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The Unemployment Rate as an
Economic Indicator ............................


Development of Electronic Funds
Transfer Systems ................ .............. 10

 58, No.


The Unemployment Rate
as an Economic Indicator


"URING the most recent recession,
the unemployment rate rose to its
highest level since the depression years
of the 1930s, reaching 8.9 percent in
May 1975. The unemployment rate has
since declined and stood at 7.9 percent
in August of this year. Despite this de­
cline, unemployment is still unacceptably high, with 7.5 million persons re­
porting that they want to work but
have not found jobs. The unemployment
picture has been aggravated by increases
in the unemployment rate in recent
months. Besides contributing to fears
that the economic recovery is weaken­
ing, such increases intensify pressure for
adopting policy measures designed to
reduce unemployment.

Labor Market Trends
















S h a d e d , are as, representtp e rio d s ot recessions.
a re a s re p re se n
Latest d a ta p lotted: 1 976 b a se d on first eight month!

The basic source of labor market information is
the monthly survey data collected by the Bureau of
the Census for the Bureau of Labor Statistics. The
civilian noninstitutional population is sampled,1 with
approximately 50,000 randomly selected households
surveyed monthly. With a carefully structured set of
questions, information is gathered which results in a
determination of the labor force status of the civilian
population, age 16 and over. The respondents are
never asked specifically if they are employed or un­
employed, nor are they given the opportunity to de­
cide their own labor force status. For example, for
persons replying that they did not work during the
survey week, questions are asked to determine
whether they had jobs from which they were absent
'The civilian noninstitutional population includes all persons
16 years of age or older who are not members of the Armed
Forces, members of penal or mental institutions, sanitariums,
or homes for the aged or infirm.

Page 2

or had no jobs whatsoever.2 If the respondents had no
jobs, further questions are asked until the sequence of
questions which leads to a labor force determination
is completed.
Household members are classified as employed if
they report doing any work at all for pay or profit
during the survey week. This includes part-time and
temporary work as well as full-time employment, and
incorporates unpaid workers who worked at least 15
hours in a family-operated enterprise. Although
workers may have been absent from work during
the survey week due to illness, vacation, strike, or
various personal reasons, they are still considered
To be classified as unemployed, persons must report
being without work during the survey week, being
2The survey covers the calendar week which includes the 12th
of each month, although it is actually conducted in the follow­
ing week.


currently available for work, and having actively
sought work at some time in the prior four weeks.
Seeking work, in the context of the survey, includes
registering at an unemployment office, answering ads,
or checking with friends or relatives about job open­
ings. Persons who are waiting to be called back to
a job from which they have been laid off or who are
waiting to report to a new job within 30 days are
considered unemployed, even though they do not
seek other work.
The total unemployment figure thus counts more
than those who have lost their jobs. It includes per­
sons who have quit their previous jobs to look for
other work, new workers looking for their first jobs,
and persons looking for jobs after an absence from
the labor force. The unemployment rate expresses
the number of persons classified as unemployed as
a percentage of the civilian labor force.
Household members who are not employed and
are not seeking employment are classified as “not in
the labor force.” Persons in this category are neither
employed nor unemployed. Some persons in this
category do not participate in the labor force be­
cause they are retired, attending school, or engaged
in home responsibilities. Others are financially inde­
pendent, or simply prefer leisure. Still others report


that they do not look for work because they believe
that no jobs are available for persons with their ex­
perience or training. This group is often referred to
as “discouraged workers.”
Due to the large size of the household sample,
labor market estimates derived from it are generally
regarded as reliable in a statistical sense. The data
are subject to some degree of sampling error, how­
ever, and this must be taken into account when an­
alyzing changes in the data. For the overall unem­
ployment rate, the error is relatively small. To be
deemed a significant change, the national unemploy­
ment rate would have to move 0.2 percentage point
or more on a monthly basis. There is a relatively
high probability that movements in the unemploy­
ment rate which are smaller than 0.2 percentage
point are due to sampling variability, instead of
changes in the unemployment situation. Unemploy­
ment rates for component groups, because they are
based on smaller samples, are subject to larger errors.
For example, the statistically significant error on
month-to-month movements in the teenage unem­
ployment rate is about 0.9 percentage point, and in
the black unemployment rate about 0.8 percentage

Productivity, Compensation, and Labor Costs

The unemployment statistics represent an attempt
to estimate the number of persons who want, but can­
not find, work. The data are most often used as meas­
ures of labor force utilization and as indicators of
general economic activity. These uses seem reason­
able (although subject to some limitations) since un­
employment, in principle, means human resources are
idled and productive opportunities are foregone.
Others use the data as measures of hardship expe­
rienced by the unemployed. Hardship resulting from
unemployment is influenced by a number of other
factors such as the amount of savings, eligibility for
unemployment compensation, food stamps, other wel­
fare programs, the number of household members
employed, and the extent of payments from former
employers or union funds. Because of the growing
importance of these other factors, the unemployment
rate tends to overestimate the extent of economic
hardship suffered relative to periods in the past.4
3“Unemployment: Measurement Problems and Recent Trends,”
U.S. Department of Labor, Bureau of Labor Statistics, Re­
port 445, 1975.

P e rc e n ta ge s a re a n n u a l rates of c h a n g e fo r p e rio d s in dicate d.
Latest d a t a plotted: 2 n d q u a rte r

4The unemployment rate for household heads is often used as
a more meaningful measure of hardship than the total unem­
ployment rate, but this rate is also subject to limitations.

Page 3


Unem ploym ent Rates*

S o u rc e : U.S. D e p a rtm e n t o f L a b o r
'P e r c e n t o f c iv ilia n l a b o r fo rce in g ro u p .
L a te st d a t a p lo tted : A u g u s t

On the other hand, the unemployment statistics
might understate the number of persons without work.
Because of the current definition of unemployment,
discouraged workers — those who forsake job search
because they feel no jobs are available for them — are
excluded from the official unemployment statistics.
Data collected in recent years indicate that dis­
couraged workers are primarily youths, women, and
blacks. If discouraged workers were added to the
seasonally adjusted unemployment rate for 1975, the
adjustment would add an average of 1.2 percentage
points to the total rate. This merely exemplifies the
depressed labor market conditions in 1975. In both
the years 1973 and 1974, discouraged workers would
have added 0.8 percentage point to the total rate
had they been included. Of course, the adjustment
in the jobless rate for adult men would be relatively
small, but would be greater on the already high rates
for women, youths, and blacks. In 1975, the addition
of discouraged workers would have increased the
unemployment rate for Negro and other races an
average of 3 percentage points.
One very important difficulty encountered with the
unemployment statistics is that questions concern­
ing wages are not part of the survey. Persons report­
ing that they believe no jobs are available are not
asked at what wage jobs appear to be unavailable.
Thus no information is gathered on the extent to
which unemployment results from an asking wage
which is too high. This situation can result from both

Page 4


a generally depressed state of economic activity
which has not convinced unemployed workers of the
general decrease in their value as factors of produc­
tion, and artificial restrictions which prevent the ask­
ing wage from falling to a level commensurate with
productive ability. Only the former case is amenable
to the traditional tools of monetary and fiscal policy.
Growth in aggregate demand will not aid those
whose unemployment results from labor market im­
perfections. For example, Government mandated wage
restrictions, such as the minimum wage, prevent em­
ployers and workers from coming together to bargain
for a mutually acceptable wage. Workers, especially
teenagers, often are willing to work at wages below
the legal minimum but are prevented from doing so.
As a result, unemployment in this group rises. Sim­
ilarly, unions negotiate wage contracts for all employ­
ees through collective bargaining and typically set
floors on wage offers. If some workers consequently
are laid off, they may be willing to work at wage
rates below union floors rather than lose their jobs,
but find they cannot do so. One alternative is to seek
other work, usually at a lower wage.
It should be noted that some degree of unemploy­
ment always prevails as workers change jobs to pur­
sue better job opportunities. This type of unemploy­
ment is typically short term, usually lasting five weeks
or less. Changes in labor supply and demand condi­
tions necessitate changes in employment and wages.
As workers become informed of better job possibili­
ties, they make changes across jobs. The unemploy­
ment resulting from movements of this sort, called
frictional unemployment, is expected in a changing
economic environment and thus is not of primary
concern for national economic stabilization purposes.5

Despite the popularity of the unemployment statis­
tics, their use alone does not provide a complete view
of the labor market situation. Use of unemployment
figures should be complemented by at least employ­
ment data.6 Too often, unemployment statistics signal
different labor market actions when viewed alone
and when viewed in conjunction with employment
figures. This is usually due to movements between
5For a discussion of the different types of unemployment, see
Roger W. Spencer, “The National Plans to Curb Unemploy­
ment and Inflation,” this Review (April 1973), pp. 2-13.
8Similarly, in analyzing the economic state of the nation, the
unemployment situation should be reviewed in conjunction
with other measures of economic performance, such as in­
dustrial production or gross national product.



Table 1




Labor Force



Unem ployed
15 W eeks
or More
as a Percent
of Total
Unem ployed

12 Months Before Trough of:
14 . 3 %

October 1 94 9


6 0 ,6 4 6

5 8 .7 %

5 8 ,3 8 7

3 .7 %

M a y 1954

106 ,9 1 0

6 2 ,6 1 5


6 1 ,0 1 9



April 1958

111 ,94 3

6 6 ,6 4 7


6 4 ,0 4 7



February 1961

116 ,70 2

6 8 ,9 4 9


6 5 ,6 2 0



Novem ber 1 97 0

1 35 ,23 9

8 1 ,3 9 7








65,5 2 3



147 ,81 6

9 0 ,5 4 9


8 6 ,033



M arch


At Trough of:
October 1949

104 ,33 8

62,1 8 5


5 7 ,2 6 9



M a y 1954

108 ,1 8 4

6 3 ,6 7 5


5 9 ,908



April 1958

113 ,41 5

6 7 ,6 4 7





February 1961

1 1 8 ,2 5 0

7 0 ,4 2 0


6 5 ,588



Novem ber 1970

138 ,05 3

83,4 2 2


7 8 ,5 3 7



1 16,448

6 9 ,4 7 0


6 4 ,7 8 7



150 ,448

9 1 ,8 8 0


84,1 1 0



October 1949

105 ,0 9 6

62,4 2 8


5 9 ,8 0 3



M ay

195 4

109 ,54 4



6 1 ,6 3 4



April 1958

114 ,9 8 6

6 8 ,3 3 9


6 4 ,768



February 1961

1 1 9 ,36 0

7 0 ,4 0 9


6 6 ,538



Novem ber 1 97 0


85,0 8 5


7 9 ,9 4 4




70,1 2 8


6 6 ,5 3 7



1 53.17 8

9 3 ,7 1 9







12 M onths After Trough of:



1A11 data are in thousands except labor force participation and unemployment rates. All data are seasonally adjusted except civilian noninstitutional population.
C h an ge From 1 2 M onths Before Trough to Trough

C hange From Trough to 1 2 Months After Trough
C ivilian
Labor Force

O vilian
Labor Force



October 1 94 9

2 .5 4 %

— 1 .9 1 %

4 .2 %

0 .3 9 %

4 .4 2 %

— 3.7 %

M a y 1954


— 1.82




— 1.6

April 1958


— 2.21




— 2.2

February 1961


— 0 .05


— 0.02


— 1.4

Novem ber 1 97 0


— 0.01






— 1.12




— 1.8


— 2.23




— 1.0



the categories of “unemployed” and “not in the labor
force.” A more complete representation and different
explanation of the labor market situation may result
when movements in employment are also considered.
Employment figures have several advantages over
the unemployment figures. Employment is a more
solid and objective concept than is unemployment.
With few exceptions, persons working during the
survey week are considered employed. Identification
of employment is relatively straightforward and thus

easier to measure than unemployment, where classifi­
cation depends on more provisos and is subject to
more uncertainties (such as in determining whether a
person is actively seeking work or is currently avail­
able for work).7 Also, employment figures are more
closely tied to output measures than are unemploy­
ment data. Decisions to look for work, for example,
’ Employment statistics are not without definitional problems,
however. Questions concerning the status of part-time and
underutilized workers are yet to be resolved.
Page 5



Total Employment
T ro u g h s= 1 0 0

T ro u g h s= 1 0 0

Seasonally Adjusted

Unem ploym ent Rate

O C T 49
M A Y 54
APR 58
F E B 61
NOV 70
M A R 75

rage of 1969-72, 1960-62,
1957-59, 1953-55, and 1948-51__






Latest data plotted: A u gu st 1976
Latest data plotted: A u gust 1976

often are based on personal factors, unrelated to
economic considerations.

Since it takes time for labor market actions to be
reflected in the unemployment rate, movements in
this rate generally trail economic activity. As the level
of economic activity falls, for example, it is usually
more feasible for employers to initially adjust work
schedules of existing workers than it is to discharge
workers employed for some time. Although actions
such as these signal the decline in economic activity,
they are not picked up by the unemployment data
until the workers are laid off. In a recovery, employers
are likely to increase hours worked of current em­
ployees rather than begin hiring procedures. Thus,
the unemployment rate tends to understate the extent
of a decline in economic activity at the start of the
decline and the extent of the recovery later on. In
past recessions, the unemployment rate typically has
peaked from one to four months after the trough of
the general business cycle.

Employment and Unemployment
The labor market response to the most recent down­
turn differs substantially from the behavior in other
postwar recession/recovery periods.8 Total employ­
ment in this recovery has already reached pre-reces­
sion levels. Employment has been increasing since
March 1975, after a 5.2 percent annual rate of de­
cline in the previous five months. This decline repre­
sents a marked change from the average of employ8The most recent recession is compared with the five postwar
recessions which reached their troughs in November 1970,
February 1961, April 1958, May 1954, and October 1949.
Recessions are identified by their trough months in this article.

Page 6

ment movements of the previous five recessions. In
these recessions, employment declined at a slower
rate, averaging a 1.1 percent drop in the 12 months
before the troughs. Employment in the 1970 recession
remained fairly constant throughout most of the eco­
nomic decline, only varying by about 350,000 workers
in the 12 months preceding the trough. The 1961
recession also did not register great declines in em­
ployment. Between June 1960 and February 1961,
total employment declined at a 1.3 percent annual
rate (see Table I, p. 5, for comparison).
Despite the steep decline, employment in the most
current period recovered faster than the average of
employment in other recession/recovery periods.
Total employment increased at a 3.1 percent rate
over the year since the 1975 trough, compared to a
2.7 percent average rate of increase for other recovery
periods. This difference has been made even more
apparent since March of this year. Between March
and August 1976, total employment rose at an annual
rate of 3.6 percent, widening the gap between employ­
ment movements in the most current and previous
recoveries (see accompanying chart). By August 1976,
employment reached 88 million workers, an increase
of four million workers in this recovery period.
While employment growth has been strong in this
recovery period, the unemployment rate has declined
only slowly. In August of this year, the unemployment
rate was only 0.6 percentage point below the rate at
the trough. Compared to the average of previous re­
coveries, the unemployment rate remains remarkably
high. Twelve months after the five prior troughs
in economic activity, the unemployment rate had
dropped an average of 1.8 percentage points, com­



spectively. For the same period after
the 1961 trough, labor force growth de­
clined by 0.1 percent.

Total Civilian Labor Force as a Percent
of Civilian Non-lnstitutional Population (16-64)*

Several factors have influenced this
labor force growth. A primary consid­
eration is the increase in labor force
participation.10 The participation rate
in August reached a high of 61.9 per­
cent of the population. The labor force
participation rate of adult women is
particularly noteworthy. As inflation
erodes real family income, other house­
"Both civilian la b o r force a n d non-institutional p o pu la tio n d a ta a re b a se d on the w orking force a g e g ro u p of 16-64. The lab o r force an d
hold members, particularly women, are
population com ponents a re b a se d on quarterly a ve rage s of monthly data. Total civilian la b o r force d ata are se aso n ally adjusted.
S h a d e d are a s represent p eriod s of recessions.
likely to be drawn into the labor force.
Latest d a ta plotted: 2nd quarter
This movement has compounded the ef­
pared to a 1 percentage point drop in the year fol­
fect of the trend for increased participation of women.
lowing the most recent trough. One year after the
By August 1976, the participation rate of women
troughs of the 1958 and 1949 recessions, the unem­
reached 47.4 percent. This is an increase of 4.1 per­
ployment rate had fallen 2.2 and 3.7 percentage
centage points since 1970 and 9.8 percentage points
points, respectively (see chart).
since 1960. As of August of this year, adult women
comprised 36.3 percent of the labor force. Another
group accounting for a larger proportion of the labor
Labor Force Growth and Unemployment
force than heretofore is teenagers. The labor force
The high unemployment rate relative to most pre­
participation rate for workers in the age group 16-19
vious recoveries can be explained in part by different
averaged 54.5 percent during 1974 and 1975, the high­
rates of labor force growth. Generally, the civilian
est in recent history. In August of this year, the par­
labor force grew at a much faster rate during the 1975
ticipation rate for teenagers reached 55.4 percent. The
recovery than in other postwar recoveries.9 Between
shifting composition of the labor force toward women
March 1975 and March 1976 (twelve months after
and youths and the higher unemployment rates gen­
the trough), the civilian labor force grew by 2 per­
cent. By contrast, in the twelve months following
other postwar troughs, growth in the civilian labor
force averaged 0.9 percent. In particular, in the twelve
months following the April 1958 trough,
the civilian labor force grew at half that
rate, and during the same period after
P e r c e it
the 1961 recession, the labor force de­
clined by 0.02 percent.

10Labor force participation rates measure the percentage of
persons in a given population, however defined, that are in
the labor force.
Selected Civilian Labor Force Participation Rates 1
Q u a rte rly A v e r a g e s of M o nth ly D ata
S e a son a lly Adjusted

P trC M t

In recent months, the differences in
labor force growth have become increas­
ingly more evident. From April to Au­
gust 1976, the civilian labor force grew
at a 3.4 percent annual rate. Labor
force growth has averaged a 2.8 percent
annual rate over the prior seventeen
months. Seventeen months after the low
points of the 1958 and 1949 recessions,
the civilian labor force had grown by
annual rates of 0.9 and 0.4 percent, re9The exception is the recovery from the Novem­
ber 1970 recession in which the civilian labor
force grew at about a two percent rate in the
twelve months following the trough.

U. Participation rates m e asu re the propo rtio n of persons in each p o pu latio n g ro u p that are in the civilian la b o r force.
Sh a d e d are as represent periods of recessions.
Latest d a ta plotted: 2nd quarter

Page 7


erally experienced by these groups tend to raise the
average level of the overall unemployment rate (see
chart entitled “Selected Civilian Labor Force Partici­
pation Rates”).

Duration of Unemployment
The behavior of the unemployment rate in this
recovery may also be related to factors which tend
to lengthen the duration of the unemployment period.
During the most recent recovery, the percentage of
the unemployed without work for 15 weeks or more
was larger than in previous recovery periods. At the
trough of the 1975 recession, 26 percent of the un­
employed were jobless for 15 weeks or more, com­
pared to 18 percent at the trough of the 1970 re­
cession and 20 percent of the unemployed at the
1949 bough. Nine months after the trough of the
most recent recession, 22 percent of the unemployed
were jobless for 27 weeks or more, while 11 percent of
the unemployed were still jobless after 27 weeks dur­
ing the 1970 recession. Nine months after the troughs
of the 1954 and 1949 recessions, 15 and 11 percent,
respectively, of the unemployed still had been with­
out work for 27 weeks or more.
The duration of unemployment depends in part on
the cost of remaining unemployed which, in turn, is in­
fluenced by the current system of unemployment com­
pensation as well as other benefit programs. By signifi­
cantly reducing the cost of remaining unemployed,
unemployment compensation tends to increase the
time devoted to searching for a job and thus lengthens
the average duration of unemployment.11
In 1975 Congress broadened the scope of eligi­
bility for unemployment insurance benefits and
provided additional benefits of up to 13 weeks a
year for covered unemployed workers who have
exhausted their regular benefits. Since workers
covered by unemployment insurance have been eli­
gible for 26 weeks of benefits per year and some
states provide an additional 13 or more weeks, this
extension by Congress enabled many unemployed
workers to receive benefits for one full year or more.
Expansion of insurance payments, coupled with
supplementary unemployment benefits and other
sources of aid such as food stamps, tend to reduce in11Longer search time, however, is not necessarily undesirable.
Accepting the first job offer reduces the probability of geting the highest-paying job and lowers one’s wealth compared
to what it would have been had one taken longer to find
other jobs. Thus, taking more time to search for a job may
“pay off” by resulting in higher lifetime earnings.

Page 8


Output versus Capacity
S t a le

Q u a rte rly Totals at A n n u a l Rates

R a tio

B i l li o n s o f D o l la r s

Se a s o n a lly Ad ju ste d

B i l lio a s o f D o lla r s

R a tio


S e a l*



n om ic C apa
(p re -1 9 7 4 )

^ ^ H e w c E n o m ic
Ca a c ilv U1259.4











U. Econom ic cap ac ity is estim ated to h a v e been decre ase d b y 4.5 percent, reflecting the effects of
h ighe r e ne rgy prices, gove rn m e nt resource a n d price control p rogram s, a n d other au tonom ous
restrictions on a g g re g a te productivity. N o adjustment is m ad e here to the rate o f grow th of c a p ­
acity, but that too p ro b ab ly h as been re du ced from the 3.6 percent norm ally used. See: De nis S.
Karnosky, 'The Link Between M o n e y a n d Prices— 1971-76 "tlune 1976).
Latest d ata plotted: 2 n d q u arte r

centives to look for work.12 Jobs are available even
during periods of highest unemployment; that is, job
vacancies do not completely dry up, but wages tend
to be unacceptably low in view of alternative pros­
pects. Workers in effect are discouraged from taking
lower paying or less desirable jobs when their cur­
rent spendable income, comprised of tax-free un­
employment insurance payments, is not very different
from their income after taxes derived from work
experience. As a result, unemployment and the
unemployment rate tend to decrease more slowly.

Although the unemployment rate has increased in
recent months, its rise is apt to convey a misleading
picture of the state of the labor market and the under­
lying strength of the current recovery. Other factors
reflect a more encouraging economic picture. Indus­
trial production, for example, rose at an annual rate
of 7.6 percent since January of this year. Real gross
national product increased at a 6.7 percent annual
rate in the first two quarters of 1976.
While the labor force has been growing at an ex­
ceptional rate, so has employment. Since January 1976,
12See Martin Feldstein, “The Economics of the New Unem­
ployment,” The Public Interest (Fall 1973).



total employment rose by 1.8 million workers, a 3.6
percent annual rate of increase. In the past year, em­
ployment rose by 3.2 percent. Thus, output growth
has been such that jobs are being provided not only
to those who became unemployed during the reces­
sion, but also to the growing numbers entering the
labor force.
Moreover, more people have been voluntarily seek­
ing other jobs in the past year than was previously the
case. Approximately 13 percent of those unemployed
in August voluntarily left their jobs to seek better
opportunities, compared to 10 percent of the unem­
ployed eleven months before. Typically, this upward
trend signals increased confidence on the part of
the job leavers that they will be able to find better
While job leavers are an increasing share of the
unemployed, job losers and new entrants/reentrants
into the labor force have been a decreasing propor­
tion of the jobless. The number of job losers among
the unemployed declined from 58.5 percent in June
1975 to 49.3 percent in August 1976. New entrants
and reentrants together represented 38 percent of the
unemployed in August, down two percentage points
since January. This downward trend suggests that
the increasing rates of participation, and thus the
strong labor force growth, may be slowing. If this is

the case, and if output growth continues at generally
expected rates, unemployment is likely to decline.

With over seven million persons unemployed, the
nation is confronted with one of the highest unem­
ployment rates in recent history. Moreover, when
compared to the average of previous postwar recov­
eries, the unemployment rate has made little progress
toward decline.
One reason for this failing is that the labor force
has grown at a much faster rate in this recovery
than in previous ones. New entrants and reentrants
have shifted the composition of the labor force to­
ward more women and youths, groups which have
higher unemployment rates. In addition, the relatively
high number of unemployed may be maintained due
to incentives for prolonged job search provided by
an expanded system of unemployment insurance
Despite the high rate of unemployment, relief may
be in the offing. Growth in employment has been
strong. Confidence in the economy to continue pro­
viding jobs is evident. If increases in labor force par­
ticipation rates decelerate, the expanding economy
should be able to integrate the currently unemployed
into desired jobs.

Page 9

Development of Electronic Funds Transfer Systems

Faster than any but the most optimistic thought
possible, electronic banking is sweeping the country
— overwhelming the laws that govern banks and
other financial institutions, changing dramatically the
banking and savings habits of millions of Americans.
Ultimately, electronic banking will revolutionize the
very concept of money itself and will probably force
a profound change in how the Federal Reserve regu­
lates the nation’s money supply. Certainly it will
touch off a flurry of competition for the nation’s finan­
cial business unlike anything seen before.1

Developments in electronic funds transfer systems
( E F T S ) have long been a popular topic of discussion
in banking circles, but as the above quotation from
a national business magazine indicates, the subject now
enjoys even wider currency. Although it does not ap­
pear likely that we are on the threshold of “the checkless-cashless society,” recent developments have been
so rapid that predictions of future developments and
effects of EFTS often seem foolhardy at best.
The diversity of views on the subject of E FT S re­
flects the broad scope of current developments. Many
bankers see E FT S as providing an opportunity for
initiating new services and reducing costs, thus in­
creasing profitability. Others, especially those repre­
senting small banks, view E FT S as being prohibitively
costly; they fear that they would not be able to com­
pete with the larger banks which could afford the
necessary computer equipment and, as a result, would
be forced out of the market. Thrift institutions view
E FT S as a means of obtaining deposits for which only
commercial banks have heretofore been permitted to
compete and have thus been in the forefront of EFTS
Government will probably play a large role in the
evolution of EFTS. Court interpretations of existing
laws have already shaped the direction of some EFTS
developments. New legislation and regulations will
1“Bank Cards Take Over the
(August 4, 1975), p. 44.
Page 10

Country,” Business


almost certainly be adopted, but as yet no clear trend
in the nature of these changes is discernible. Some of
these changes may be dependent on the findings of
the National Commission on Electronic Funds Trans­
fers. This commission, which held its first meeting last
February* is due to submit an interim report to Con­
gress in October. It expects to complete its study and
make recommendations by the end of 1977.2

To speak of the electronic funds transfer system is
an oversimplification. In fact, E F T developments are
proceeding in several directions, with a number of
different systems in various phases of development or
use. The common factor in these systems is that they
speed the transfer of funds by communicating infor­
mation relating to payments by electronic means
rather than by use of paper instruments as is pre­
dominant today. Thus, E F T systems are designed to
replace manual processes with electronic data proces­
sing and to speed the flow of funds through high
speed data transmission.
Although E FT S is often considered a revolutionary
development with far-reaching effects, E F T develop­
ments can be viewed as just another step in the evolu­
tion of the payments mechanism — the system by
which resources are transferred from one economic
unit to another. This evolution reflects the continu­
ing effort to improve the efficiency of trading. Money,
which is simply a device which facilitates trade, repre­
sented an improvement over barter in that it reduced
transactions costs and thus freed resources for use in
the production of other goods and services. Checks
came into widespread usage because they offered con­
siderable advantages over cash; they were easily trans­
2“E F T Commission Rebuffs Mitchell’s Plea for Comment on
Proposed Changes to Reg. J,” American Banker (March 15,
1976), p. 1.



ported in any amount, easily transferred between
individuals, involved much less danger of loss or theft
than cash, and served as proof of payment. Checks
thus reduced the transactions costs involved in mak­
ing many types of money payments. Still, considerable
transaction costs are associated with the processing of
these paper documents.
Furthermore, because of the indirect nature of the
check clearing process, there is often a delay in the
availability of “good funds” for the payee. These de­
lays can be costly, especially when large sums are
involved. The development of wire transfers, through
which banks can effect funds transfers by sending
electronic messages rather than paper documents,
represented a major improvement in the payments
mechanism. One of the large wire transfer networks
is operated by the Federal Reserve System, which
transfers large volumes of funds for member banks
and their customers through its computerized com­
munications system. The dollar volume of funds trans­
ferred by the Federal Reserve Communications
System in 1975 was almost seven times as large as the
amount handled by the Fed’s check clearing system.3
The average transfer is quite large — about $1.8
million in 1975 — but the number of wire transfers is
only a small fraction of the number of checks handled.
To the extent that wire transfers reduce transaction
costs and processing time they can be said to improve
the efficiency of the payments mechanism. However,
the use of wire transfers has not significantly reduced
the vast flow of paper through the payments system.
A major reduction in paper volume would require
implementation of electronic systems designed to be
utilized for smaller retail-oriented payments, such as
the systems described below.

For the sake of clarity and simplicity, E F T systems
can be grouped into three categories: teller machines,
point-of-sale systems, and automated clearing houses.
These systems differ in types of payments handled
and in means of processing.

Teller Machines
Machines through which an individual may conduct
various routine banking services can be grouped un­
der the heading of teller machines. Much of the
recent EFTS development has involved these ma­
chines, which are called customer-bank communica­
ZAnnual Report of the Hoard of Governors of the Federal
Reserve System (1 9 7 5 ), p. 379.

tion terminals (C BC Ts) by the Comptroller of the
Currency and remote service units (RSU s) by the
Federal Home Loan Bank Board. In principle, these
machines can be located either on a bank’s premises
or elsewhere, conceivably at great distances from the
bank. They may be manned or automatic and vary
greatly in complexity, ranging from simple communi­
cations terminals to more complicated automated
teller machines (A TM s). Services which ATMs can
typically perform include receiving deposits, dispens­
ing funds from checking or savings accounts, trans­
ferring funds between accounts, making credit card
advances, and receiving payments. The less compli­
cated manned terminals handle the communications
between the customer and his bank while the receipt
or disbursing of funds is physically accomplished by
the clerk who operates the terminal.
Teller machines are usually accessed by a combina­
tion of a magnetic stripe card (on which account
information is encoded) and a personal identification
number which, for security reasons, is known only to
the customer. If the device is connected “on-line” to
the bank’s computer, the customer’s account is up­
dated immediately; otherwise, a record maintained in
the machine is periodically delivered to the bank for

Point-of-Sale Systems
On-line systems which allow customers to transfer
funds to merchants in order to make purchases are
usually called point-of-sale (PO S) systems. Systems of
this type may be used for check authorizations and
credit card transactions, as well as for so-called “debit
card” transactions in which funds are immediately
transferred from the purchaser’s account to the mer­
chant’s account. Conceivably, they could also be used
for instantaneously transferring funds between busi­
nesses and/or individuals, using terminals or push­
button telephones.
Large-scale POS systems generally operate in the
following manner. On-line terminals are located at
check-out counters or other points of sale. When mak­
ing a purchase, a customer’s card is inserted into a
terminal which “reads” the data encoded on it. Other
data concerning the transaction are entered manually
by the clerk or through an electronic cash register or
products code reader. If the customer’s bank is dif­
ferent from the store’s bank, a switching and proces­
sing center (SPC ) connects the computers of the two
banks. The computer at the customer’s bank verifies
that the card and identification code are valid and
that the customer’s account has sufficient funds. The
Page 11


customer’s account is debited for the amount of the
purchase while the store’s account is credited for the
same amount. Both parties to the transaction receive
a printed statement at the time of the transaction, and
the customer’s regular bank statement contains a de­
scriptive listing, much like those which many credit
cards presently use. Since some 30 percent of personal
checks are written to grocery or other retail stores,4
this type of system would allow automation of a sub­
stantial portion of check payments as well as many
payments presently made by cash or credit card.

Automated Clearing Houses
Another type of E F T system, which is conceptually
different from the two systems described above, is the
automated clearing house (ACH ). As the name sug­
gests, an ACH is analogous to a traditional clearing
house, in that it represents a system for the interbank
clearing of debits and credits. The main difference
between automated and conventional clearing houses
is that the debit and credit items in an ACH exist in
the form of electronic signals, whereas they are paper
items in a conventional clearinghouse operation. An
ACH is thus not a system for automating the handling
and clearing of paper checks. The payment items
must enter the system in the form of electronic data,
usually computer-generated magnetic tape.
To illustrate how an ACH works, consider how a
payroll payment could be made directly to an em­
ployee’s checking or savings account through an ACH.
The employee authorizes his employer to make such
direct payments, eliminating the need for a check to
pass through the employee’s hands, be endorsed,
cashed or deposited, and sent through the check clear­
ing process to the employer’s bank. The employer
prepares the payroll data on computer tape and sends
it to the company’s bank. The bank directly credits
the employee’s account if he is a customer and com­
bines the data for the remaining payees with those
from other employers on a magnetic tape. This con­
solidated tape is delivered or transmitted to the ACH,
where a computer processes all the data for a day in a
single run, sorting out all payees for each participat­
ing bank. Each bank then receives a computer tape
(or paper advice if it is not equipped to handle tape)
which lists the payees and the amount to be credited
to each account. The employer’s accounts are debited
by the originating banks. Net settlement among the
4This estimate is based on surveys reported in Research on
Improvements of the Payments Mechanism: The Final Re­
port on Phase I, An Analysis of Payments Transactions and
Phase II, Payments Flow Data, Volume 1 of 3 (Atlanta:
Georgia Tech Research Institute, 1971), p. 30.
Digitized forPage 12


banks is accomplished in the same manner as with
paper checks.
ACHs are especially suited for handling recurring
payments, such as payroll, social security, or pension
payments, or recurring payments made by individuals.
Payors would authorize their banks to pay a specified
amount to a payee (mortgage lender, insurance com­
pany, etc.) on a specified date. Parties to these types
of payments would receive a descriptive statement
documenting the payment.
Many types of payments — those where the payee
and amount vary — are not amenable to this type of
preauthorization. The case of regularly recurring bills
of varying amounts, such as utility bills, represents a
middle ground between the extremes of identical re­
curring payments and more or less random payments.
The customer could, for example, authorize his bank
to pay the amount billed by a specified creditor.5
Since many people are reluctant to give such broad
power to their banks, a system called Bill Check
has been developed.6 This type of payment allows
the customer to control the amount and timing of
payments to creditors but still achieves some of the
benefits of ACHs.
An ACH thus differs considerably from teller ma­
chines and POS systems. The ACH is essentially a
“batch” processing system used for the interbank set­
tlement of recurring credits and debits, whereas many
of the other systems allow instantaneous transfers of
funds between the customer and his bank or from the
customer to third parties.


Costs of the Check-Based Payments System
Knowledge of the number of checks written in a
year and the cost of processing them is imprecise.
However, it is estimated that in 1975 between 25 and
‘’American Express has initiated such a service for credit card
customers in California. Based on a preauthorization, the full
amount of a credit card bill would be paid from the cus­
tomer’s bank account to American Express, unless the custo­
mer objected within a specified period after receiving the
bill. See “American Express Will Begin Testing Preauthor­
ized Payments through CACHA,” Payment Systems News­
letter (February 1975), p. 6.
6The Bill Check itself is a portion of the bill on which the
customer indicates the amount to be paid and signs his name,
and then returns to the creditor. This completed form au­
thorizes a debit from the customer’s account to pay the bill.
The creditor transfers the data to computer tape and sends
the tape to the ACH for processing. The paper Bill Check is
retained by the creditor for its records. See Atlanta Payments
Project, Automated Clearing Houses: An In-Depth Analysis
(Atlanta: Committee on Paperless Entries, 1974), pp. 35-39.


30 billion checks were written7 involving total proc­
essing costs of around $6 billion.8
When a payee cashes or deposits a check through a
teller line, lock box, or other arrangement, the first
bank receiving the check must encode the amount of
the check in magnetic ink character recognition
(M IC R ) readable symbols. This completes the encod­
ing of the check (the bank’s routing number and
payor’s account number are already encoded on the
check), so most of the remaining processing can be
conducted by machines capable of reading the MICR
characters. The transit items (those drawn on other
banks) are sent to the bank on which they are
drawn, either directly or through a clearing house,
correspondent bank, or the Federal Reserve’s check
collection facilities. When the check returns to the
bank against which it is drawn, the writer’s account
is debited, and the cancelled check is returned to the
writer with the periodic statement. Altogether, the
average check is handled some ten times and passes
through two and one-third banks.9
Much of the processing described above is now
automated. Machines read and sort the encoded
check according to destination and perform most of
the accounting functions. However, a number of the
processing functions have not been amenable to auto­
mation. Many checks are still handled by tellers, the
encoding process requires human handling, and the
checks must still be physically transported through
the banking system and back to the payor.
These manual processes appear to be among the
most expensive in the check processing function. The
average costs of these various processes were esti­
mated by the Atlanta Payments Project through sur­
veys of Atlanta banks.10 The estimated cost of re­
ceiving an item through a branch was 7.4^ and the
cost of proof and encoding an item was 1.3^. To­
gether, these accounted for nearly 60 percent of the
7According to one estimate more than 24 billion checks were
processed in 1974, with the number increasing at a 7.3 per­
cent annual rate between 1971 and 1974. See R. William
Powers, “A Survey of Bank Check Volumes,” Journal of
Bank Research (Winter 1976), pp. 245-56.
sThe latest estimates of average check processing costs of
commercial banks are in the 16-21e range. To these costs
must also be added the indirect costs borne by writers and
receivers of checks, as well as Federal Reserve expenses for
check clearing. See Arthur D. Little, Inc., The Consequences
of Electronic Funds Transfers, prepared for the National
Science Foundation (1975), p. 51.
1Mark J. Flannery and Dwight M. Jaffee, The Economic
Implications of an Electronic Monetary Transfer System
(Lexington, Mass: D.C. Heath and Company, 1973), p. 41.
10Atlanta Payments Project, Automated Clearing Houses: An
In-Depth Analysis, pp. 218-19.


13.9«* cost of processing an “on-us” item (a check de­
posited in the bank on which it was drawn) and more
than 80 percent of the 10.6^ cost of a transit item.11
Given this situation, the prospects of lowering the
average cost of check processing materially below its
present levels do not appear to be good. Economies of
scale in check processing may well be nearly ex­
hausted. As labor and other costs rise, the average
cost of check clearing is also likely to rise.
These factors have led many to believe that radical
changes in the payments mechanism are necessary if
costs are to be kept at present levels or be reduced. If
the paper document which carries the payments data
can be replaced by an electronic signal, manual han­
dling can be significantly reduced and the flow of
payments data accelerated by high speed data

Cost Characteristics of EFT S
Although few cost data are available because of the
limited experience with EFTS, some dated but
representative cost estimates are available. Most E F T
systems involve large total cost, much of which is
associated with the expensive computer hardware
necessary to operate these systems: computers, ter­
minals, and communication links. Even teller ma­
chines, which are among the less expensive types of
systems, involve purchase costs that may exceed
$40,000 per ATM, depending on features.
More complicated systems involve higher total
costs. An on-line POS system would involve high costs
not only for the banks’ computers, the terminals in
stores, and the communications links joining them,
but also for the SPC which interconnects the com­
puters of the different banks. In one study, published
four years ago, the Atlanta Payments Project esti­
mated total costs for a proposed POS system linking
the banks in that city.12 These included about
$650,000 for SPC processing equipment and $655,000
for SPC development costs, about $1,200 for each
terminal and associated communications equipment,
and about $54,000 for bank communications interface
n An interesting sidelight of this study is that much of the cost
of processing a check is borne by the bank of first deposit
rather than the bank on which the check is drawn. Of
course, the cashing bank frequently receives new deposits in
the process which can compensate it for the costs it bears.
'-Atlanta Payments Project, Research on Improvements of the
Payments Mechanism: Phase III General Systems Design
and Analysis of An Electronic Funds Transfer System, Vol­
ume 3 of 6 Systems Design and Analysis-Point of Sale
System (Atlanta: Georgia Tech Research Institute, 1972),
Chapter 8.
Page 13



E F T S has such a significant potential for changing
costs and providing new services that it will likely have
far-reaching effects on the structure of and competition
within the financial industry. In turn, these competitive
forces will doubtless influence the course of E F T S im­
plementation, reflecting developments within the finan­
cial industiy and concerns of legislators and regulatory
Many people expect that in the years to come E F T S
will be one of the principal areas of competition among
banks. The changing cost structure associated with new
ways of making payments also has considerable implica­
tions for the competition between commercial banks and
thrift institutions.

Competition and Regulation
Competition between firms and industries is generally
considered a good thing, since it forces the sellers to pass
the benefits of technological change on to the consumer
in the form of lower prices a n d /o r improved service.
From the standpoint of the whole economy, competition
also leads to an efficient allocation of resources.
In competitive markets, it is a normal form of adjust­
ment for inefficient firms to incur losses and eventually
drop out of the market. However, because of the widely
held belief that considerable social costs are involved in
bank failures, the depository financial institutions have
been subjected to regulation which in general limits
competition. Although there have been some recent reg­
ulatory efforts toward encouraging (o r allowing) more
competition, there is a distinct possibility that some limits
will be placed on competition through E F T S , especially
if increased bank failures or pressures on thrift institu­
tions are expected to result from such competition. Thus,
some efficiency gains which might result from E F T S
probably will be foregone in order to avoid increased

Effect on Structure
Many observers expect that E F T S will lead to major
changes in the structure of the banking industry. Since
teller machines can provide many routine banking serv­
ices and are much less expensive than traditional “brick
and mortar” branches, many observers believe they will
be the “branches” of the future. If so, there would be con­
siderable competition as banks attempt to gain customers
by installing these machines in convenient locations. It has
been argued that big banks, through E F T machines, will
enter the market areas of smaller banks all across the
country and, because of the huge initial costs of E F T sys­
tems, the smaller banks will not be able to compete.
It is not clear, however, that smaller banks would be
at a disadvantage in operating these machines. F o r ex­

Page 14

ample, relatively small banks might find that prudent
deployment of these machines would enable them to
expand their market areas at a much lower cost than
with a conventional branch. These machines could thus
prove relatively more beneficial to the smaller banks
than to the larger ones which have the capability to op­
erate a large number of conventional branches.
A major regulatory question is involved here: are teller
machines branches within the meaning of the M cFadden
Act, which subjects branching by national banks to state
branching laws, or simply communications devices? If
the former is ruled to be the case, deployment of the
teller machines would be subject to state branching re­
strictions and regulatory controls; if the latter is accepted
their deployment might be relatively unfettered. All but
one of the court decisions rendered to date have found the
machines to be branches under the M cFadden Act. Since
this Act defines a branch to include “any branch place of
business . . . at which deposits are received, or checks
paid, or money lent,” banks affected by the rulings have
been forced to cease these functions at their remote teller
machines which are not located in a permissible branch.
Savings and loan associations are not subject to the
M cFadden A ct and hence have not been subject to the
same limitations as banks. Partly as a result of this
apparent regulatory inequality, legislation which would
exempt bank teller machines from these branching limi­
tations has been enacted in some states and is pending
in others.

Ownership of E F T Systems
The question of ownership of E F T systems has fre­
quently been raised. Some individuals and groups argue
that operation of competing E F T systems would be
uneconomical and could thus lead to increased bank
failures. This argument is based, at least in part, on the
belief that E F T systems are “natural monopolies,” much
like local public utilities.
The essential characteristic of the economic concept of
natural monopoly is that economies of scale are so per­
vasive that average costs decline over the entire extent
of demand in the market. One seller of the product could
produce a given volume at minimum average cost,
whereas two or more sellers would each be inefficiendy
small, necessitating higher prices.
The issue of ownership of E F T systems thus turns on
the empirical question of whether there are extensive
economies of scale in such systems. Although there is as
yet little evidence on which to make a judgment, some
generalizations can perhaps be made. There do appear
to be economies of scale in such systems, but it is not at
all clear that these economies of scale are so extensive
that only one firm could operate a large-scale E F T sys­
tem efficiently. F o r example, both major bank credit

card concerns (which have large networks of participat­
ing banks and merchants as well as extensive computer
systems for authorization of transactions and interchange
of charge items among the banks) are presently develop­
ing POS systems, as are some larger correspondent banks
and various other organizations. A retail store could
utilize more than one competing system through a single
dial-up type terminal and existing telephone lines.
The ownership question is applicable to ACHs as
well. ACHs have developed similarly to conventional
clearinghouses, with only one ACH serving a geograph­
ical area. All but two operating or planned ACHs are
operated by the regional Federal Reserve Banks, the
principal justification being that these ACH services are
basically extensions of the present check clearing func­
tion of the Fed.
As in the case of POS systems, there is the question of
whether competing ACHs would be feasible. The Justice
Department, apparendy believing that competition could
develop in the provision of automated clearing services,
has questioned whether the Federal Reserve System or
other governmental agencies should directly operate the
The greatest danger is that a Federal E F T system
— especially one that is artificially low-priced —
could deter private competitors from deploying pri­
vate E F T systems, and inflict severe injury on those
who have already begun to operate them . . . Many
private entities stand ready to supply the same sort
of facilities and services that Reserve Banks offer
to financial institutions . . . The Board [of Governors
should] . . . play the role of overseer, and leave the
practical day-to-day operations of the ACH to the
private sector with the marketplace acting as the

Role of Thrift Institutions
The role of thrift institutions in E F T systems is cur­
rently much at issue. These nonbank institutions have
been in the forefront of some E F T developments, notably
in teller machines and POS systems. This is partly be­
cause E F T S provides the thrifts an entry into the pay­
ments mechanism which legislation has largely denied to
them, and partly because some laws and regulations have
been less restrictive of E F T S development by thrifts than
by banks.
The involvement of thrift institutions is currendy at
issue in many ACHs. Utilization of ACHs has usually
been opened to all banks in an area, but thrift institutions
have frequently been denied access, at least on an equal
footing with banks.
’ Comments of the United States Department of Justice in
the Matter of Regulation J, reprinted in American Banker
(June 15, 1976), pp. 4 ff.

Originally thrift institutions w ere required to use a
“pass through” arrangement in which transfers to and
from the thrift institutions were made through a bank
which had direct access to the ACH. Of course, this in­
volved additional costs and some delays for the thrifts.
Interim guidelines adopted by the Board of Governors
in January allow thrifts to receive direct delivery of
credit or debit items from Fed-operated ACHs if the
institutions have sufficient volume to warrant it and are
on an existing courier route. The guidelines also allow
any institution which is a member of an automated clear­
ing house association to send items to the ACHs. Previ­
ously only those institutions with demand deposit author­
ity were allowed to originate these items. The thrifts
believe that these guidelines still discriminate against
many of them and leave them at a competitive disad­
vantage relative to the banks with more direct access.
It is a long-standing principle of antitrust law that
where there is a unique resource such as a clearinghouse,
all competing firms should have access to it.2 At present
there are legal distinctions between banks and thrifts, a
major one being the ability to offer accounts from which
customers can make payments to third parties. Demand
deposit powers have traditionally been limited to com­
mercial banks, but thrift institutions have long sought
third party payment powers, primarily as a source of
deposits. Although thrifts have developed some close sub­
stitutes for checks (notably NO W accounts) they ap­
parently hope to bypass the cumbersome and expensive
check-based payments system and to enter the payments
mechanism directly through E FT S .
Many of the services already offered by thrifts serve
as close substitutes for third party payment powers. For
example, the First Federal-Hinky Dinky TMS system in
Nebraska allows customers to deposit or withdraw funds
through transfers from or to the supermarket’s First F ed ­
eral account. This is tantamount to a third party POS
system. Introduction of services like these has forced
banks to offer competing services. The distinction be­
tween savings accounts at thrift institutions and demand
deposits at banks is being blurred, and with it the dis­
tinction between banks and thrifts themselves.
Greater competition among types of financial institu­
tions can be expected to result from development of
E F T S . A blurring of the distinctions between financial
institutions and a lowering in price of services (and an
increased return on deposits) could be expected, in the
absence of restrictive regulation. Consumers stand to
benefit as financial institutions compete in offering in­
centives to customers to shift from checking to E F T
services. The economy as a whole could also benefit
through a more efficient payments mechanism.
-Donald I. Baker, “Antitrust and Automated Banking,” Bank­
ing Law Journal (September 1973), p. 703-18.
Page 15


The Federal Reserve Bank of Cleveland has esti­
mated total costs of operating a larger POS system,
which would link 39 banks in the Fourth Federal
Reserve District.13 Assuming that the system would
capture 6-7 percent of total retail transactions, in the
tenth year the average costs of operating the SPCs
alone would be an estimated $3.8 million. Costs of
participating banks in the tenth year would be an­
other $13.9 million, it was estimated. Total costs for
the first ten years of operation would exceed $100
Many of the costs which are associated with E F T
systems do not vary with the number of transactions
and thus can be considered as fixed costs. An example
is the depreciation of the computers, terminals, and
other equipment used in the system, which would be
the same regardless of the level of usage. Some other
costs probably do not vary significantly with the level
of usage either. The costs of operating a computer
used solely for an E F T system would probably be
little higher at relatively high levels of transactions
than at low.
There are other costs which do vary with the level
of output or usage. For example, labor costs associ­
ated with operating a manned terminal may be greater
at higher levels of usage than at low. The cost of
computer time necessary to process teller machine or
POS transactions would also depend on the number
of transactions. One study estimated the cost of
the infinitesimal amount of computer time neces­
sary to process a POS transaction to be about 1^ per
To date, ACHs have utilized an existing computer
(in most cases at a Federal Reserve Bank), since a
computer run processing a whole day’s accumulated
items usually takes an hour or less. The processing
time and labor costs do not appear to vary greatly
with the number of transactions processed. Estimated
costs of operating the Atlanta ACH at various levels
of output are shown in Table I.
A characteristic of the costs of many E F T systems
is evident in this table: the average cost of a transac­
tion declines significantly as the number of transac­
tions increases. This is caused by the predominance
of relatively fixed costs in most E F T systems. From
the standpoint of the Federal Reserve System, which
operates most ACHs, a high level of output would
13Arthur D. Little, Inc., The Consequences of Electronic
Funds Transfer, pp. 195-8.
14Atlanta Payments Project, Research on Improvements of the
Payments Mechanism: Phase III, Vol. 3 of 6, p. 166.

Page 16


Table 1

M onthly

M onthly

Cost Per

20 ,000

$ 2 ,1 5 0

1 0.8 «

1 5 2 ,5 0 0



2 8 5 ,0 0 0

3,1 5 0


4 1 7 ,0 0 0

3,6 5 0


5 5 0 ,0 0 0

4,1 6 0


Note: These estimates are for the Atlanta ACH. The program used
requires about one hour of processing time for any daily vol­
ume up to 25,000. Thus, some costs will be relatively fixed up
to the monthly volume of 550,000 shown in the table. The
Project anticipates that software changes could expand the
hourly volume to 75 - 100,000 ; operating costs would remain
about the same, and the average cost of a transaction would
drop to about 0.20.
Source: Atlanta Payments Project, Automated Clearing Houses: An
In-Depth Analysis, Chap. 10.

have to be reached before the average cost of a
transaction would fall below the Fed’s average cost of
clearing a check, which is about l£. The data on
Federal Reserve check processing and ACH costs
presented in Table II indicate that, at current vol­
umes, processing an ACH item is much more expen­
sive to the Fed than processing a check. Of course,
this means that ACHs are presently operating at far
less than efficient volumes. Furthermore, potential
cost savings to participating banks from making elec­
tronic payments through an ACH rather than using
checks should also be considered. Data from the
Atlanta Payments Project suggest that monthly vol­
umes of more than 160,000 transactions at the Atlanta
ACH would result in the average cost of an ACH
transaction falling below the average cost of a check.15
Estimates of average costs of POS transactions also
suggest that if sufficiently large volume is attained,
the average cost of a POS transaction can fall below
the average cost of a check. In the Cleveland Fed
study, referred to above, the average cost per trans­
action over a three-year period was estimated to be
11.3<; this would be reduced to 7.1< by the tenth year
because of expected economies of scale in operation
of the system.16
15Atlanta Payments Project, Automated Clearing Houses: An
In-Depth Analysis, p. 229. This estimate assumes no bank
marketing costs associated with the ACH operation.
16Arthur D. Little, Inc., The Consequences of Electronic
Funds Transfer, pp. 195-98. The Cleveland Fed Study
estimates that the POS system would generate cost savings
such that the annual savings would exceed annual costs by
the seventh year and cumulative savings exceed cumulative
costs by the tenth year. This estimate did not include sav­
ings experienced by merchants as a result of using the POS



Table II

Checks Processed


Total Expense

Cost Per Check1

$ 1 2 0 ,5 5 9 ,0 0 5

0 .9 9 5 *

1 1 ,4 1 1 ,3 3 7


“ Check Im a g e s" Processed

Total Expense

Cost per " Im a g e "


$ 4 3 1 ,8 8 3

7 .2 7 1

1This item excludes postage and expressage on items handled by others, which were included in the "Total Expense” category.
Source: Board o f Governors o f the Federal Reserve System, Functional Expense Report, 1975 Annual Report.

Another cost concept should be considered. This is
marginal cost, which is simply the change in total
cost which results from increasing output by one unit.
Marginal cost is thus not affected by fixed cost but
only by variable costs. In the case of E F T systems,
the marginal cost would be the change in cost that
resulted from conducting one additional transaction.
The considerations described above suggest that the
marginal cost of an E F T transaction is likely to be
very low. In most cases, little or no additional labor is
involved, and only an infinitessimal amount of com­
puter time is used. Thus, an additional transaction
should add very little to the cost of the system. In
comparison, the marginal cost of a check is probably
relatively high because of the labor intensiveness of
check processing.17
In summary, many E F T systems will involve large
fixed costs but relatively small variable costs. Because
of this predominance of fixed costs, average costs of
E F T transactions will probably decline over a fairly
large range of output. The hypothetical cost curves
H y p oth e tic al C osts of F und s Transfers


17One study estimated the marginal
below the average cost estimated
nery and Jaffee, The Economic
tronic Monetary Transfer System,

cost to be 14c, not much
in the same study. Flan­
Implications of an Elec­
p. 42, footnote 10.

presented in the accompanying figure show the aver­
age cost of an electronic funds transfer to be greater
than the average cost of a check at relatively low
volumes. Beyond some point, however, the average
cost of checks levels off while that of electronic funds
transfers continues to fall. The average cost of elec­
tronic transfers is less than that of checks for relatively
large volumes. Although these cost relationships are
hypothetical, they demonstrate the general relation­
ship between the costs of check systems and EFTS.

If the potentially lower unit costs of E FT S are to be
realized, a substantial proportion of present payments
must be switched to electronic means. Otherwise,
banks may find themselves with the worst of both
worlds: a large, slow, expensive check handling sys­
tem, plus a very expensive underutilized E F T net­
work. Thus, failure to consider customer acceptance
of E FT S could have exactly the opposite effects from
those hoped for.
At present, there seems to be little incentive for
customers to change their payments practices from
using checks to E F T systems. Surveys have found that
individuals are generally satisfied with the present
payments system. Using checks provides many bene­
fits, including unquestioned proof of payment. The
surveys also indicate that many individuals, especially
those in lower income groups, have a negative atti­
tude toward many aspects of E F T systems.18 Custo­
mers tend to fear a “loss of control” over their finances
which would result from preauthorized deposits or
withdrawals, as well as possible losses of privacy,
costly errors, and lack of proof of payment. Thus, in
many cases, it may take considerable incentive to
induce individuals to shift their payments from checks
to electronic means.
18See Arthur D. Little, Inc., The Consequences of Electronic
Funds Transfer, pp. 43-46, 253-63.
Page 17


Such an incentive could be provided if the cost
savings which would result from a fully utilized E F T
system were passed on to the customer. However,
current regulations reduce the likelihood of banks pro­
viding such incentives. For example, since banks are
prohibited by Regulation Q from paying an explicit
return on demand deposits, they usually pay an im­
plicit return by subsidizing the checking costs of their
customers, either totally or in part.19 Thus, the cost
to the individual of writing an additional check is
usually less than the marginal cost to society of
processing the check. As a result, “too many” checks
are written, and a greater than optimal quantity
of resources is allocated to check processing. As
long as banks are prohibited from explicitly paying
interest on demand deposits, it does not seem likely
that they will charge fees for checking services which
approximate the marginal costs of the checks. As a
result, the prospects of banks providing sufficient
incentives for customers to switch from checking to
the lower-marginal-cost electronic funds transfer serv­
ices are reduced.
lfl“ ‘Yields’ on Checking Accounts Rise in Recent Years,”
Federal Reserve Bank of Philadelphia Business Review
(March 1975), pp. 14-15.

Page 18


The underutilization of E F T systems which would
stem from the prohibition of interest on demand de­
posits could be worsened if customers receive addi­
tional disincentives to use E F T systems. Such disin­
centives could take the form of high initial prices for
E F T services which banks may charge, predicated on
the notion of recovering the large fixed costs of the
E F T systems relatively quickly.

Many of the questions surrounding E F T S cannot
yet be answered definitely, since they depend on
costs, regulations, and other factors for which there
are few or no data. However, it is reasonable to expect
marginal costs of making a transfer through E FT S to
be less than through the check system; average costs
of transfers could also be lower, if a sufficiently large
volume is achieved. Such possibilities for reducing
costs, other things equal, would encourage banks and
other producers to increase their supply of these serv­
ices relative to checking services. However, such fac­
tors as the prohibition against paying interest on de­
mand deposits appears to reduce the incentive for
customers to use E F T systems, thus slowing their