
to deal with their debt burden, many developing countries are cutting
back on their i m p o r t s This, or course, adversely affects the exports of the
U S and other industrialized c o u n t r i e s However, bigger IMF quotas
cannot be justified on the grounds of a g e n e r a l liquidity crisis.
" S e e , for example. Edwards, op. cit. (1980).

65
FEDERAL RESERVE B A N K O F A T L A N T A




I

international lender of last resort likewise w o u l d
h a v e t o b e t h e u l t i m a t e s o u r c e of i n t e r n a t i o n a l
reserves. For if an i n t e r n a t i o n a l l e n d e r o f last
resort h a d t o b o r r o w t h e f u n d s it lent, it w o u l d
n o t b e t h e last resort. 2 6 A d d i t i o n a l l y , a n intern a t i o n a l l e n d e r o f last resort m u s t b e a b l e t o
m a k e loans t o s o l v e n t , c r e d i b l e b o r r o w e r s w h o
o t h e r w i s e c o u l d n o t b o r r o w m o n e y in t h e
m a r k e t p l a c e d u r i n g a g e n e r a l l i q u i d i t y crisis.
Such " l a s t r e s o r t " l e n d i n g m i g h t o c c u r d u r i n g a
l i q u i d i t y crisis a n d l i k e l y c o u l d m a n i f e s t itself in
increased d e m a n d for ( i n t e r n a t i o n a l transactions
money.
M a n y w h o a d v o c a t e an i n t e r n a t i o n a l l e n d e r
o f last resort c o n t e n d t h a t t h e I M F c u r r e n t l y
performs this role a n d s h o u l d e x p a n d its responsibility. 2 7 S o m e a u t h o r s argue t h a t t h e I M F is in
possession of substantial u n u s e d financial
resources, t h e p o w e r t o raise a d d i t i o n a l f u n d s ,
a large u n p l e d g e d g o l d stock, a n d t h e p o w e r t o
issue Special D r a w i n g Rights (SDRs) representing
" a f o r m i d a b l e p a c k a g e of 'last resort' f i n a n c i a l
resources a n d p o w e r s . " 2 8
T h e I M F was c r e a t e d t o p r o m o t e w o r l d t r a d e
a n d assist m e m b e r c o u n t r i e s w i t h s h o r t - t e r m
balance of p a y m e n t s deficits t h r o u g h extensions
o f short-term
loans. Because t h e I M F l e n d s t o
s o m e c o u n t r i e s t h a t c a n n o t get e n o u g h loans in
t h e m a r k e t p l a c e , it m a y s u p e r f i c i a l l y r e s e m b l e
a l e n d e r o f last resort. In its c u r r e n t f o r m ,
h o w e v e r , t h e I M F c a n n o t f u n c t i o n as a l e n d e r
of last resort, as it c a n n o t c r e a t e m o n e y or
i n t e r n a t i o n a l reserves. Instead, t h e I M F m u s t
depend on limited contributions from m e m b e r
countries for funds t o lend. O n c e t h e IMF
reaches this q u o t a , its f u n d s are e x h a u s t e d ; it
cannot create either w o r l d
currency or the
c u r r e n c i e s of its m e m b e r s . 2 9 Since t h e a b i l i t y t o
create m o n e y is t h e chief feature distinguishing a
l e n d e r o f last resort, t h e I M F d o e s n o t q u a l i f y
f u l l y f o r t h a t role.
In s p i t e of t h e fact t h a t t h e I M F is n o t a t r u e
lender of last resort, s u p p o r t has b e e n o b t a i n e d

for increasing I M F quotas t o avert an international
crisis in c o n f i d e n c e . T h e I M F r e c e n t l y has b e e n
p r o v i d i n g further financial assistance t o selected
debt-burdened countries on the condition
t h a t t h e r e c i p i e n t c o u n t r i e s i m p l e m e n t agreedu p o n a u s t e r i t y measures. T h e s e m e a s u r e s inc l u d e reducing g o v e r n m e n t b u d g e t deficits
and slowing monetary growth to lower inflation
a n d t o r e d u c e n o m i n a l i n t e r e s t rates, w h i c h in
t u r n s h o u l d increase d e b t o r c o u n t r i e s ' e x p o r t s
and decrease their imports, thereby improving
t h e i r b a l a n c e o f p a y m e n t p o s i t i o n s . U. S. c o m m e r c i a l banks, a m o n g o t h e r s , also are a g r e e i n g
t o m a k e a d d i t i o n a l loans, c o n t i n u e e x i s t i n g
loans a n d reschedule r e p a y m e n t s o n o u t s t a n d i n g
loans.
A crucial q u e s t i o n is w h e t h e r I M F actions,
w h i c h u l t i m a t e l y are f u n d e d b y t h e U. S. a n d
o t h e r m e m b e r c o u n t r i e s , r e p r e s e n t s u p p o r t for

"Some analysts contend that an
international lender of last resort is
essential."

large U. S. a n d i n t e r n a t i o n a l c o m m e r c i a l banks.
Clearly, U. S. banks, w h i c h had implicitly a c c e p t e d
t h e risks of f o r e i g n l e n d i n g , b e n e f i t at least
t e m p o r a r i l y f r o m such financial assistance. Their
actual losses a n d potential insolvency p r o b l e m s
are p o s t p o n e d , if n o t e l i m i n a t e d , p r o v i d e d n o
d e f a u l t s are legally d e c l a r e d . 3 0 C u r r e n t l y , t h e
I M F makes loans t o countries suffering liquidity
p r o b l e m s , in part b e c a u s e p r i v a t e l e n d e r s h a v e
assessed t h e s e c o u n t r i e s t o b e t o o r i s k y t o
increase l e n d i n g t o t h e m . As d i s c u s s e d , t h e
p u r p o s e of a l e n d e r of last resort is t o p r o v i d e
liquidity t o p r e v e n t t h e default of w e l l - m a n a g e d
and o t h e r w i s e s o u n d institutions. M a k i n g loans t o
high-risk d e b t o r c o u n t r i e s d o e s n o t fit t h a t
definition.

26

Dean a n d Giddy p. 41. See also R. G. Hawtrey, T h e Art of C e n t r a l
B a n k i n g , p. 274.
" S e e , for example, Dean and Giddy (1981), p. 33.
20
Weintraub, Robert, pp. 43-44.
" T h e IMF may borrow from any source a n d in the currency of any member
country, but it must first obtain the consent of the government of the
member country in w h o s e currency it proposes to borrow. Thus far it has
b o r r o w e d limited funds from member countries but never from t h e
m a r k e t s In January 1982, the IMF's Executive Board confirmed that
quotas should continue to be the main source of funds. See Group of
Thirty T h e I n t e r n a t i o n a l M o n e t a r y F u n d a n d t h e Private M a r k e t s .
New York 1983, p. 2.

66




30

A loan is not legally in default until the lender declares that the borrower
has failed to honor the terms of the loan. Also, banks carry loans at book,
not m a r k e t value. However, the FDIC may close a bank based upon a
comparison of the market value of assets to insured d e p o s i t s There is
currently a move to disclose more information abput a bank's balance
sheet so that depositors may more fully discern the risk a t t a c h e d to
dealing with any particular b a n k

JANUARY 1984, E C O N O M I C

REVIEW

Some Concluding Thoughts
U n d e r current circumstances, then, n o additional p o w e r s n e e d b e g i v e n t o t h e I M F t o
enable it t o a s s u m e t h e role of a n i n t e r n a t i o n a l
lender of last resort for t h e global b a n k i n g system.
No " w o r l d l i q u i d i t y crisis" has e m e r g e d . Even
should s u c h a crisis o c c u r , it c o u l d b e a l l e v i a t e d
by t h e n a t i o n a l m o n e t a r y a u t h o r i t i e s of t h e
i n d u s t r i a l i z e d c o u n t r i e s a c t i n g as l e n d e r s of
last resort f o r d o m e s t i c c o m m e r c i a l b a n k s a n d
their foreign subsidiaries a n d b y pursuing stable,
predictable, non-inflationary and thus c r e d i b l e
monetary policies. 3 1 C e n t r a l b a n k s m u s t h a v e
well-established and recognized policies t o
avoid a l l o w i n g b a n k failures t o a f f e c t t h e i r
national m o n e y s u p p l i e s .
In s u m , s t a b l e
monetary policies and reliable d o m e s t i c lenders
of last resort p r o v i d e a d e q u a t e defense against
liquidity crises. T h u s t h e m e c h a n i s m is already

3

'There is c u r r e n t l y s o m e a m b i g u i t y a b o u t w h o legally b e a r s t h e l e n d e r of
last resort r e s p o n s i b i l i t y for a s u b s i d i a r y of a f o r e i g n bank. H o w e v e r , m o s t
U S. l o a n s t h r o u g h t h e E u r o c u r r e n c y m a r k e t a r e h a n d l e d t h r o u g h L o n d o n
branches of U.S. banks, not subsidiaries." E v e n so, " s u b s i d i a r i e s d o play a
significant role in s o m e cases, s u c h as s u b s i d i a r i e s of G e r m a n b a n k s
o p e r a t i n g in L u x e m b o u r g . " D e s p i t e t h i s l o o p h o l e in l e n d e r of last r e s o r t
coverage, " t h e e v e n t s of 1 9 8 2 - 8 3 illustrate a w i l l i n g n e s s of c e n t r a l b a n k s
to work t o g e t h e r in crisis, s u g g e s t i n g that, if n e c e s s a r y , t h e y c o u l d a g r e e
on t h e d i v i s i o n of l e n d e r of last resort r e s p o n s i b i l i t y for c u r r e n t l y
a m b i g u o u s cases." S e e W i l l i a m R. Cline, I n t e r n a t i o n a l D e b t a n d t h e
S t a b i l i t y o f t h e W o r l d E c o n o m y , I n s t i t u t e for I n t e r n a t i o n a l E c o n o m i c s ,
S e p t e m b e r 1 9 8 3 , pp. 1 0 3 - 1 0 5 .

established for p r e v e n t i n g international d e b t
p r o b l e m s f r o m triggering a d o m e s t i c financial
crisis.
So l o n g as t h e s e p o l i c i e s a r e p u r s u e d c o n sistently, o n e d o e s n o t n e e d t o b e c o n c e r n e d
a b o u t t h e financial system's vulnerability t o a
m o n e t a r y collapse.
Still, t h e s e v e r i t y of t h e c u r r e n t i n t e r n a t i o n a l
d e b t situation highlights t h e n e e d for a t h o r o u g h
assessment of t h e I M F ' s role in a n i n c r e a s i n g l y
i n t e r d e p e n d e n t w o r l d e c o n o m y a n d of t h e
financial resources required to support that
role. T h e issue c e r t a i n l y is a c o m p l e x o n e .
M a k i n g t e m p o r a r y s h o r t - t e r m loans t o ease
pressure d u r i n g t i m e - c o n s u m i n g loan reschedu l i n g n e g o t i a t i o n s i n d e e d m a y b e a v a l i d role
for central banks and international agencies .
A n assessment of t h e IMF's role remains crucial
even t h o u g h t h e recent d e b a t e over o u r nation's
I M F f u n d i n g has e n d e d , w i t h C o n g r e s s a u t h o rizing t h e increase t h a t e v e r y o n e h o p e s can
h e l p resolve t h e d e b t p r o b l e m .
—James R. Barth
and Robert E. Keleher
This paper was written while lames K Barth was a Visiting Scholar with the
Federal Reserve Bank ol Atlanta. He is currently visiting the
Congressional
Budget Office while on leave Irom the George Washington
University. The
authors are grateful for helpful c o m m e n t s and suggestions from Bryan Boulier,
K. Dan Brumbaugh, lerrv Dwyer, Paclma Cotur, ¡im Hauver, lohn Hillev, George
Iden, lorge Laumas, Neela Manage, Lisa Kockoff, Steve Sheffrin, Lee Slutz
Stephen Thurman, and joe Whitt.

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A g e n d a f o r R e f o r m . F e d e r a l H o m e L o a n B a n k Board, W a s h i n g t o n , D.C.,
M a r c h 1983.
Aliber, Robert. " B a g e h o t , The L e n d e r of Last Resort, a n d T h e I n t e r n a t i o n a l
F i n a n c i a l System," u n p u b l i s h e d m a n u s c r i p t ( n o date).
Anderson, B a r r y L a n d J a m e s L. B u t k i e w i c z . M o n e y , S p e n d i n g , a n d t h e
Great D e p r e s s i o n , " S o u t h e r n E c o n o m i c J o u r n a l , O c t o b e r 1 9 8 0
Bagehot, Walter. L o m b a r d S t r e e t (1873), A r n o Press, N e w York, 1 9 7 8 .
oarth, J a m e s R. a n d J o s e p h Pelzman. I n t e r n a t i o n a l Debt: C o n f l i c t a n d
Resolution," I n t e r n a t i o n a l Debt S e r i e s M o n o g r a p h N o 3, Dept. of
E c o n o m i c s , G e o r g e M a s o n University. J a n u a r y 1984.
B e r n a n k e , B e n S. N o n m o n e t a r y E f f e c t s of t h e F i n a n c i a l Crisis in t h e
P r o p a g a t i o n of t h e G r e a t Depression," A m e r i c a n E c o n o m i c
Review, June 1983.
Brunner, Karl, et. al. " T h e I n t e r n a t i o n a l D e b t Problem, I n s o l v e n c y a n d
llliquidity: A Policy Proposal," S t a t e m e n t p r e p a r e d by t h e Ad H o c
C o m m i t t e e o n I n t e r n a t i o n a l D e b t a n d U S. F i n a n c i a l Policies,
D i s t r i b u t e d by T h e C e n t e r for R e s e a r c h in G o v e r n m e n t Policy a n d
Business, Graduate S c h o o l of M a n a g e m e n t University of Rochester,
J a n u a r y 14, 1983.
Dean, J a m e s W. a n d Ian H. G i d d y A v e r t i n g I n t e r n a t i o n a l B a n k i n g C r i s e s
M o n o g r a p h 1 9 8 1 - 1 , N e w Y o r k University, T h e M o n o g r a p h S e r i e s
in F i n a n c e a n d E c o n o m i c s , 1 9 8 1 .
Diamond, D o u g l a s W. a n d P h i l i p H. Dybvig. " B a n k Runs, Deposit Insurance,
a n d Liquidity," J o u r n a l o f P o l i t i c a l E c o n o m y , J u n e 1983.
Edwards, Franklin. " F i n a n c i a l I n s t i t u t i o n s a n d R e g u l a t i o n s in t h e 2 1 s t
C e n t u r y : A f t e r t h e Crash," M i m e o g r a p h , C o l u m b i a University,
1980.
Friedman, M i l t o n a n d A n n a Schwartz. A M o n e t a r y H i s t o r y o f t h e U n i t e d
S t a t e s , P r i n c e t o n U n i v e r s i t y Press, P r i n c e t o n , N e w Jersey, 1963.

FEDERAL RESERVE B A N K O F A T L A N T A




G r o u p of Thirty. T h e I n t e r n a t i o n a l M o n e t a r y F u n d a n d t h e P r i v a t e
M a r k e t s , N e w York, 1983, p. 2.
Guttentag, J a c k a n d Richard Herring. T h e L e n d e r o f Last R e s o r t F u n c t i o n
i n a n I n t e r n a t i o n a l C o n t e x t Essays in I n t e r n a t i o n a l F i n a n c e , No.
151, M a y 1983. International F i n a n c e Section, P r i n c e t o n University.
H a w t r e y , Ralph. T h e A r t o f C e n t r a l B a n k i n g , Frank C a s s a n d Co. Ltd.,
L o n d o n , 1962.
H u m p h r e y , T h o m a s M T h e C l a s s i c a l C o n c e p t of t h e L e n d e r of Last
Resort," E c o n o m i c R e v i e w , F e d e r a l R e s e r v e B a n k of R i c h m o n d ,
January/ February 1975.
K i n d l e b e r g e r , C h a r l e s P M a n i a s , P a n i c s , a n d C r a s h e s , Basic Books, N e w
York, 1 9 7 8 .
Mayer, T h o m a s " S h o u l d L a r g e B a n k s B e A l l o w e d t o Fail?", J o u r n a l o f
F i n a n c i a l a n d Q u a n t i t a t i v e A n a l y s i s , N o v e m b e r 1975.
M o g g r i d g e , D. E. " F i n a n c i a l C r i s e s a n d L e n d e r s of Last Resort: Policy in t h e
C r i s e s of 1 9 2 0 a n d 1929, J o u r n a l o f E u r o p e a n H i s t o r y , V o l u m e
10, No. 1, S p r i n g 1 9 8 1 .
Smith, Vera. T h e R a t i o n a l e o f C e n t r a l B a n k i n g , L o n d o n , P. S. K i n g & S o n
Ltd., W e s t m i n s t e r , 1936.
Sprague, O M. W. H i s t o r y o f C r i s e s U n d e r t h e N a t i o n a l B a n k i n g S y s t e m ,
W a s h i n g t o n , D. C.. U. S. G o v e r n m e n t P r i n t i n g Office, 1910.
S t e e r i n g C o m m i t t e e . " R e p o r t of a S y s t e m C o m m i t t e e , " R e a p p r a i s a l o f t h e
F e d e r a l R e s e r v e D i s c o u n t M e c h a n i s m , B o a r d of G o v e r n o r s of
t h e Federal R e s e r v e System, V o l u m e 1, A u g u s t 1 9 7 1 .
Tussig, A. Dale. " T h e C a s e for B a n k Failure," J o u r n a l of L a w a n d
E c o n o m i c s , V o l u m e X, O c t o b e r 1967.
W e i n t r a u b , R o b e r t E. I n t e r n a t i o n a l D e b t : C r i s i s a n d C h a l l e n g e , D e p a r t m e n t of E c o n o m i c s , G e o r g e M a s o n University, Fairfax, V i r g i n i a
April 1 9 8 3 .

67

n

FINANCE
NOV
1983

OCT
1983

NOV
1982

ANN.
%
CHG.

NOV
1983

OCT
1983

NOV
1982

586,027
17,785
163,094
424,395
SEPT
472,267
31,827

611,947
17,927
179,418
417,960
AUG
472,701
32.013

540,063
12,403
95,622
433,517
SEPT
485,125
17.176

N.A.
N.A.
N.A.
N.A.
SEPT

N.A
N.A.
N.A.
N.A.
AUG

N.A.
N.A.
N.A.
N.A.
SEPT

5,144
141
864
4,186
SEPT
3,712
272

5,158
146
875
4,182
AUG
3,704
257

4,530
106
569
3,908
SEPT
3,787
46

53,379
2,029
15,337
36,406
SEPT

53,070
2,033
15,647
35,725
AUG

48,108
1,335
8,065
38,758
SEPT

N.A.
N.A.
N.A.
N.A.
SEPT

N.A.
N.A.
N.A.
N.A.
AUG

N.A.
N.A.
N.A.
N.A.
SEPT

8,929
190
2,408
6,407
SEPT

8,883
190
2,403
6,374
AUG

8,033
127
1,268
6,665
SEPT

+ 11
+ 50
+ 90
- 4

2,527
92
499
1,960
SEPT

2,543
92
506
1,976
AUG

2,420
63
241
2,138
SEPT

+ 4
+ 46
+ 107

7,333
213
1,526
5,636
SEPT
5,762
222

7,303

6,543
122
710
5,723
SEPT
5,992
130

+ 12
+ 75
+115

CHG.

$ millions
commercial Bank
Demand
NOW
Savings
Time
C r e d i t Union Deposits
Share D r a f t s
Savings & T i m e

1,298,909 1,296,169 1,191,183
298,864
307,622
302,058
82,970
82,865
65,046
344,646
346,078
153,992
603,985
596,651
703,288
60,557
60,902
51,741
5,412
5,461
3,859
49,834
50,054
43,340

9
1
+ 28
+ 124
- 14
+ 17
+ 40
+ 15

Savings & Loans**
T o t a l Deposits
NOW
Savings
Time

C o m m e r c i a l Bank Deposits
Demand
NOW
Savings
Time
C r e d i t Union Deposits
Share D r a f t s
Savings & T i m e

146,684
34,474
10,641
38,619
66,159
5,933
474
5,066

146,524
35,595
10,598
38,247
65,946
5,946
483
5,063

127,260
34,120
8,439
15,153
72,541
4,927
360
4,157

+ 15
+ 1
+ 26
+155
- 9
+ 20
+ 32
+ 22

Savings & Loans
T o t a l Deposits
NOW
Savings
Time

C o m m e r c i a l Bank Deposits
Demand
NOW
Savings
Time
C r e d i t Union Deposits
Share D r a f t s
Savings ¿c T i m e

15,388
3,642
966
3,160
8,054
911
84
783

15,333
3,734
957
3,141
8,066
914
87
780

14,057
3,537
736
1,611
8,623
874
70
729

+ 9
+ 3
+ 31
+ 96
- 7
+ 4
+ 20
+ 7

Savings & Loans*'
T o t a l Deposits
NOW
Savings
Time

Commercial Bank Deposits
Demand
NOW
Savings
Time
C r e d i t Union Deposits
Share D r a f t s
Savings & T i m e

51,416
11,951
4,395
17,882
18,041
2,604
240
2,067

51,173
12,418
4,405
17,598
17,864

+ 24
+ 1
+ 19
+ 179

Savings & Loans**
T o t a l Deposits
NOW
Savings
Time

242
2,057

41,464
11,793
3,686
6,420
20,431
2,206
193
1,719

commercial Bank
Demand
NOW
Savings
Time
C r e d i t Union Deposits
Share D r a f t s
Savings <5c T i m e

21,347
6,732
1,461
4,815
9,382
1,334

21,372
6,959
1,426
4,770
9,330
1,352
72
1,203

18,054
6,285
1,230
1,705
9,728
906
39
814

Savings & Loans
T o t a l Deposits
NOW
Savings
Time

Commercial Bank Deposits
Demand
NOW
Savings
Time
C r e d i t Union Deposits
Share D r a f t s
^SavingTime

24,868
5,661
1,383
5,361
12,967

24,903
5,734
1,373
5,317
13,007
199
23
194

23,096
5,890
1,144
2,469
14,068
164
11
155

Savings k Loans**
T o t a l Deposits
NOW
Sav'ngs
Time

Commercial Bank Deposits
Demand
NOW
Savings
Time
C r e d i t Union Deposits
Share D r a f t s
Savings & T i m e

11,529
2,287
777
2,440
6,279
*
*

C o m m e r c i a l Bank Deposits
Demand
NOW
Savings
Time
C r e d i t Union Deposits
Share D r a f t s
Savings <5c T i m e

22,136
4,201
1,659
4,961
11,436
883
59
831

68

1,191

201

23
194

2,602

-

12

+ 18
+ 24
+ 20

+ 9
+ 43
+ 71
2
3
+ 85

Mortgages Outstanding
Mortgage C o m m i t m e n t s

Mortgages Outstanding
Mortgage Commitments

+ 14
+ 33
+ 52
+ 7
- 2
+491

Mortgages Outstanding
Mortgage C o m m i t m e n t s

Mortgages Outstanding
Mortgage C o m m i t m e n t s
Savings & Loans**
T o t a l Deposits
NOW
Savings
Time
Mortgages Outstanding
Mortgage C o m m i t m e n t s

22,259
4,352
1,652
5,001
11,446
879
59
829

20,045
4,304
1,034
2,185
12,625
777
47
740

+ 10
2
+ 60
+127
9
+ 14
+ 26
+ 12

Savings & Loans**
T o t a l Deposits
NOW
Savings
Time
Mortgages Outstanding
Mortgage Commitments

210

1,545
5,603
AUG
5,739
210

-

2

- 4
+ 70

A l l deposit data are extracted from the Federal Reserve Report of Transaction Accounts, other Deposits and Vault Cash (FR2900),
and are reported f o r the average of the week ending the 1st Wednesday of the month. This data, reported by institutions w i t h
over $15 m i l l i o n in deposits as of December 31, 1979, represents 95% of deposits in the six state area. The major differences between
this report and the " c a l l report" are size, the treatment of interbank deposits, and the treatment of f l o a t . The data generated from
the Report of Transaction Accounts is for banks over $15 m i l l i o n in deposits as of December 31, 1979. The t o t a l deposit data generated
from the Report of Transaction Accounts eliminates interbank deposits by reporting the net of deposits "due t o " and "due f r o m " other
depository institutions. The Report of Transaction Accounts subtracts cash items in process o f collection from demand deposits, while
the call report does not. Savings and loan mortgage data are from the Federal Home Loan Bank Board Selected Balance Sheet Data.
The Southeast data represent the t o t a l of the six states. Subcategories were chosen on a selective basis and do not add t o t o t a l .
* = f e w e r than four institutions reporting.
* * - S&L deposits subject to revisions due to reporting changes.
N . A . = not available at this t i m e .

68FRASER
Digitized for


JANUARY 1984, E C O N O M I C R E V I E W

CONSTRUCTION
SEPT
1983

OCT
1982

ANN
%
CHG

Nonresidential Building "Permits - $ M i l .
Total Nonresidential
50,568
Industrial Bldgs.
5,640
Offices
12,568
Stores
6,717
Hospitals
2,062
Schools
878

49,130
5,300
12,197
6,468
1,903
886

45,545
5,302
12,215
5,205
1,760
807

+ 11
+ 6
+ 3
+ 29
+ 17
+ 9

Residential Building Permits
Value - $ M i l .
Residential Permits - Thous.
Single-family units
M u l t i - f a m i l y units
T o t a l Building Permits
Value - $ M i l .

Nonresidential Building Permits
Total Nonresidential
Industrial Bldgs.
Offices
Stores
Hospitals
Schools

Mil.
7,845
635
1,833
1,249
472
171

7,679
666
1,835
1,189
466
168

6,204
713
1,344
955
260
82

+ 26
- 11
+ 36
+ 31
+ 82
+ 109

Residential Building Permits
Value - $ M i l .
Residential Permits - Thous.
Single-family units
M u l t i - f a m i l y units
T o t a l Building Permits
Value - $ M i l .

Nonresidential Building Permits Total Nonresidential
Industrial Bldgs.
Offices
Stores
Hospitals
Schools

Mil.
450
26
59
86
23

430
20
58
83
24

389
82
54
64
25

+ 16
- 68
+ 9
+ 34
- 8
0

Residential Building Permits
Value - $ M i l .
Residential Permits - Thous.
Single-family units
M u l t i - f a m i l y units
T o t a l Building Permits
Value - $ M i l .

+ 27
+ 5
+ 31
+ 39
+126
+ 184

Residential Building Permits
Value - $ M i l .
Residential Permits - Thous.
Single-family units
M u l t i - f a m i l y units
T o t a l Building Permits
Value - $ M i l .

OCT
1983

ANN
%

OCT
1982

SEPT
1983

OCT
1983

CHG

12-month Cumulative R a t e

'RID A
Nonresidential Building Permits - $ M i l .
Total Nonresidential
3,933
Industrial Bldgs.
376
Offices
852
Stores
701
Hospitals
294
Schools
54

3,875
358
854
661
298
52

3,090
359
650
506
130
19

Nonresidential Building Permits - $ M i l
1,272
Total Nonresidential
176
Industrial Bldgs.
352
Offices
138
Stores
36
Hospitals
28
Schools

1,233
173
373
132
26
28

983
145
220
89
27
18

+
+
+
+
+
+

29
21
60
55
33
56

Residential Building Permits
Value - $ M i l .
Residential Permits - Thous.
Single-family units
M u l t i - f a m i l y units
T o t a l Building Permits
Value - $ M i l .

Nonresidential Building Permits - $ M i l .
T o t a l Nonresidential
1,210
Industrial Bldgs.
46
Offices
365
Stores
129
Hospitals
123
Schools
69

1,209
47
406
122
78
65

925
80
297
150
24

+ 31
- 43
+ 23
- 14
+339
+ 188

Residential Building Permits
Value - $ M i l .
Residential Permits - Thous.
Single-family units
M u l t i - f a m i l y units
T o t a l Building Permits
Value - $ MQ.

T o t a l Nonresidential
Industrial Bldgs.
Offices
Stores
Hospitals
Schools

192
8
19
43
18
7

190
7
17
38
18
8

150
13
17
34
5
3

+ 28
- 38
+ 12
+ 26
+260
+ 133

Residential Building Permits
Value - $ M i l .
Residential Permits - Thous.
Single-family units
M u l t i - f a m i l y units
T o t a l Building Permits
Value - $ M i l .

T o t a l Nonresidential
Industrial Bldgs.
Offices
Stores
Hospitals
Schools

788
58
150
151
24
5

742
61
127
154
22
6

667
35
106
114
43
10

+
+
+
+
-

Residential Building Permits
Value - $ M i l .
Residential Permits - Thous.
Single-family units
M u l t i - f a m i l y units
T o t a l Building Permits
Value - $ M i l .

28

18
66
42
32
44
50

65,165

63,233

36,804

+ 77

870.2
674.2

850.8
653.3

493.3
417.1

+ 76
+ 62

115,733

112,363

82,349

+ 41

11,920

11,549

6,693

+ 78

179.1
149.3

174.2
143.7

100.5
83.4

+ 78
+ 79

19,765

19,228

12,897

+ 53

397

384

229

+ 73

7.7
7.1

7.7
6.8

4.4
4.2

+ 75
+ 69

847

815

618

+ 37

6,860

6,693

4,015

+ 71

95.6
82.6

92.3
81.2

52.0
50.3

+ 84
+ 64

10,793

10,568

7,105

+ 52

2,314

2,243

1,243

+ 86

40.5
24.1

39.8
23.3

23.8
12.0

+ 70
+ 101

3,586

3,475

2,227

+ 61

1,064

1,009

619

+ 72

16.9
16.0

16.6
14.4

10.3
8.1

+ 64
+ 98

2,273

2,218

1,544

+ 47

310

288

162

+ 91

4.8
4.5

4.7
3.8

3.3
2.1

+ 45
+ 114

501

478

312

+ 61

976

933

425

+ 130

13.5
15.1

13.2
14.2

6.9
6.8

+ 96
+ 122

1,691

1,602

1,091

+ 55

NOTES"
Data supplied by the U. S. Bureau of the Census, Housing Units Authorized By Building Permits and Public C o n t r a c t s , C-40.
Nonresidential data excludes the cost of construction for publicly owned buildings. The southeast data represent the t o t a l of
the six states. The annual percent change calculation is based on the most recent month over prior year. Publication of F . W.
Dodge construction contracts has been discontinued.


FEDERAL
RESERVE BANK O F ATLANTA


69

GENERAL
LATEST
DATA

Personal Income
($bil. - SAAR)
Taxable Sales - $bil.
Plane Pass. A r r . 000's
Petroleum Prod, (thous
Consumer Price Index
1967=100
K i l o w a t t Hours - mils.

2Q

NOV

CURR.
PERIOD

PREV.
PERIOD

2,709.1
N.A.
N.A.
8,634.7

2,650.6
N.A.
N.A.
8,670.0

YEAR
AGO

ANN.
%
CHG.

2,556.1
N.A.
N.A.
8,637.5

+ 6

0

-

303.1
201.6

302.6
207.7

293.6
183.6

+ 3
+ 9

319.5
N.A.
4,282.6
1,399.5

306.4
N.A.
3,268.7
1,384.5

+ 7

SEP
NOV

326.8
N.A.
3,649.4
1,399.0

SEP

N.A.
33.5

N.A.
34.8

N.A.
33.8

- 1

2Q
AUG
OCT
NOV

36.2
28.1
111.6
52.0

35.5
27.5
105.8
52.0

33.9
27.3
106.6
53.0

+
+
+
-

SEP

N.A.
4.5

N.A.
4.6

N.A.
4.7

Personal Income
($bil. - S A A R )
2Q
Taxable Sales - $ bil.
OCT
Plane Pass. A r r . 000's
SEP
Petroleum Prod, (thous.) NOV
Consumer Price Index - Miami
Nov. 1977 = 100
K i l o w a t t Hours - mils.
SEP

122.0
72.1
1,677.0
52.0
NOV
164.0
9.8

118.8
71.4
2,039.2
55.0
SEPT
162.9
9.9

113.4
66.6
1,474.2
68.0
NOV
156.8
9.2

+ 8
+ 8
+ 14
-24

Personal Income
($bil. - SAAR)
2Q
Taxable Sales - $ b i l .
3Q
Plane Pass. A r r . 000's
OCT
Petroleum Prod, (thous.)
Consumer Price Index - A t l a n t a
1967 = 100
SEP
K i l o w a t t Hours - mils.

58.2
41.1
1,646.3
N.A.
OCT
304.4
4.9

56.6
40.4
1,446.3
N.A.
AUG
303.9
5.7

53.5
39.3
1,294.0
N.A.
OCT
297.8
5.2

+ 9
+ 5
+27

45.3
N.A.
241.7
1,207.0

44.7
N.A.
271.0
1,172.5

+ 3

OCT
NOV

45.9
N.A.
286.7
1,209.0

SEP

N.A.
5.7

N.A.
5.7

N.A.
5.9

OCT
NOV

20.8
N.A.
35.3
86.0

20.4
N.A.
32.1
85.5

19.8
N.A.
27.7
91.0

SEP

N.A.
2.4

N.A.
2.5

N.A.
2.4

2Q
NOV
OCT
NOV

43.7
37.7
160.7
N.A.

42.9
36.9
146.5
N.A.

41.1
34.8
156.0
N.A.

SEP

N.A.
6.2

N.A.
6.4

N.A.
6.4

Personal Income
($bil. - S A A R )
Taxable Sales - $ bil.
Plane Pass. A r r . 000's
Petroleum Prod, (thous.
Consumer Price Index
1967=100
K i l o w a t t Hours - mils.
Personal Income
($bil. - SAAR)
Taxable Sales - $ bil.
Plane Pass. A r r . 000's

Personal Income
($bil. - SAAR)
Taxable Sales - $ b i l .
Plane Pass. A r r . 000's
Petroleum Prod, (thous.)
Consumer Price Index
1967 = 100
K i l o w a t t Hours - mils.
Personal Income
($bil. - SAAR)
Taxable Sales - $ b i l .
Plane Pass. A r r . 000's
Petroleum Prod, (thous.)
Consumer Price Index
1967 = 100
K i l o w a t t Hours - mils.
Personal Income
($bil. - S A A R )
Taxable Sales - $ bil.
Plane Pass. A r r . 000's
Petroleum Prod, (thous.)
Consumer Price Index
1967 = 100
K i l o w a t t Hours - mils.

NOV
SEP

2Q

2Q

2Q

+ 11
+ 1

7
3
5
2

- 5

+ 5
+ 6

+ 2
- 6

+ 6
+ 3

- 4

+ 5
+27
- 5

0

+ 8
+ 3

NOV
1983

ANN.
%
CHG.

NOV
1982

OCT
1983

Agriculture
Prices Rec'd by Farmers
135
Index (1977=100)
73,141
Broiler Placements (thous.)
59.2
C a l f Prices ($ per cwt.)
33.0
Broiler Prices (4 per lb.)
7.97
Soybean Prices ($ per bu.)
243
Broiler Feed Cost ($ per ton)

134
73,681
57.1
29.3
7.96
237

128
75,276
58.1
24.8
5.34
198

+ 5
- 3
+ 2
+33
+49
+23

Agriculture
Prices Rec'd by Farmers
123
Index (1977=100)
27,657
Broiler Placements (thous.)
55.5
C a l f Prices ($ per cwt.)
32.1
Broiler Prices (4 per lb.)
7.98
Soybean Prices ($ per bu.)
229
Broiler Feed Cost ($ per ton)

119
28,559
51.9
28.2
7.91
227

114
28,231
52.8
24.1
5.45
185

+ 8
- 2
+ 5
+ 33
+ 46
+ 24

Agriculture
Farm Cash Receipts - $ m i l .
1,206
(Dates: A U G , AUG)
9,278
Broiler Placements (thous.)
53.9
C a l f Prices ($ per cwt.)
33.0
Broiler Prices (4 per lb.)
7.80
Soybean Prices ($ per bu.)
255
Broiler Feed Cost ($ per ton)

9,577
51.7
29.0
7.84
240

1,232
9,406
52.2
23.5
5.41
192

- 2
- 1
+ 3
+40
+44
+33

Agriculture
Farm Cash Receipts - $ m i l .
3,116
(Dates: A U G , AUG)
1,755
Broiler Placements (thous.)
Calf Prices ($ per c w t . )
56.5
Broiler Prices (4 per lb.)
31.0
Soybean Prices ($ per bu.)
7.80
Broiler Feed Cost ($ per ton)
250

1,810
55.1
27.5
7.84
255

2,998
1,852
55.0
23.5
5.41
210

+ 4
- 5
+ 3
+32
+44
+ 19

Agriculture
Farm Cash Receipts - $ m i l .
1,734
(Dates: A U G , AUG)
10,928
Broiler Placements (thous.)
C a l f Prices ($ per c w t . )
50.4
Broiler Prices (4 per lb.)
31.5
Soybean Prices ($ per bu.)
7.79
Broiler Feed Cost ($ per ton)
210

11,490
47.6
29.0
7.72
220

1,781
11,307
49.8
23.5
5.31
181

- 3
- 3
+ 1
+34
+47
+ 16

775
N.A.
55.2
25.0
5.55
245

- 9

_ Z = H

Agriculture
Farm Cash Receipts - $ m i l .
(Dates: A U G , AUG)
Broiler Placements (thous.)
Calf Prices ($ per cwt.)
Broiler Prices (4 per lb.)
Soybean Prices ($ per bu.)
Broiler Feed Cost ($ per ton)

-

-

-

-

704
N.A.
55.0
33.0
8.19
290

N.A.
51.9
28.5
7.75
290

Agriculture
Farm Cash Receipts - $ m i l .
1,042
(Dates: A U G , AUG)
5,695
Broiler Placements (thous.)
Calf Prices ($ per cwt.)
58.7
Broiler Prices (4 per lb.)
32.0
Soybean Prices ($ per bu.)
8.06
Broiler Feed Cast ($ per ton)
205

5,682
52.7
26.0
8.03
195

Agriculture
Farm Cash Receipts - $ m i l .
1,086
(Dates: A U G , AUG)
N.A.
Broiler Placements (thous.)
56.7
Calf Prices ($ per cwt.)
30.0
Broiler Prices (4 per lb.)
7.89
Soybean Prices ($ per bu.)
225
Broiler Feed Cost ($ per ton)

N.A.
51.2
28.2
8.12
225

-

1,088
5,666
53.6
26.5
5.41
161

1,051
N.A.
51.3
23.0
5.53
170

- 0
+32
+ 48
+ 18

- 4

+1
+ 10
+21
+49
+27

+ 3
+ 11
+30
+43
+32

Personal Income data supplied by U. S. Department of Commerce. Taxable Sales are reported as a 12-month cumulative t o t a l .
Plane
Passenger Arrivals are collected f r o m 26 airports. Petroleum Production data supplied by U. S. Bureau of Mines. Consumer Price
Index data supplied by Bureau of Labor Statistics. A g r i c u l t u r e data supplied by U. S. Department o f A g r i c u l t u r e . Farm Cash
Receipts data are reported as cumulative for the calendar year through the month shown. Broiler placements are an average weekly
r a t e . The Southeast data represent the t o t a l of the six states. N . A . = not available. The annual percent change calculation is based
on most recent data over prior year. R = revised.

0
Digitized 7for
FRASER


JANUARY 1984, E C O N O M I C REVIEV

EMPLOYMENT
OCT
1983

SEPT
1983

OCT
1982

C i v i l i a n Labor Force - thous.
T o t a l Employed - thous.
T o t a l Unemployed - thous.
Unemployment Rate - % SA
Insured Unemployment - thous.
Insured Unempl. Rate - %
Mfg. A v g . Wkly. Hours
M f g . A v g . Wkly. Earn. - $

112,042
102,659
9,383
8.8
N.A.
N.A.
40.7
363

112,197
102,366
9,830
9.3
N.A.
N.A.
40.8
363

110,767
99,825
10,942
10.5
N.A.
N.A.
39.0
334

Civilian Labor Force - thous.
T o t a l Employed - thous.
Total Unemployed - thous.
Unemployment Rate - % SA
Insured Unemployment - thous.
Insured Unempl. Rate - %
Mfg. A v g . Wkly. Hours
M f g . A v g . Wkly. Earn. - $

14,671
13,292
1,378
9.6
N.A.
N.A.
41.1
318

14,725
13,353
1,374
9.5
N.A.
N.A.
41.1
317

14,498
12,987
1,511
10.7
N.A.
N.A.
39.9
296

C i v i l i a n Labor Force - thous.
T o t a l Employed - thous.
T o t a l Unemployed - thous.
Unemployment Rate - % SA
Insured Unemployment - thous.
Insured Unempl. Rate - %
Mfg. A v g . Wkly. Hours
M f g . A v e . Wkly. Earn. - $

1,769
1,551
12.9
N.A.
N.A.
41.7
318

1,74a
1,531
215
12.8
N.A.
N.A.
41.6
316

1,752
1,484
268
15.9
N.A.
N.A.
39.8
289

Civilian Labor Force - thous.
T o t a l Employed - thous.
T o t a l Unemployed - thous.
Unemployment Rate - % SA
Insured Unemployment - thous.
Insured Unempl. Rate - %
M f g . A v g . Wkly. Hours
M f g . A v g . Wkly. Earn. - $

5,003
4,571
432
8.2
N.A.
N.A.
40.9
303

5,113
4,697
416
7.8
N.A.
N.A.
40.8
302

C i v i l i a n Labor Force - thous.
T o t a l Employed - thous.
T o t a l Unemployed - thous.
Unemployment Rate - % SA
Insured Unemployment - thous.
Insured Unempl. Rate - %
Mfg. A v g . Wkly. Hours
M f g . A v g . Wkly. Earn. - $

2,696
2,504
192
7.3
N.A.
N.A.
41.8
298

C i v i l i a n Labor Force - thous.
T o t a l Employed - thous.
T o t a l Unemployed - thous.
Unemployment Rate - % SA
Insured Unemployment - thous.
Insured Unempl. Rate - %
Mfg. A v g . Wkly. Hours
M f g . Avg. Wkly. Earn. - $

ANN.
%
CHG.

+1

ANN.
%
CHG.

OCT
1982

SEPT
1983

OCT
1983

Nonfarm Employment- thous.
Manufacturing
Construction
Trade
Government
Services
Fin., Ins., & Real Est.
Trans. Com. & Pub. U t i l .

91,716
19,195
4,326
20,752
15,763
20,084
5,484
5,079

91,116
19,148
4,282
20,747
15,369
19,961
5,501
5,077

89,541
18,504
4,070
20,421
15,863
19,195
5,334
5.077

+2
+ 4
+ 6
+ 2
- 1
+ 5
+ 3
+ 0

Nonfarm Employment- thous.
Manufacturing
Construction
Trade
Government
Services
Fin., Ins., <5c Real Est.
Trans. C o m . & Pub. U t i l .

11,624
2,217
659
2,758
2,174
2,304
668
701

11,544
2,204
653
2,744
2,139
2,297
668
698

11,352
2,140
641
2,682
2,154
2,240
650
697

+
+
+
+
+
+
+
+

Nonfarm Employment- thous.
Manufacturing
Construction
Trade
Government
Services
Fin., Ins., & Real Est.
Trans. C o m . & Pub. U t i l .

1,319
335
61
268
293
218
59
71

1,314
335
61
267
290
218
59
71

1,310
+ 1
328
+ 2
6 0 + 2
267
+ 0
292
+ 0
218
+ 0
59
0
71
0

4,937
4,483
454
8.7
N.A.
N.A.
40.0
289

Nonfarm Employment- thous.
Manufacturing
Construction
Trade
Government
Services
Fin., las., óc Real Est.
Trans. C o m . & Pub. U t i l .

3,917
483
264
1,049
646
938
295
233

3,877
477
261
1,038
631
932
295
233

3,740
454
243
992
634
898
281
229

+ 5

2,695
2,504
191
7.2
N.A.
N.A.
41.7
296

2,693
2,487
205
8.0
N.A.
N.A.
40.0
272

Nonfarm Employment- thous.
Manufacturing
Construction
Trade
Government
Services
Fin., las., óc Real Est.
Trans. Com. <5c Pub. U t i l .

2,279
515
108
544
440
396
121
148

2,269
513
108
542
433
396
121
148

2,215
499
103
525
441
378
117
145

+
+
+
+
+
+
+

1,930
1,719
210
11.3
N.A.
N.A.
40.7
399

1,924
1,699
226
12.1
N.A.
N.A.
40.5
402

1,892
1,676
217
11.7
N.A.
N.A.
41.3
390

Nonfarm Employment- thous.
Manufacturing
Construction
Trade
Government
Services
Fin., las., <5c Real Est.
Trans. C o m . & Pub. U t i l .

1,596
194
116
368
314
308
80
124

1,587
193
115
367
310
308
80
124

1,608
201
121
369
310
304
80
128

+
+

C i v i l i a n Labor Force - thous.
T o t a l Employed - thous.
T o t a l Unemployed - thous.
Unemployment Rate - % SA
Insured Unemployment - thous.
Insured Unempl. Rate - %
Mfg. A v g . Wkly. Hours
M f g . A v g . Wkly. Earn. - $

1,065
948
117
12.0
N.A.
N.A.
40.6
277

1,069
947
122
12.2
N.A.
N.A.
40.8
276

1,075
956
119
12.1
N.A.
N.A.
39.6
255

Nonfarm Employment- thous.
Manufacturing
Construction
Trade
Government
Services
F i n . , Ins., & Real Est.
Trans. Com. & Pub. U t i l .

799
207
39
163
182
124
33
40

795
207
39
163
181
123
33
39

795
199
42
163
182
124
33
41

C i v i l i a n Labor Force - thous.
T o t a l Employed - thous.
T o t a l Unemployed - thous.
Unemployment Rate - % SA
Insured Unemployment - thous.
Insured Unempl. Rate - %
Mfg. A v g . Wkly. Hours
M f g . A v g . Wkly. Earn. - $

2,208

2,179
1,975
204
10.3
N.A.
N.A.
41.0
310

2,149
1,901
248

+ 5
-16

N.A.
N.A.
39.0

+ 5

Nonfarm Employment- thous.
Manufacturing
Construction
Trade
Government
Services
Fin., las., & Real Est.
Trans. Com. & Pub. U t i l .

1,714
483
71
366
299
320
80
85

1,702
479
69
367
294
320
80
83

1,684
459
72
366
295
318
80
83

ft

Notes:

218

1,999
209
10.5
N.A.
N.A.
41.1
312

12.2

282

+ 3
-14

+ 4
+ 9

+1
+ 5
-19

+ 5
+10

+ 11

2
4
3
3
1
3
3
1

3
3
5
4
0
5
3
2

1
3
4
1
1
1
0
- 3

+ 1
+ 4
-7
0
0
0
0
- 3

+ 2
+ 5

- 1
0
+1
+1
0
+ 2

A l l labor f o r c e data are from Bureau of Labor Statistics reports supplied by state agencies.
Only the unemployment rate data are seasonally adjusted.
The Southeast data represent the t o t a l of the six states.
The annual percent change calculation is based on the most recent data over prior year.

FEDERALfor
RESERVE
BANK O F ATLANTA
Digitized
FRASER


71

Federal R e s e r v e B a n k o f A t l a n t a
P.O. B o x 1 7 3 1
Atlanta, Georgia 3 0 3 0 1

Bulk Rate
U . S . Postage

Address Correction Requested

Atlanta, Ga.
Permit 292




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