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"A Businessman Looks at the Fed —

Up Close”

by
Edward W. Kelley, Jr.
Member
Board of Governors of the Federal Reserve System
Before
The National Economists Club

Washington, D.C.
June 8, 1993

Highly successful organizations in all walks of life share one
common characteristic, which is that they all have a clear
understanding of exactly what constitutes the heart of their mission.
They build out logically from there with a network of policies,
products, relationships, and most of all, human skills which are all
focused on fulfilling the core mission through excellence in
performance and mutual reinforcement. Here is one person’s view
of the Federal Reserve System from that perspective.
As I observed the Fed from afar over my private sector years,
it was not always clear to me that the institution met these
specifications.

In recent years as I have become much more

knowledgeable about what the Fed really is and does, I have come
to have considerable comfort that the essentials for successful
performance are in place. I have considerable discomfort, however,
that many opinion- and policy-makers do not adequately understand
the central bank, as I did not, and that this could lead to a lack of
public support which could, over time, undermine the institution’s

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strength. Such an eventuality would be deeply unfortunate for the
country.
In my view, the Fed internally has a firm grasp of its mission.
That purpose is to undergird the financial system of this country by
providing stability and reliability to the nation’s monetary unit - the
dollar - and to the flows of funds that lubricate the everyday
operations of the economy.

Over the years the System has

structured itself tightly around this core mission and its policies,
products, procedures and people are very focused on excellence and
mutual reinforcement in fulfilling the mission. The System operates
through three interactive and interdependent groups of activities:
direct responsibility for monetary policy, key leadership in the
payment system, and extensive participation in the supervision and
regulation of depository institutions. They are three parts to a single
theme, a trilogy, and together they provide the thrust that is needed
to achieve the mission.
As a longtime outsider suddenly provided with an insider’s
view, let me share with you what I would like to have understood
years ago about each of these mission elements, and then comment

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on certain factors critical to sustained success in the future.
My objective in this is to contribute to an enhanced understanding
of the nation’s central bank.
Many view the conduct of monetary policy as the job of the
central bank and some see it as the decisive element in determining
the nation’s economic performance. Others see it as increasingly
impotent and irrelevant.

It is neither.

Monetary policy can

obviously influence short-term nominal interest rates and through
them may influence the near-term pace of the economy.

Only

indirectly can it influence long-term interest rates, which are far
more economically significant.

If misused in the short-run,

monetary policy may be counter-productive in the long-run. In the
long-run, policy cannot create jobs or otherwise positively influence
the nation’s economic progress in any way other than by fostering
a climate of confidence in the stability of the financial system. This
specifically includes price level stability.

That is a critically

important contribution, of course, basic to a successful economy.
But that’s it. To expect monetary policy to produce results beyond
its scope is to assure criticism and negativism that could easily

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result in impeding the central bank’s ability to do what it can and
must do in the nation’s long-term interest. Monetary policy is a
highly significant, but limited, instrument of macro-economic
management.
Our payment system, which the Federal Reserve anchors and
in which thousands of depositories participate, is also vital to our
financial system. It is a vast and complex public utility, analogous
to our electrical power grid, that moves mind-boggling quantities of
funds around the country and the world in settlement of financial
obligations. Clearly, a modem industrial economy must perform
this function well and nobody does it better than, or on so vast a
scale as, the United States. Its operation consumes a significant
amount of our most sophisticated human and physical resources and
with the very rapid evolution of communications capabilities,
computer technology, and the structure of the financial services
industry, it is in a period of dramatic change. If it should seize up,
which it will not, the economy would be seriously disrupted, to say
the least.

Yet, this essential public service resource is taken

completely for granted and rolls along unknown and unrecognized

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by almost everyone not directly involved. That’s a shame. One can
only hope that a day never comes when some unforeseeable issue
requires a level of public understanding and support that might not
be available.
Extensive participation in the supervision and regulation of
depository institutions is the third aspect of the trilogy of activities
through which the Fed fulfills its mission.

These activities are

clearly important, but how do they fit into the trilogy?
necessary to look back at the first two.

It’s

Monetary policy is

delivered to the economy through the conduit of depositories and it
is depositories which operate the payment system. Further, a crisis
in the payment system requiring the Federal Reserve’s powers of
lender-of-last-resort would involve depositories as part of the
solution as well as, most likely, part of the problem. For these
reasons and more, the central bank must be active everyday in a
hands-on manner in the work of this vital industry. There is no
other way to understand in depth, and in real time, what is going
on. Supervision, which involves the detailed study of individual
institutions, and regulation, which involves deciding upon and

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setting forth the rules of the game, provides that required hands-on
activity.
Let me turn now to several factors central to the Fed’s ability
to fulfill its mission. The first factor has been weaving through
much of what has already been discussed, namely the interdepen­
dency and mutually reinforcing nature of the trilogy of
monetary policy, payment system participation and supervision and
regulation. Monetary policy is implemented through the depository
operated payment system and is enriched in turn by the flow of real
time financial intelligence that is generated in the process of
supervising and regulating depository institutions, and participating
in the payment system. In the long run, a sound payment system
depends on sound policy. As mentioned above, supervision and
regulation strengthens both of the other two by strengthening the
depository system, especially through its effective participation in
crisis resolution. It is, in turn, itself strengthened in its work by
exposure to the concerns of monetary policy and the payment
system. The point here is that each of these three activities is
necessary to the full effectiveness of the other and, hence, to the

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central bank’s ability to fulfill its mission at the highest possible
level.
A second key factor is the Fed’s unique public-private
structure, whereby a policy making government body, the Federal
Reserve Board, oversees the activities of the quasi-privately
managed twelve district Reserve Banks. The United States is a very
large country, with a highly diverse and complex economy, and a
decentralized central banking system is clearly appropriate. The
quasi-private nature of the District Banks has the highly desirable
result of providing a carefully tailored and skilled management
attuned to each area, and enabling the Board to stay in intimate
touch with economic conditions and developments in all of their rich
variety across the country. In all three elements of the trilogy, it
works superbly. There are those who do not feel that this extent of
private participation in public business is proper, and various
proposals have been advanced in Congress to change the setup.
From my vantage point, I see a highly effective organization
operating with total dedication to the public interest and the core
missions of the System. It is far from "broke," and great caution

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should be exercised before trying to "fix" it. The nation could be
a big loser in the attempt.
Congress is the third key factor.

Congress created the

Federal Reserve, delegates to it whatever powers it may exercise,
and can alter it as desired. Although the Congress has granted the
Federal Reserve a considerable degree of independence, especially
in monetary policy, all of the Fed’s activities are subject to
Congressional oversight. And there are many areas well worth
ongoing public scrutiny.

Stability of prices, adequacy of the

payment system, stewardship of resources, fairness of competition
in payment services, maintaining an apolitical and disinterested
public service orientation, and banking regulation to name just a
few.
A matter of concern involves the clear articulation of the
System’s assigned mission as part of the nation’s economic
management. Congress is quite clear that our basic national
economic goal is maximum sustainable economic growth,
but it sends out mixed signals as to its attitude toward inflation as
a factor in the policy mix. Economists and the public generally

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agree inflation is an economic evil.

Many governments have

instructed their central banks to suppress it, and others are moving
into this posture. For its part, the Fed is dedicated to price level
stability as a prerequisite to realizing the goal of maximum
sustainable economic growth. While I am unaware of any political
leader actively supporting inflation on its merits, some do from
time-to-time advocate policies which have clear pro-inflation
potential. This confuses our public and other governments as to the
attitude of the United States, thereby immeasurably complicating the
Fed’s battle. It would be most helpful if our national leadership
would express itself unequivocally, and explicitly instruct the central
bank accordingly.
Permit me a personal observation as a final key basic factor
in assessing this institution. An unmitigatedly positive one. The
Federal Reserve System, over its near eighty-year history, has
acquired a corporate culture of unique quality. It has taken on a
tradition of excellence of performance, disinterested public service,
and integrity in the most complete sense. The long staggered terms
of its appointed Governors and long tenure of career staff provide

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a depth of sophistication and an institutional memory of central
banking that is a priceless national asset. A rare set of qualities.
When you find it, cherish it.