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Reading copy The Fed— A Case Study Remarks by John J . B a lle s, President Federal Reserve Bank of San Francisco Harvard Business School Club of Northern C a lifo r n ia San Francisco, C alifo rnia September 30, 1975 The Fed— A Case Study I fm not sure how w e ll a l l you fin a n c ia l tigers have done since you transferred your expertise from the banks of the Charles River to the shores of San Francisco Bay, but you a l l look prosperous, so it would seem your balance sheets must be in pretty gpod order. Since y o u Tre a ll hard-bitten veterans of the case-study method, I ’ d like to give you a case study to ponder— the management of a regional Federal Reserve Bank. I T11 begin by outlin in g some of the new management in it ia tiv e s I Tve taken during my three years as P re side n t, and then discuss that important case study which we analyze every month at the meetings of the Federal Open Market Committee— the state of the national economy. Then you can start fir in g questions, and those that I don’ t want to handle I 111 toss to my associate, Gerald R. K e lly , Senior Vice President in charge of Branch Operations. The Fed was organized sixty years ago with twelve semi-autonomous Federal Reserve Banks, operating under the general supervision of the Board of Governors, a seven-man body appointed by the President of the United States and confirmed by the Senate. The West was the logical area for the location of a new Reserve Bank, and that logic has become more evident over the years with the westward flow of population. Between 1914 and today, our nine-state D is t r ic t has increased its share of the n a tio n ’ s commercial-bank deposits from 6% to 14% percent. In 1 9 1 4 , the San Francisco Reserve Bank opened with a s t a ff of just 21 people— o f f i c e r s , t e l l e r s , bookkeepers, stenographers, messengers, one guard and one ja n ito r . When I arrived several years ago I had the impression 2 that some of those people were s t i l l on the p ay roll. S e r io u s ly , any i n s t i tution is bound to gather some cobwebs over a period of time, and that is especially true of an organization lik e ours which was largely dominated for the f i r s t 50 years of its existence by just two in d iv id u a ls. As I took over, it seemed to me that new approaches were necessary in each of our major field s of a c tiv ity — operations, regulations and monetary policy. Pub lic Relations and Regulations My f i r s t job was to let the world know that we were he re , and this meant more p ublic appearances by me and my s t a f f , and an expanded publications program directed toward key opinion leaders in the business and fin a n c ia l worlds. This program was designed to bring so lid information on major national issues to the public through an annual report, reprints o f my speeches and a weekly new sletter. But the job of showing the flag frequently meant ex tensive t r a v e l, and in one case involved a 35,000-mile tour of nine Far Eastern countries to meet foreign monetary o f fic ia ls and commercial bankers. That t r i p , not in c id e n ta lly , was involved with my second i n it ia t iv e — the area of bank regulation. During my meetings both here and in the Far East w ith l e g is la t o r s , regulatory o f fic ia ls and bankers, I became closely involved in the question of foreign-bank regulation in this country. The work o f many people in this problem area has now helped formulate le g isla tio n designed to extend Federal regulation , on a nondiscriminatory b a s i s , to a ll foreign banks operating inside the United States. my worries in the regulatory f i e l d . But that was only one of Early in my tenure, the U .S . National Bank of San Diego closed its doors, and although that was not w ith in our area of supervision— national banks are examined by the Comptroller of the 3 Currency--it became clear that we and the other regulatory agencies needed a better early warning system to detect fin an cial problem areas. I Tve spent a lot of time on that problem, and eventually decided to set up a sp ecial financial-monitoring unit to make sure that there would be no more U .S . Nationals or Franklin Nationals in this area. Restructuring Management But along the way, I decided that we needed not just one or two new units but a complete restructuring of our management and operations. what did we do? Right— we called in the consultants. questions answered. I wanted three Could we improve our organization chart? improve our operating procedures? So Could we Could we improve our salary structure? A separate set of consultants went to work on each problem, and (you w on’ t be surprised to hear) th eir answer was yes to each question. F i r s t , it was evident that there were several drawbacks to the Bank’ s former structure. The old organization chart showed five headquarters o ffic ers reporting directly to me, and nine other officers here and four others at branch o ffic e s ) Vice President. (fiv e of them reporting directly to the First This unwieldy structure frequently caused slip-ups in communications and delays in decisionmaking. With our restructuring, top- management decisions can now be implemented smoothly through a five-man Managing Committee consisting of the heads of three new adm inistrative groups plus the F irst Vice President and myself. Mr. Kelly is the overseer of our District- wide central banking se rv ic e s, heading up the five branches— a newly-organized branch here in San Francisco, plus the four offices in 4 Los Angeles, Portland, Salt Lake City and Seattle. Another Senior VP heads up a group of D is t r ic t Departments, including such a c t iv it ie s as economic research, bank examination and credit. The other Senior VP heads up Corporate S t a f f , including such ac tiv itie s as computer systems, budget and other house keeping chores. W hile we were redrawing the organization chart > another consulting firm conducted a diagnostic review of a l l internal Bank operations. This study led to the creation of a productivity-improvement program which has resulted in a b a s ic overhaul of operations, in an attempt to improve cost effectiveness and to develop more clearly defined jobs and improved working conditions. On balance, we reduced our sta ff by 16%, even after certain additions to some departments that needed beefing up in order to perform e ffe c t iv e ly . To my mind, this program was e s s e n tia l, so that we could handle sharp increases in workload without unacceptable cost increases. But it was also essential that we reward adequately those of our personnel who were c o n tri buting to these productivity improvements. Thus we implemented a new job- evaluation program for o f f i c ia l and mid-level staff p o s itio n s, and in ad d itio n , conducted new salary studies to ensure that our salary scale remains competi tive w ith that of progressive firms elsewhere. The Economy and Monetary Policy But so much for internal reforms. Our greatest task is to help keep the economy h e alth y , and here we can best contribute through our work w ith that key decisionmaking body, the Federal Open Market Committee. I attend all of the monthly meetings of that committee in Washington, and attempt to make a contribution through a searching analysis of the issues as presented by my own research s t a f f as well as the Board of Governors’ s t a f f . Several 5 years ago I reached out to the Midwest and hired an economist from the St. Louis Federal Reserve Bank— world famous for its independent approach— to head up our research s t a f f . But I too am from the Midwest; although a native of I l l i n o i s , philosophically I ’ m from M isso u ri, so I make sure to get inputs not just from economists but from as wide a c ircle of informed opinion as p ossible . fu l. This is where a good Board of Directors can be h e lp Each Federal Reserve Bank (and each branch) have directors representing local business and fin a n c ia l communities as well as the p ub lic in te r e s t. These boards have some of the management powers that corporate boards e xe rcise, and in ad d itio n , they are immensely valuable to me as sources of economic information regarding the various in d u strial and regional sectors in which they operate. Here again is another example of the virtues of the regional structure developed by the founders of the Federal Reserve System 60 years ago. Now let me give you an example of the context in which the Federal Open Market Committee operates, by reviewing b r ie fly the state of the economy and the complexity of the factors which influence monetary p o lic y. We begin w ith an economic turnaround which became v is ib le during the late spring and summer months. This recovery should be sustained by consumer buying along with some Inventory restocking, but i t fs lia b le to be somewhat uneven because of the structural problems of the key auto and housing in d u stries. Business spending for inventories was the weakest lin k in last w i n t e r fs severe slump, but because of its self-correcting nature, it should be one of the stronger elements of the outlook for the next year or so. Business i n ventories declined at a $25- billion annual rate in the firs t h a l f of this y ear, so that stockroom shelves have now been cleared of most of their 6 excess sup p lies. Just ending the cutbacks, without any net increase in inv e n to rie s, would thus remove a $25- billion depressant on GNP. Now, the major factor in the late-spring turnaround in real GNP was an upsurge in consumer spending. A fte r adjustment for price increases, consumer spending rose at more than a 6-percent annual rate during that p e rio d, r e fle c ting an unparalleled 22-percent rate of gain in real disposable income. Take- home pay was boosted about $48 b il l i o n this spring by the provision of the Tax Reduction A c t , including actual tax cuts as w ell as increases in socialsecurity and other transfer payments. That stimulus was reinforced by a slowing of the in fla t io n r a t e , which also helped boost real income. The catch is that the upturn could now be endangered i f the price situation turns around and the in fla t io n rate speeds up once again. I'm sure y o u ’ ve a l l noticed the recent increases in food, f u e l , and industrialgoods p ric e s. I should add that recent price and wage gains are s ig n ific a n tly smaller than last y e a r ’ s increases, but they are s t i l l extraordinarily high in the context of the worst business slump in the past generation. Far stronger anti-monopoly p o lic ie s may be needed to keep this type of costpush in fla t io n under control. The greatest danger, however, is a price upsurge generated by the same b asic forces that have been behind the powerful groundswell of prices throughout the past decade; that i s , unparalleled Federal budget d e fic its and a necessarily accommodative monetary policy. On the heels of fisc a l 1 9 7 5 Ts $44- billion d e f i c i t , fisc a l 1976 w ill have the distinction o f breaking the World War I I record with a d e fic it currently estimated at $59 b i l l i o n . 7 More Federal spending would aggravate the pressures already evident in fin a n c ia l m arkets, with unparalleled Federal demands p ile d on top of gradually reviving private credit demands. This is the w ell- publicized and all-too-real problem of crowding out. Some observers argue that the Federal Reserve's task is to ensure that a ll borrowing demands— both Federal and private— are accommodated at stable or d e clining rates. with l iq u id it y , Such an approach, by flooding the markets could prevent current credit-market strains but at the expense of fu e lin g in fla t io n anew as the recovery builds up steam. But, the question goes, w ith so many id le resources in the economy, how could inflationary pressures arise from easy money at this stage? The answer, at least in p art, involves the lags in the effects of monetary p o lic y , which seem to be much shorter for production, employment and p ro fits than for p ric e s. is s t i l l imperfect. S till, Our knowledge about the length of those lags i t 's reasonably clear that when an easy-money policy is adopted, the "good news" appears f i r s t , with production, employ ment and p rofits expanding w ithin 6 to 12 months or so. comes la t e r , But the "bad news" in the form of increased in flatio n with a lag of 1 to 3 years. Conversely, i f a tight-money policy is adopted, the bad news of a dampening of economic activ ity comes f i r s t , whereas the good news of a diminished rate of in fla t io n is delayed. Is it any wonder that elected o f fic ia ls who must face the voters at regular intervals usually p refer an easy-money policy? Concluding Remarks With this broad-brush treatment, I 'v e tried to show that the economy is much more complex now than it was in 1 914, so that the institution s which 8 deal w ith the economy must make every e ffo rt to keep up to date in their own operations. There are some signs that our task in the future w i l l be even more complex. In one crucial area, the Brave New World of electronic funds transfers could c all for completely new approaches in central-banking services-““for example, by revolutionizing our check—processing a c t iv it ie s —— as w e ll as in the f i e l d of bank regulation. In an even more important area, monetary p o lic y , the growing s iz e and interdependence of the world economy is bound to create ever-more-complex problems. With developments lik e these, we can be certain that the B School w xll never run out of new cases to study.
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