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For release on delivery
10:00 A.M., E.D.T.
June 27, 1985

Statement by
Paul A. Volcker
Chairman, Board of Governors of the Federal Reserve System




before the
Subcommittee on Economic Goals
and Intergovernmental Policy
of the
Joint Economic Committee

June 27, 1985

I appreciate the opportunity to appear before this Committee to discuss issues involved in the budgetary treatment and
procedures of the Federal Reserve System.

Attached to my state-

ment are several appendices which discuss these questions more
completely.

I request those materials be included in the record.

The appropriate budgetary treatment of the Federal
Reserve has been considered a number of times.

Each time Con-

gress has examined the issue, it has concluded that the Federal
Reserve's functional independence is inextricably intertwined
with its budgetary independence.

I believe the ability of the

Federal Reserve, as provided by the Congress, to conduct its
monetary policy with relative freedom from day-to-day political
pressure has served the nation well over the years.

Maintaining

the independence necessary to accomplish that objective should
remain in the forefront of any consideration to change our budgetary treatment.




- 2 I realizef Mr. Chairman, that you are sensitive to those
concerns.

I understand that it is not your intent to propose

that the Federal Reserve be subjected to the regular budget control processes of the Administration or to Congressional appropriations.

Your concern, as I understand it, is to assure

adequate information is available to permit and encourage appropriate Congressional review and public understanding of Federal
Reserve spending.
In approaching that problem, we share the common ground
that the Federal Reserve is accountable to the Congress, and
through the Congress ultimately to the American public, for its
spending.

The fact is we do make available substantial and

detailed information on our spending and operations.

Budgets for

both the Board of Governors and the Reserve Banks are discussed
and approved in open meetings of the Board.

I would submit, in

those respects, our accounts and budget process are already an
"open book," as they should be.




Mr« Chairman/ following my earlier discussions with you
I have reviewed this matter in detail.

I would readily agree the

"open book" is hard to read -- sometimes confusing and enormously
complex.

I believe there are changes we can implement to make

our budgets more conveniently accessible and more generally
usefulo

For instance, with that objective in mind this year's

Annual Report of the Board of Governors to the Congress includes
a chapter reviewing Federal Reserve spending over the last ten
years and our budgets for 1985.

We intend to present similar

information in each Annual Report in the future.
The burden of my comments this morning is that the
legitimate objectives of disclosure and public accountability can
be best achieved by retaining independent budgetary reporting for
the Federal Reserve (with our net earnings, as at present,
reflected in the regular budget document).

Integrating Federal

Reserve expenditures into the Federal Budget, contrary to our




- 4 entire history and earlier Congressional decisions, would, I
fear, be interpreted as a clear step toward Executive influence
and control over the Central Bank.

I am convinced that, in the

end, the effect would be to make our operations less intelligible
and "transparent" rather than more.

At the same time, I believe

we can better achieve your objectives by working with the
Congress to improve procedures for reporting and oversight.
The Federal Reserve as a Self-Funding Central Bank
The Congress established a central bank for the United
States much later in the nation's history than has been the case
in most other industrialized countries.

To a considerable extent

this reflected long and strongly felt concerns about concentration of economic power.

At the same time, the Congress clearly

wished to insulate the Federal Reserve from partisan politics.
These concerns led to the creation of a regional system, with
operational responsibilities diffused among 12 Reserve Banks,




each with its own board of directors and with the entire system
supervised by the Board of Governors in Washington.
In that connection, Congress plainly understood that the
ability to make considered monetary judgments, independent of
day-to-day pressures of the political arena, required freedom
from outside fiscal control.

These concerns were also evident in

the important revisions of the Federal Reserve Act in 1935, which
cast the System in essentially the form it has today.
The desirability of independent funding of the Federal
Reserve and freedom from potential domination by the Executive
Branch has been reaffirmed each time questions have been raised.
And it has not been a partisan or parochial position.

For

instance, in 1975 six former Secretaries of the Treasury, in a
letter to Senator Proxmire, stressed how important they felt it
was that the Federal Reserve retain its status as a
nonappropriated agency in these words:




- 6 "We all feel that the Congressional reasoning
of 60 years ago which purposely insulated the
Federal Reserve from immediate political pressures
is even more valid today. It is probably more
difficult today than 60 years ago for the Congress
to take a long view that may well appear to conflict
with immediate problems. And yet, this is precisely
what the Federal Reserve must do each day and why
we feel that its independence must be preserved.
"We all agree from a combined total of many years
of experience in government that the independence of
the Federal Reserve would inexorably be eroded by
the appropriations process exposing our country
to great potential danger. "JL/
I should also point out that the budgetary status of the
Federal Reserve is hardly unique; it is indeed the norm for central banks around the world•

For instance, whatever other

arrangements surround their functional independence, all the
central banks of the G-10 countries finance their expenditures
out of their own income.

Typically, they return all or major

parts of their income in excess of expenses to the national treasury, as is the case in the United States, but in no instance is
a budget statement for the central bank included in the budget
for the central government.

That approach by other major indus-

trialized countries reflects widely held concerns about assuring

1/ Federal Reserve Reform and Audit Hearings, 1975, hearings
before the Senate Committee on Banking, Housing and Urban Affairs,
on S. 2285; and S. 2509, 94th Congress (October 20, 1975), p. 140.
(Appendix A discusses the history of Federal Reserve budgetary
independence more fully.)



operational autonomy for central banks.

(Appendix B discusses

financing of the Central Banks of other major countries in more
detail.)
I recognize and appreciate that the stated aim of H.R.
1659 is not to disturb the present method of Federal Reserve
funding or expense control, much less to change the status of the
System within government.

My concern, nonetheless, is that the

proposed inclusion of Federal Reserve expenditures within the
Executive's budget document could be the first step down a slippery slope, encouraging those who clearly would wish to impair
our functional independence by bringing the System more fully
into the budgetary and appropriation process or otherwise.
Federal Reserve System Budget
The objective specifically sought by H.R. 1659 can, in
my judgment, be reached more effectively and more cheaply by
other approaches consistent with present procedures and budgetary




— ft —

treatment.

To help place this issue in context, I would like to

summarize the existing budget process and results.
The Process
The Federal Reserve has an intensive planning budget and
control process for both the Reserve Banks and the Board of Governors.

That process reflects throughout strong concern with

both economy and efficiency.
Initial general guidelines for System spending are
approved by the Board of Governors on the basis of analyses and
projections of expected workloads, trends in prices and wages,
and productivity gains in each area of Federal Reserve responsibility.

Within each of the Reserve Banks, Directors drawn from

the private sector, participate in the budgetary process,
bringing to bear a great deal of business experience.
approve the budgets of their banks.




They must

- 9 I would emphasize too that more than 40 percent of
Reserve Bank budgets represent expenditures for "priced services11*

As a matter of law and principle, these services must meet

a market test in that all expenses (including overhead, and the
imputed cost of capital and taxes) are covered by charges.
As a last step, budgets for both the Reserve Banks and
for the Federal Reserve Board operations are presented to the
Board of Governors for its review and approval at meetings that
are open to the public.

(The internal review process is outlined

in Appendix C.)
The Results
In the end, the effectiveness of the process must be
measured by results.

In the ten-year period from 1974 to 1984

Federal Reserve spending has increased at an average annual rate
of about 0.7 percent in conscant dollars (Chart 1 ) , In the same
period, total System employment has fallen by about 13 percent,




- 10 from roughly 28,000 to 24,000 (Chart 2 ) . Over the same decade,
the principal measures of operational workload have increased by
50 to almost 400 percent (Table 1 ) . The long-term decline in
Federal Reserve employment in face of persistent increases in
output reflect in large measure persistent efforts to improve
productivity in the operating functions of the Federal Reserve
Banks.
For 1985 the Federal Reserve Banks and the Board of
Governors have budgeted total operating expenditures of approximately $1.2 billion.2/

Of this amount, some $900 million

reflects operational services to financial institutions, the
public, the Treasury and Government agencies, most of which is
recovered by charges or reimbursements.

Overall, this will

represent an increase of about 5 percent, in nominal terms, over
the 1984 spending level (Table 2 ) .
2/ This does not include another $175 million which will be
paid to the Bureau of Engraving and Printing for Federal Reserve
notes to be distributed to the public. This sum is not usually
included in analyses of Federal Reserve spending because it
represents simply the cost of providing currency*




- 11 As I indicated a few moments ago, under the provisions
of the Monetary Control Act, the System must recover the full
cost of most services (including an adjustment for imputed taxes
and the cost of capital) it makes available to depository
institutions,

In this area ~

clearing checks, providing wire

transfers, and other payments services —

the Federal Reserve

effectively has to compete in terms of price and quality with
other actual and potential suppliers of such services.

In 1984

the Federal Reserve met this test and recovered the full cost of
priced services*
As fiscal agent for the Uo S* Government, the Federal
Reserve is responsible for issuing and redeeming a variety of
Treasury and other government debt instruments ranging from savings bonds and food stamps to large denomination Treasury bills,
notes and bonds*

We are reimbursed in whole or in part for these

services by other agencies, bringing our receipts for services to




- 12 more than $600 million this year, about half of total expected
Federal Reserve expenditures budgeted for 1985.
While this may not be the time or place to review the
spending record in great detail, I have attached relevant
material in Appendix D and wouldf of course, be glad to respond
to any questions you may have.

But I do want to affirm that I

believe that further analysis will confirm a disciplined
budgetary process and a consistent pattern of economy and
efficiency in our actual spending.

Indeed I am not aware that

our record in these respects has been challenged in any material
before the Committee.
Information Now Publicly Available on Federal Reserve Spending
The Federal Reserve now makes available detailed
information on its spending.

Much of this data is drawn directly

from the Federal Reserve's accounting and management information
system (Planning and Control System, or "PACS") used for internal




- 13 control.

That system contains data on spending by every Reserve

Bank and branch office by service and subservice line and by
object of expenditure (i.e., salaries, materials and supplies,
equipment, travel and others).

All in all, the "PACS11 reports

provide data on 96 services and subservices by 71 detailed
objects of expenditure, as well as productivity and service
quality measures.

These data are publicly available on a

quarterly basis with a six-week time lag, and I know of no other
governmental body that provides publicly so much detail about its
spending and productivity so promptly. 3/
PACS information by its nature is retrospective.

How-

ever, the Federal Reserve also makes available late in each year
information in the form of tables and analyses of anticipated
expenditures for the forthcoming year.

These are released to the

public prior to the open Board meetings at which spending levels
for the Board and the Reserve Banks are set.

J3/ I have included with my statement a Summary PACS report
for the first quarter of 1985 for your information.




- 1 4 •

Whether we have provided all available information in as
readily convenient a form as possible is another question.
believe improvements can be made.

I

We are working to that end.

Difficulties with the Approach of H.R. 1659
Our Federal Reserve budgeting generally follows business
accounting principles, including depreciation of capital assets.
The budgets are on a calendar year basis, and we do not regularly
make multi-year expenditure forecasts.
H.R. 1659 would require changes in that approach.

All

budget information would be provided in the same format, and with
the same accounting conventions, as used for "on budget" agencies.

The data would then be included in the Federal budget

documents, although without provisions for Executive Branch
review or Congressional appropriations.
Technical issues, as well as fundamental philosophical
concerns, would need to be resolved before such an approach could




- 15 be adopted*

And, I do not believe the results would effectively

achieve the limited aims sought —- that is, improved
understanding and review of our expenditures by the Congress or
the public.
The technical concerns are threefold:

first, problems

arising from differences in the accounting procedures used by the
Federal Reserve and those employed by budgeted agencies; second,
the costs that would be associated with the necessity of
maintaining a dual accounting system, and third, the difficulties
of meaningfully forecasting Federal Reserve earnings several
years ahead.
With respect to accounting conventions, the Federal
Reserve is a "business-like" organization that basically keeps
its books as would a private concern —• that is using generally
accepted accounting principles (GAAP).

The primary difference in

approach from Federal budget concepts is that the Federal Reserve




- 16 capitalizes and depreciates major assets rather than expensing
them in the year that they are acquired#4/

Indeed, we could not

sensibly price our services on any other basis, given that the
production of these services is highly capital intensive and that
our prices, by law, must be set in a manner consistent with
methods used by private sector providers.

Specifically,

expensing computers and other equipment in the year acquired
rather than following GAAP —

—

would result in widely fluctuating

prices for Federal Reserve services, rendering the pricing
approach stipulated by the Monetary Control Act practically
impossible.

More generally, from the standpoint of budgetary

management of both the Board of Governors and the various Federal
Reserve Banks —
the public —

and the comprehensibility of those budgets to

GAAP accounting seems more sensible.

4/ The GAAP approach used by the Federal Reserve is particularly
recommended by the accounting profession for organizations that
must cost and price products. See, for instance: Comptroller
General of the United States, Report to the Chairman, Committee on
Banking, Housing and Urban Affairs, United States Senate, "An
Examination of Concerns Expressed about the Federal Reserve's
Pricing of Check Clearing Activities;" and Arthur Andersen & Co.,
"Federal Reserve System: Report on Priced Services Activities,"
September 19 8 4.



- 17
These problems implicit in Federal budgetary treatment
could be overcome only by maintaining dual accounting systems,
which would involve some sizable developmental and maintenance
costs if done with precision*

And, two parallel accounting

systems are more likely to contribute to confusion than clarity•
H.R. 1659 also would require the Federal Reserve to
forecast our revenues.

The great bulk of the Federal Reservess

earnings are a by-product of the implementation of monetary policy.

Earnings on our portfolio of securities account for more

than 95 percent of Federal Reserve receipts and reflect mostly
the amount of currency outstanding, Congressional and Federal
Reserve decisions as to the level of reserve requirements, decisions on open market operations, and the level of interest rates.
Meaningful forecasts of those variables are simply not feasible
and would be liable to gross misinterpretation if considered
indicative of future monetary policy.




I would also point out

- 18 that forecasts of costs and receipts in the priced services area
would also be subject to market uncertainties, and necessarily be
somewhat speculative.
Policy Concerns
My greatest concerns about the approach proposed in H.R.
1659 transcend these technical considerations.
We plainly have the obligation to report to the Congress
fully on our policies and operations.

My sense is the arrange-

ments for such reporting have, in most respects, worked relatively well over the years.

As you know, as a matter of law, I

testify four times each year before the Congress on the general
conduct of monetary policy.

Altogether, other Governors, Federal

Reserve officials and myself appeared formally before the
Congress on 34 occasions last year, and 34 times so far in 1985,
testifying on a variety of subjects*




- 19 The question raised is whether, in this testimony, in
other reports, or otherwise, there is enough focus on our "housekeeping" responsibilities -- running an economical, costeffective operation.

Appropriate Congressional oversight of

Federal Reserve spending can and should contribute to that process «

I believe this can be done in a manner that does not raise

questions about the independence of our budgetary processes and
which contributes to public understanding.




To those ends, I would suggests
1)

Within the Federal Reserve, we take steps to assure

that the mass of information now available in several documents about our spending and budgetary process be presented
at times and in a manner more accessible to public and Congressional oversight.

We are taking steps in that direction,

and would welcome further suggestions you may have.

- 20 2)

We retain our present accounting format, using

GAAP concepts rather than shifting to the Federal budget
accounting conventions.

My strong belief is that Federal

Reserve spending is likely to receive more, and better
informed, Congressional and public scrutiny as part of a
separate report consistent with GAAP accounting.
The net fiscal impact of Federal Reserve operations is
already fully and accurately reported in the Budget.

Forc-

ing the full array of supporting material into the dark
recesses and precise format of a budget presentation
developed for quite different purposes -- a presentation
that already runs to thousands of pages -- could hardly be a
service to public understanding.

It would, I suspect^

become just another hard-to-understand

D3

special analysis/'

alongside a number of others virtually incomprehensible to
those untutored in the intricacies of budget accounting for
government or government-sponsored enterprises.




- 21 3)

Finally, the appropriate oversight committees in the

House and Senate might wish to resume a practice, followed
for some years in the Senate, of annual hearings directed
specifically toward the Federal Reserve budget and internal
management.

I believe we, as an organization, benefitted

from that procedure in the past, and would be glad to cooperate in the future.
In closing, Mr, Chairman, I appreciate the careful way
in which you have undertaken a reexamination of these questions.
Our goals are congruent —

to achieve effective cost containment

and appropriate accountability.

I believe those aims can be

accomplished in ways fully consistent with our traditional role
in Government, and without raising unintended questions about
whether the conduct of monetary policy will continue to be free
from partisan and passing political pressures.




CHART 1

TOTAL EXPENSES
FEDERAL RESERVE SYSTEM
1.2

1.145,
1.1 -

million

1 -1

Avg. Annual Growth Rate
Nominal 7.6%
Real
.7%
million

0.4

i

75

76

77
a

78

79

60

NOMINAL!

I

81

j

74

82

83

84

REAL$

CHART 2

TOTAL EMPLOYMENT
FEDERAL RESERVE SYSTEM
27928
Avg.

Annual Growth Rate
-1.4%
-3671 employees
-13.1 % absolute

24
74

Note:



75

76

77

YEAR
D
ANP
These data include Reserve Bank and Board expenses% excluding currency
costs, because the Fed reimburses the Bureau of Printing and Engraving
for their total costs of producing Federal Reserve notes. Constant
dollar data calculated using the GNP. implicit price deflator 1972=100*

Table 1
Federal Reserve System
Expenditures, Employment and Volume Measures
1974-1984
% Change

1974/1984

Average Annual Rate

Expenditures
Real

7.2%

0.7%

Nominal

108.0%

-7.8%

Employment

-13.1%

-1.4%

386%

17.1%

Currency

99%

7.1%

Check Collection

53%

4.3%

Operating Volumes
Funds Transfer




Table 2
Federal Reserve Expenditures
1984 Actual - 1985 Budget

federal Reserve System 1/
1984 Actual - 1985 Budget
(in millions)

Reserve Bank Expenses 2/
1984 Actual - 1985 Budget
(in millions)

Board of Governors Expenses 3/
1984 Actual - 1985 Budget
(in millions)

1984

1985

% change

1984

% change

1984

1985

change

Monetary & Economic Policy

130-2

131.7

1.1

99.4

98.4

- 1.0

30.8

33.3

8.1

Services to Treasury
& Government Agencies

129-4

140.6

8.6

126.3

137.0

8.5

3.2

3.5

9.3

Services to Financial
Institutions

728.2

757.9

4.1

701.5

730.3

4.1

26.7

27.6

3.3

Supervision and
Regulation

158.1

174.4

10.3

140.7

156.7

11.4

17.4

17.7

1.7

1145.7

1204.4

5.1

1067.8

1122.3

5.1

78.1

82.1

5.1

Total

1985

!_/ These data are for Reserve Banks and Board of Governors expenses excluding currency costs. The data are derived
from two separate accounting systems, for comparability over the time periods estimates were made to allocate
expenses into major programs and for the Board of Governors which accounts for 7 percent of the total system
expenditures.
2J Includes support and overhead allocation*
_3/ Includes depreciation expense. Figures may not add due to rounding.




Table of Contents
Page
Appendix A: HISTORICAL SUMMARY:
FEDERAL RESERVE S/STEM STRUCTURE AND BUDGETARY TREATMENT
Introduction
The Federal Reserve's Budgetary Independence

•2

Major Legislation

3

World War II and the Federal Reserve/Treasury Relationship

4

Congressional Proposals

5

Other Reviews of the Federal Reserve's Budgetary Status

7

Chronology of Federal Reserve Legislation

9

Appendix B: FINANCIAL INDEPENDENCE OF CENTRAL BANKS OF THE
G-1O COUNTRIES
Appendix C: PLANNING, BUDGET AND CONTROL PROCESSES OF THE
FEDERAL RESERVE SYSTE5T
I.

Reserve Banks

1

II. Board of Governors

13

Appendix D: FEDERAL RESERVE SYSTEM EXPENDITURES, EMPLOYMENT
AND PRODUCTIVITY
Overview
I.

Total System Expenses and Employment by Program
A. Monetary and Economic Policy
B. Services to the Treasury and Government Agencies
C. Services to Financial Institutions and the Public
D. Supervision and Regulation

II. Reserve Bank
Reserve Bank
A. Service
B. Service
C.
D.

Expenses
Expenses
Line I:
Line II:

and Employment
and Employment by Service Line
Monetary & Economic Policy
Services to the Treasury
and Government Agencies
Service Line III: Services to Financial
Institutions and the Public
Service Line IV: Supervision and Regulation

6
6
8
9
12
14
17
19
23
27
31

III. Board of Governors' Expenses and Employment
Board Expenses and Employment by Program Structure

33
35

IV. PACS Performance Measures
Productivity

37
39

V.

41




1985 Federal Reserve Budgets

Appendix A
HISTORICAL SUMMARY
FEDERAL RESERVE SYSTEM STRUCTURE AND BUDGETARY TREATMENT

Introduction
The budgetary independence of the Federal Reserve is part of a carefully
constructed Congressional design to ensure the independence of the nation's
monetary authority from day-to-day political influence.
is not isolated from the Congress that created i t :

The Federal Reserve

frequent testimony enables

the Congress to oversee the Federal Reserve, to communicate i t s views, and to
alter the Federal Reserve's operating functions, as i t did in the Monetary
Control Act of 1980, and in many previous legislative acts.
However, while the role of the Federal Reserve—and i t s budgetary
independence—have been frequently reviewed both by the Congress and other
groups, the conclusion has always been that i t is in the nation's interest to
retain the budgetary arrangements as the Congress originally framed them,
Background
The United States created i t s central bank much later in the nation's
history than most other major industrial countries.

The Federal Reserve

System was established in 1913 following a string of bank failures and money
panics.

Six such economic crises had occurred in the preceding 30 years.

With the most severe shock of 1907 s t i l l in mind, the 62nd Congress acted to
create an institution that would preserve the value of U.S. currency and
promote a stable economy.
The Federal Reserve Act, signed into law by President Woodrow Wilson on
December 23, 1913, provided for:




-2...the establishment of Federal reserve banks, to furnish an elastic
currency, to afford means of rediscounting commercial paper, to establish
a more effective supervision of banking In the United States, and for
other purposes.'
The Federal Reserve Act was crafted by Senator Carter Glass under the
guidance of President Wilson. President Wilson made clear his desire for a
decentralized central bank, composed of a system of regional reserve banks In
which national banks, and voluntarily participating state banks, would be
required to hold stock and maintain their reserves. He was equally adamant on
the matter of dispersion of power and control stipulating that while six of
each regional Reserve Bank's proposed nine directors would be chosen by banks,
only three of these could themselves be bankers. The remaining three
directors, Including the Chairman, would be chosen by a separate Federal
Reserve Board located In Washington and designed to be the capstone of the
System,
The Federal Reserve's Budgetary Independence
Since the System's early years Its independent status and its relationship
to the Congress and the Executive have been the subjects of widespread
discussion. The Congress carefully provided sufficient independence to enable
the System to pursue the goal of maintaining a stable currency and economy
insulated from day to day political influences and from the private banking
community. The legislative history of the original Federal Reserve Act
indicates that Congress was adamant on that point. Its exemption from the
congressional appropriations process was seen as an essential part of this
insulation, and the debate surroundinq the passage of the Act is replete with

Preamble to the Federal Reserve Act, December 23, 1S13.




statements reflecting this concern. The Federal Reserve Act specifically
states that the Federal Reserve Board is to pay its expenses out of the
earnings on Reserve Bank assets. It was clearly understood that the Reserve
2
Banks themselves would not be subject to appropriations.
Major Legi siati^n
o

The Banking Act of 1933
The Congress passed the Banking Act of 1933 in an effort to strengthen the

Federal Reserve Board and implement programs for economic recovery. It
further clarified the Federal Reserve Board's and the Reserve Banks1
independence by adding a new paragraph to section 10 of the Federal Reserve
Act:
•..The Board shall determine and prescribe the manner in which its
obligation shall be incurred and its disbursements and expenses allowed
and paid, and may leave on deposit in the Federal Reserve Banks the
proceeds of assessments levied upon them to defray its estimated expenses
and the salaries of its members and employees, ...; and funds derived from
such assessments shall not be construed to be Government funds or
appropriated moneys. (12 U.S.C. Section 244.)
According to both the House and Senate Banking Committee reports, the
purpose of the amendment was to leave "to the Board the determination of its
3
own internal management policies." The Senate Report specifically states
(pp. 11-12) that one of the purposes of the Act was to strengthen the Federal
Reserve System by increasing the independence of the Federal Reserve Board.

2 See attached chronology relating to Federal Reserve legislative
developments.




3

S. Rep. No. 77, 73rd Cong., 1st Sess., p. 14, May 17, 1933,
H. Rep. No. 150, 73rd Cong., 1st Sess., p. 2, May 19, 1933.

-4o

The Banking Act of 1935
The Banking Act of 1935 further strengthened the powers of the Board of

Governors by removing the Secretary of the Treasury and the Comptroller of the
Currency from the Board. A former Treasury Secretary, Senator Carter Glass,
sponsored this amendment. He argued that the Secretary of the Treasury didn't
belong on the Federal Reserve Board because of the chance that the Secretary
would exercise undue influence on the Board, "treating the board as a mere
5
bureau of the Treasury Department." Glass said that Senator ffcAdoo, who
had also been a Treasury Secretary, agreed with him. They believed that
influence of this sort was not proper, and it was never contemplated that the
Federal Reserve would function as an adjunct to the Treasury.
Although the American banking community lobbied for more control of the
banking system when the Banking Bill of 1935 was being considered, they also
expressed strong concern that the central bank not come directly under the
influence of the Executive Branch. Political pressures would always be for
inflation, they claimed, never for curbing the false prosperity of booms.
World War II and the Federal Reserve/Treasury Relationship
The Federal Reserve Board was given greater powers to control money and
credit during World War II, but the Treasury's financing requirements
necessarily dominated war time Federal Reserve policy. In an address in May
1948$ Marriner Eccles said:
The record of the financing of the war shows that as much as $8 billion a
month vwas being spent, the public debt grew from around $40 billion to
$280 billion in the short space of four or five years. The public debt
was 60 percent of all debt. It would be perfectly obvious that in order
to do that at a fixed interest basis, which was maintained throughout the
war* we had tof have a central open market operation. We were able to say
to treasury: We will finance whatever is necessary at the rates of
interest now prevailing.1 That was just before the war and we did.6
5

79 Cong,, Rec. 11,766-77 (1935).

6

Address of Marriner S. Eccles, Chairman, Board of Governors of the
to the Chairmen's Conference, White Sulfur Springs,
1948.


Federal Reserve System
http://fraser.stlouisfed.org/
West Virginia, May 29,
Federal Reserve Bank of St. Louis

-5While this cooperative policy of war financing was obviously in the national
interest, postwar support for government bond prices had long-term
inflationary consequences, and the Board believed that supporting government
bonds at a fixed rate was feeding inflation*

In 1951 the Federal Reserve

reached the historic "Accord" with the Treasury, which asserted the Fed's
independence and relieved i t of the responsibility of fixing the interest rate
on Treasury debt issues*
Congressional Proposals
Putting the Federal Reserve System financing under the congressional
appropriations process is not a new idea.

Several proposals have been

considered, but each time the Congress has decided to maintain the current
system*

The Congress has thereby succeeded in avoiding the problems that

could arise i f the nation's monetary policy were influenced by considerations
of short-term expediency*
In 1964 the Congress held hearings entitled, "The Federal Reserve System
After Fifty Years," in which a proposal calling for an audit by the G O (H.R.
A
9631) was submitted, as was a b i l l (H.Ra 9685) addressing the issue of putting
the Fed under appropriations.

Testifying on behalf of the Treasury before the

House Committee on Banking and Currency, Secretary C, Douglas Dillon advised
against taking such action:
This committee is dealing with a living institution—an institution
that has demonstrated its capacity to innovate, to experiment, and to
adapt itself to a very wide range of circumstances. But in this process
of change, i t has never lost certain characteristics—an established
tradition of independent judgment: a mixture of regional participation in
policymaking with ultimate central control that is unique in our
Government; an ability to attract highly qualified officials and staff;
and a reputation for operating efficiently and impartially.




-6Change without clear purpose can be dangerous too. If there are
persuasive reasons for particular proposals—if it can be shown that
ownership of Federal Reserve Bank stock by member banks has biased Federal
Reserve policy decisions or if budgetary or auditing practices have been
loose, to take two examples—by all means, this committee should act. But
I doubt the advisability of taking action simply for the sake of achieving
symmetry with other Government agencies particularly if there was danger
that such action might impair a long tradition of regional participation
and efficient service of which I believe the country can be proud.7
The legislation was not adopted.
In 1968, the House Banking and Currency Committee again held hearings on
proposed structural changes to the Federal Reserve. The hearings on H.R. 11,
chaired by Congressman Wright Patman, also addressed the issue of having the
Congress appropriate operating funds for the Fed. In testimony the Treasury
Department stated that subjecting the Fed to the appropriations process was
unnecessary and "might widely be regarded as increasing the possibilities for
reducing the independence of the System within the Government and as possibly
leading to undesirable interferences with policies."
In 1975 the Senate Banking, Housing and Urban Affairs Committee considered
a proposal to submit the Federal Reserve's budget to appropriations. Again,
the argument was that such involvement by the Congress would largely dissolve
the shield of relative independence from political influence that was built
into the Federal Reserve Act. This principle was reiterated in a 1975 letter
to Senator Proxmire from Joseph W. Barr, former Secretary of the Treasury,
along with five other past secretaries, stressing how important they felt it
was for the Federal Reserve to retain its status as a nonappropriated agency.

7

"The Federal Reserve System After Fifty Years," Hearings before the
Subcommittee on Domestic Finance of the House Committee on Banking and
Currency, 88th Cong. (Jan.-April* 1964.)




In 1978 with passage of the Federal Banking Agency Audit Act the Congress
included an exemption from GAO audit for Federal Reserve transactions with
foreign central banks and foreign governments, monetary policy matters, and any
documents dealing with these topics*

In passing this exemption, the Congress

relied in large measure upon fears that information collected during the GAO
audits (or GAO comments or criticisms) might be used to influence the System's
policies for short-term political reasons. The key provision is the setting of
limitations on the auditing process; one limitation is the absolute prohibition
against auditing monetary policy matters.
Other Reviews of the Federal Reserve's Budgetary Status
In October 1967, the President's Commission on Budget Concepts presented its
report, which led to the present federal unified budget concept. While the
Commission found that the budget as a general rule should comprise the full range
of federal activities, it did not recommend including the Federal Reserve in the
budgetary process. The report observed that to do so might jeopardize the
flexibility and independence of the central bank's monetary policy function.

8

The Report of the President's Commission on Financial Structure and
Regulation, also known as the Hunt Commission Report, stated in 1971 that "it is
wise to keep the central bank and its decision making responsibility in a
basically insulated position within the Federal Government." The Hunt Commission
concluded that:
The present position of the Federal Reserve provides for enough
communication of ideas and coordination of action with the Executive
Branch to serve tbe purposes of effective government. It also permits
thorough and frequent review of central bank performance by the Congress
to assure accountability to the public will. These vital safeguards are
currently fully respected. The Commission strongly urges that the Federal
Reserve System retain its present independence of decision-making to
protect monetary policy from partisan political influences
(Recommendation 1 3 ) . 9
8

p. 28.
^




Report of the President's Commi s s i on on Bud get C one ep ts.

(GPQ, 1967)

"~~
~
'
of the Presi dent,: sL^onmiTss jon j ) n P nancj gj^tnjeture and

-8More recently, in September 1976, in its report on the "Off-Budget
Activities of the federal government," the House Committee on the Budget
reviewed the budgetary status of a number of agencies exempt from inclusion in
the budget. That report notes that the Board of Governors1 budget (but not
that of the Federal Reserve Banks) is included in the Appendix to the federal
government's budget. Although the Committee recommended that a number of
entities1 budgets no longer be "off-budget," it chose not to review the
expenses and budget status of the Federal Reserve.
Conclusion
The Federal Reserve's independence from the budget process has not
isolated the Fed from the Congress. In 1978 the Congress passed the Full
Employment and Balanced Growth Act, also known as the Humphrey Hawkins Act.
It requires that the Board report twice a year to Congress on its monetary
policy objectives and plans as they relate to the most recent Economic Report
of the President. Rather than becoming involved in Federal Reserve System
operations, the Congress has opted over the years to strengthen the System's
reporting procedures and requirements. In the years since 1978, members of
the Board or its staff have frequently testified before the Congress on many
matters, including the Federal Reserve's budget.
The Federal Reserve System was created by the Congress in legislation
carefully crafted to insulate the central bank from influences of private
bankers, the Executive Branch and short-term political pressures in the
Congress. This system has been examined and reexamined by committees of the
Congress and independent commissions examining the banking and budget
systems. All have concluded that the Congress acted wisely in establishing
and maintaining the budgetary independence of the Federal Reserve System.




-9CHRONOLOGY OF MAJOR CONGRESSIONAL CONSIDERATION OF
FEDERAL RESERVE STRUCTURE AND FINANCING
1913

Federal Reserve Act of 1913; Pub. L. 63-43: Determined structure of
the Federal Reserve; designed as a regional system with a governing
Board. Provided the Federal Reserve with unique status as an
"independent" central bank within government, and organized its
operation with the intent of insulating it from political pressures.
The Act stipulated that the System's operating expenses were to be
funded by assessments on earnings of the Reserve Banks. Ten percent
of the Reserve Banks0 net earnings was in a special surplus account
maintained by the Treasury, and the remainder (90 percent) was paid
to the U.S. government as a franchise tax.

1927

McFadden Act, also known as the Banking Act of 1927; Pub. L. 69-639:
Extended the charters on the Reserve Banks for an indeterminate
period {initially the Federal Reserve Act provided for renewable
20-year charters.) Certain restraints put on branch banking by state
member banks in the FRS. American Bankers Association president
testified that member banks want optional, rather than obligatory,
contribution to capital of FRS and want "a voice in placing . . .
reserve funds with approved Reserve agents as now, instead of all
being impounded by law, and from the earnings of which the government
abstracts a part." Because reserve funds are the property of the
member banks, the member banks believed they should have a voice in
how the funds are used. This view was not reflected in the act that
passed. (House Banking and Currency Committee, Hearings on
H.R. 6855, 68 Cong. 1 Sess, (GPO, 1924J)

19311932

Hearings on the Reconstruction Finance Corporation. The bill
"requires the FR Banks to transact the business of this corporation,
to receive deposits from it," but the Fed is not provided
compensation for it, Glass said. During the hearings Glass contended
that the Government owns not a dollar of interest in the Federal
Reserve System. Undersecretary of the Treasury Ogden Mills says that
the government has interest in the Federal Reserve System through the
franchise tax« Glass questioned the arrangement saying the FR Banks
were not government institutions. He said that the franchise tax
(which has since been repealed) should not be collected any longer.
He and Mills agreed that the FR Banks "do for government in its
fiscal operations a tremendous amount of business without any
compensation at all," and should be compensated. (H.R. 5060 and
H.R. 5116, 72 Cong. 1 Sess., (GPO, 1932.))




193233

Hearings on Operation of the National and Federal Reserve Banking
System in the U.S. Senate (later became the Banking Act of 1933).
In discussion before the Senate Banking Committee, Eugene Meyer,
Chairman of the Board, and Senator Glass discussed government
financing of emergency recovery programs and institutions. Meyer
said that the government had not contributed any money to the
maintenance of the Federal Reserve System, and Glass said that it
never should. Glass reiterated: "The government does not own one
dollar of proprietary interest in the Federal Reserve System, and I
for one have been intent on keeping it that way. I don't think the
government should have anything to do with it except by waiy of
supervisory control." (S. Res. 71, 71 Cong. 3 Sess. (GPO, 1932.))

1933

Banking Act of (June 16) 1933, Pub, L. 73-66: In addition to
important changes in operating procedures and structure of FOMC, the
Act stated that funds of the Federal Reserve System, the FDIC and the
Comptroller of the Currency were not public moneys. Subsequently the
Federal Reserve was not subject tcTSAO audit, or the appropriations
process. Federal Reserve surplus account funds used to capitalize
the FDIC. Franchise tax requirement was eliminated to enable the
Reserve Banks to restore their surplus accounts. To strengthen the
Board's political independence, terms of governors were extended from
10 to 12 years. (S. Rep. 77, 73 Cong. 1 Sess., (GPO, 1933.))

1934

Hearings of the House Appropriations Committee on H.R. 9410;
Permanent Appropriations Repeal Act, 1934. All government agencies
were required to address Congress on their budgetary status.
Testimony given regarding the Federal Reserve's special status
These hearings constituted the only written explanation (as far as
can be determined) of the amendment. Testimony explicitly addressed
the language in the 1933 Banking Act formally granting the Federal
Reserve its financial independence. Testifying on behalf of the
Board was Chester Merrill, Secretary of the Board and chief
administrative officer. He was, in part, responsible, along with
Senator Carter Glass, for the provision in the 1933 Banking Act that
the Federal Reserve's funds were "not to be construed as government
funds or appropriated moneys," Merrill said that the Federal Reserve
had never considered the funds to be anything else.




"We do not agree that they were ever public moneys or appropriated
moneys." Nothing was ever done about it until ... the Banking Act of
1933 when Senator Glass "who took very great exception" to that idea,
"objected to any such idea being permitted to exist, and incorporated
into the Banking Act an amendment to the Federal Reserve Act to that
effect." (H.R. 9410, 73 Cong. 2 Sess., (GPO, 1934.))

1935

Banking Act of 1935; Pub. L. 74-305: The FOMC was created in its
present form; salaries of Board members were improved to help attract
qualified individuals and to restore to the Board the stature to
which it was legislatively entitled. Independence was further
defined and promoted by extending terms of governors from 12 to 14
years and removing the Secretary of the Treasury and Comptroller of
the Currency from the BoardJ

1938

Hearings on "Government Ownership of the Twelve Federal Reserve
Banks," H.R. 72?9, sponsored by Wright Patman, before the House
Banking and Currency Committee, chaired by Congressman Steagali.
Instead of concentrating on whether the Federal Reserve Banks "shall
be the property of the United States;" the hearings were used by the
Housing Banking Committee to question Federal Reserve officials, such
as Chairman Marriner Eccles, on monetary policy and System
operations. (H.R. 7230, 75 Cong. 3 Sess. (GPO, 1938.))
The bill also recommended expanding the Federal Reserve Board to 15
members, including the Treasury Secretary, the Comptroller of the
Currency, and Chairman of the FDIC. The bill was not seriously
considered,

1945

Senate hearings on the "Government Corporation Control Act" on
providing for financial control of Government Corporations. The
General Accounting Office expressed the view that the Reserve Banks
should be excluded fron? the Act because they were examined frequently
and thoroughly by examiners under the direction of the Board of
Governors. (Expenditures in the Executive Department's Committee
Hearings on H.R. 2177, 79 Cong. 1 Sess., (GPO, 1945J)

19491950

Douglas Committee. Report of the Joint Economic Committee
issued. Key recommendations stated that credit policies must be
flexible and the Federal Reserve System must remain independent of
executive domination. Hearings before the subcommittee on monetary,
credit and fiscal policies (81 Cong. 1 Sess., pursuant to Sec. 5A of
Pub, No. 304 (GPO, 1949.))

1

Before enactment of the 1935 Banking Act, the title "governor"
referred to the chief executive officer of the Board, and there were eight
Board "members" on the Board. With passage of that Act their titles were
changed to governor. As a result, the Board had seven governors and a
chairman.




1952

Patman hearings on General Credit Control and Debt Management before
the Joint Economic Committee. Overwhelming weight of testimony
favored independence of the Federal Reserve from political pressures
and agreed on the inherent inflationary risks in using the Federal
Reserve to supply the Treasury with cheap credit. Congressman Patman
indicated that his interest in government audit of the Federal
Reserve was not only for information, he wanted Congress to exercise
control over income and expenditures by the Board and the Reserve
Banks so that it could influence the policies of the System* "I do
not mean inconvenience just to inconvenience you (the Fed) but I mean
quickly to pass upon policies."
No mandate issued from Congress but the Federal Reserve furnished its
own audit reports to appropriate congressional committees for
inspection. (Subcommittee on General Credit Control and Debt
Management, 82 Cong. 1 Sess,, (GPO, 1951-1952.))

1964

Hearings on "The Federal Reserve System After Fifty Years":
Proposals made for improvement of Federal Reserve and introduction of
H.R. 9631 calling for audit by the GAO; and H.R. 9685 addressing the
issue of the Federal Reserve being put under appropriations by
Congress. After the conclusion of these exhaustive hearings,
Congressman Hayes summed up the committee's overall evaluation: "If
there were any evidence of corruption or bad management,
inefficiency, I think there would be a prima facie case for making
some change. But it seems to me that the reputation of the Federal
Reserve System for integrity and honesty in the way they handle their
affairs is unrivaled." (Proposals for the Improvement of the Federal
Reserve, and Staff Report, Subcommittee on Domestic Finance of the
House Committee on Banking and Currency, 88 Cong. 2 Sess. (GPO, Aug.
1964.))

1968

The House Banking and Currency Committee Report on H.R. 11, proposed
by Congressman Wright Patman, Proposed structural changes to the
Federal Reserve System, among them: an annual audit of the Board and
Reserve Banks and Branches by the Comptroller General of the U.S. and
operating funds for the Federal Reserve System to be appropriated by
Congress. The Treasury Department stated that the measures (either
government auditing or subjecting the Fed to appropriations process)
were unnecessary and "might widely be regarded as increasing the
possibilities for reducing the independence of the System within the
Government and as possibly leading to undesirable interferences with
policies." The hearings did not result in legislation.




The Treasury further noted that Congress has also exempted other
raajor bank supervisory authorities—the FDIC and the Comptroller of
the Currency—from the regular appropriations process. (Compendium
on Monetary Policy Guidelines and Federal Reserve Structure pursuant
to H.R. 11. 90 Cong. 2 Sess. (GPO, December 1968.))

-131975

The Senate Banking, Housing, and Urban Affairs Committee hearings on
S. 2285 and S. 2509 chaired by Senator William Proxmire.
Consideration was given to a proposal to limit expenditures by the
Board of Governors and the Federal Reserve Banks to amounts approved
in appropriations acts. (Hearings before the Senate Banking, Housing
and Urban Affairs Committee on S. 2285 and S. 2509, 94 Cong. 1 Sess.
(GPO, 1976.)) Similar hearings held 1977-1980 by Senate banking
Committee covered substantive issues as well as budgetary issues.

1977

Federal Reserve Reform Act of 1978, Pub. L. 95-188: Amendments
passed that provided for Senate confirmation of Board's Chairman and
Vice Chairman and for the extension of conflict of interest
provisions to Federal Reserve Bank directors* officers and
employees. This action was seen by Congress as a way of making
Federal Reserve management more accountable to Congress.

1978

Federal Banking Agency Audit Act of 1978; Pub. L. 95-320: Congress
authorized the GAO to perform audits of banking agencies but included
an exemption from GAO audit for Federal Reserve transactions with
foreign central banks and foreign governments for monetary policy
matters and for any documents dealing with these topics. In passing
this exemption, Congress relied in large measure upon concerns that
information collected during the GAO audits (or GAO comments or
criticisms) might be used to influence the System's policies for
short-term political reasons. Full Employment and Balanced Growth
Act; also known as the Humphrey-Hawkins Act; Pub. L. 95-523:
Requires that the Board report twice a year to the House and Senate
Banking Committees on its monetary policy objectives and plans as
they reiat; to the most recent Economic Report of the President.
{Heariiigs before the Senate Governmental Affairs Committee on H.R.
2176, 95 Cong. 1 Sess. (GPO, 1978.))

1980

Monetary Control Act of 1980; Pub. L. 96-221: Required that all
depository institutions be subject to reserve requirements set by the
Board. Also required the Federal Reserve Banks to charge depository
institutions for services.
The GAO report entitled "Response to Questions Bearing on the
Feasibility of Closing the Federal Reserve Banks" concluded that
there were no overbearing reasons for closing the Federal Reserve
Banks. The study also stated that "no alternative to the banks
presently exists." House Banking, Finance and Urban Affairs
Committee, Hearings on H.R. 7; 96 Cong. 1 Sess, (GPO, 1979.))

1985




The Congressional Budget Office Report on "The Budgetary Status of
the Federal Reserve System:" CBO addressed three budgetary options
for Congressional treatment of the Federal Reserve. In testifying
before the JEC on the results of the study, the director of the
Congressional Budget Office noted that the risks of reducing the
Federal Reserve's independence on policy matters is greatest if
Federal Reserve expenses are appropriated and if the Reserve System
is required to project its financial operations. The risk is smaller
(but still exists) if the budgetary coverage is primarily
informational and limited to operating expenses.

Appendix B
FINANCIAL INDEPENDENCE OF CENTRAL BANKS OF THE G-10 COUNTRIES1
While detailed arrangements differ from country to country, in general the
central banks in the G-10 countries have a high degree of budgetary autonomy,
even in countries where the central bank has less autonomy than the Federal
Reserve in determining monetary policy. Budgets are developed and implemented
by the central banks themselves. The degree of subsequent central government
review varies from modest to none (except in Japan where a more extensive
review takes place). In no case is the central bank's budget submitted to the
legislature or parliament for formal review or included in the central
government's budget.
The degree of independence of G-10 central banks is summarized in
Table A. Following is a more detailed description of each of the G-10 central
banks with regard to budget processes and earnings distributions.
BELGIUM
1.

Budget process. The National Bank of Belgium drafts its own budget.

A government official then reviews the budget to see if it is in accordance
with the general thrust of government budgetary policy. The Bank, as a rule,
tries to stay within the overall guidelines of the government, but it is not
legally obligated to do so and the process of reconciling views of the Bank
and the government on budgetary matters is informal.
2.

Earnings distributions. The amount of profits that the Bank returns

to the government is determined in part by formulas described by law and in
part reflects discussions between the Bank and the Ministry of Finance. In
recent years only about 7 percent of net profits have been added to reserves
with the remainder going to the government.




The G-10 countries now include Switzerland.

-2CANADA
"*•

Budget process.

The Bank of Canada's yearly budget i s drawn up by

the Bank's s t a f f under the d i r e c t i o n of the Governor of the Bank and submitted
f o r approval to the Bank's Board of D i r e c t o r s .

(The Board consists of f i v e

d i r e c t o r s , including the Deputy Minister of Finance serving ex o f f i c i o . )

The

Bank's functions as the governments f i s c a l agent ( p r i m a r i l y i n v o l v i n g debt
management and foreign exchange transactions) are audited by the Auditor
General.

The Bank's own a f f a i r s are audited by two external

auditors

appointed by the cabinet on the recommendation of the M i n i s t e r of Finance.
2.

Earnings d i s t r i b u t i o n .

The c e n t r a l government has received a l l

p r o f i t s of the central bank i n recent years.

At times i n the past, the Bank

of Canada used a portion of i t s p r o f i t s to b u i l d up an i n t e r n a l contingency
fund.

However, the r e l a t i v e l y low statutory c e i l i n g on the size o f t h i s fund

was reached a number of years ago, and since then a l l p r o f i t s have gone t o the
government.
FRANCE

1.

Budget process. The Bank of France has the authority to set its own

budget. Normally, however, the Bank voluntarily follows any government
policies setting limits on overall spending increases in government agencies.
The Bank pays for its budgetary expenses out of income earned from its
operations.
2.

Earnings distribution. All profits are turned over to the Treasury.




-3GERMANY
1.

Budgetjjrocjess.

The Bundesbank's budget i s set by the Central Bank

Council.

This procedure is not a part of the overall government budget

process.

In accordance with German corporate law, the Bank publishes an

annual income statement.
2

*

i a .*! n A n JI!.Alsti^bjitjjon.

Almost a l l Bundesbank p r o f i t s have recently

been distributed to the central government.
additions to reserves have also been made.

In the past, significant
The law governing the Bundesbank

provides that up to 20 percent of annual p r o f i t s should be added to a reserve
pool, so long as cumulative contributions do not exceed an upper l i m i t of 5
percent of the notes and coins in c i r c u l a t i o n .

A further 10 percent of annual

profits can be added to reserves within certain r e s t r i c t i o n s .

Recently, only

small additions to reserves have been made, with nearly a l l p r o f i t s
(98 percent in 1984, the most recent year for which data are available)
distributed to the central government.
ITALY

1.

.Budget process. The Bank of Italy is autonomous in regard to budget

and salary matters. The Bank submits its budget once a year for ratification
by the Treasury, which is generally pro forma.
2.

Earnings distribution. Over half of the Bank's profits are turned

over to the Treasury, with the remainder going into a reserve account.
JAPAN
^

Budget p r y ess.

The budget of the Bank of Japan is not included in

the central government's annual budget.

However, the Bank's budget must be

submitted t o , and approved by, the Ministry of Finance, which has occasionally
required the Bank to alter proposed budgets.

The Bank's budget and

expenditure practices are also subject to examination by the Board of Audit, a
separate government agency roughly akin to the U.S. General Accounting Office.



-4JAPAN, cont.
2.

Earnings distribution. All profits are turned over to the government.

THE NETHERLANDS
1.

Budget process. The Netherlands National Bank sets its own budget

and is not subject to budgetary control by the central government.
2.

Earnings distribution. Earnings from the Bank's operations over and

above its expenses are generally turned over to the Treasury.
SWEDEN
!•

Budget process. The areas 1n which the Swedish Riksbank may make

expenditures are limited by law, but the government does not set the
Riksbank's budget. Indeed the Riksbank does not appear to have a formal
budget, although it does maintain personnel, administrative, and some other
budgets as forms of Internal control.
2.

Earnings distribution. The Riksbank determines the amount of profits

to be returned to the Treasury. A large proportion of earnings is simply put
into reserves.
SWITZERLAND
1.

Budget process.

The Swiss National Bank is essentially autonomous in

i t s budget-making authority.

The budget for the Bank's operation does not

need the approval of government ministers or the Federal Council.
Annual Report, which details i t s expenditures, earnings and reserve
accumulations, is submitted to the Federal Council.




The Bank's

-5SWITZERLAND, cont.
2.

Earnings distribution. In Switzerland, the central bank is a private

corporation. As part of its expenses the central bank pays a (small) fixed
dividend to shareholders, makes a stipulated (small) addition to reserves,
p^ys federal income tax to the central government, and makes a fixed per
capita distribution to the local cantons. The law provides for distribution,
two-thirds to the cantons and one-third to the federal government, of any net
profits resulting from earnings above expenses and after additions to
reserves. In practice, the Bank has chosen to exercise its rights as a
private corporation and has added to its reserves each year in amounts large
enough to leave no net profits after additions to reserves. As a consequence,
the federal government has received almost none of the Bank's earnings.
UNITED KINGDOM
1.

Budget process.

The Bank of England has a high degree of autonomy in

determining i t s own budget.

The Bank draws up i t s own annual operating budget

which must be approved by i t s Court of Directors.

While the government never

directly reviews the Bank's budget, i t can have an indirect influence on the
Bank's expenditures.

About half the Bank's income is from fees the government

pays for services the Bank performs, mainly marketing government debt and
acting as the government's fiscal agent.

The fees which the Bank charges the

government for these services are reviewed annually, giving the government an
opportunity to raise questions about the costs of the Bank's operations on i t s
behalf.




-6Z9

Earnings distribution. The profits of the Bank of England are

derived from the Issue Department (concerned with the provision of currency)
and the Banking Department (dealing with all other central bank matters). All
profits of the Issue Department are turned over to the Treasury. Profits of
the Banking Department are divided Into three different parts. One part,
consisting of a payment In lieu of dividends as spelled out in the Bank of
England Act, goes to the Treasury. Another part goes to the government in the
form of corporate taxes. The remainder is transferred to reserves, Since
profits of the Issue Department have been much larger than profits of the
Banking Department, only a small portion (about 2 percent in recent years) of
total profits have been added to reserves, with the rest (about 98 percent)
distributed to the Treasury.
Conclusion
In all of the G-10 countries, budgets of the central banks are handled
outside of the normal governmental appropriations process. Each of the
central banks finances its expenditures out of its own income (mainly interest
earnings on their portfolio holdings). Profits in excess of expenses are then
turned over to the government or added to reserves in varying degree. In no
case is a budget statement for the central bank listing the bank's expenses
and receipts included in the central government's budget document*

In all

cases except Switzerland (where no central bank profits have been turned over
to the central government in recent years), the central government's budget
does contain a line for profits received from the central bank.




-7Table A
The Budgetary Independence of Central Banks of G-10 Countries2
Is the central
bank subject to
the normal
governmental
appropriations
process?

What i s the
degree of the
government's
review of the
central bank's
own budget
proposals?

What percentage
of the central
bank's p r o f i t s
after expenses
has been turned
over to the
government i n
recent years?
95%

Belgium

No

Low

Canada

No

Low

100%

France

No

Low

100%

Germany

No

None

95%

Italy

No

Low

50%

Japan

No

Moderate

100%

The Netherlands

No

None

100%

Sweden

No

None

60%

Switzerland

No

None

0
%

United Kingdom

No

Low

95%

The G-10 countries now include Switzerland.




Appendix C
PLANNING, BUDGET AND CONTROL PROCESSES OF THE FEDERAL RESERVE SYSTEM

Both the Reserve Banks and the Board of Governors use an annual, calendar
year planning, budget and control process* Each process has been developed to
ensure that objectives and goals are met in an efficient and effective
manner. Following is a detailed description.
RESERVE BANKS
The planning process for the Federal Reserve Banks includes strategic
planning and short-term tactical planning at the System and Reserve Bank
levels. Major goals, objectives and strategies are identified during the
planning process. The budget process includes the identification, review and
approval of resources needed to achieve goals and objectives. The control
process includes the comparison of actual results against planned goals and
objectives, and the comparison of actual financial performance against the
approved budget.
The Planning and Control System (PACS)
In 1977, the Federal Reserve Banks implemented a new accounting and
budgeting system, PACS, which allows for a more effective review of expenses,
an expense audit trail and an expense accountability structure. PACS is a
uniform expense accounting, cost accounting and reporting system that enables
the Board to compare Reserve Banks1 financial performance and facilitates
uniform expense aggregation among Reserve Banks and Branches. The PACS system
also serves the control function by allowing for comparisons of actual
performance against budget at a detailed object and activity level.




-2A uniform chart of accounts and functional grouping of expenses are
identified in PACS. Costs are identified at a detailed expense level—such as
officer salaries—and are separated into three groups: direct, support and
overhead. All costs are accumulated by major function, the largest aggregation
being the four primary missions of the Federal Reserve System: (1) Monetary
and Economic Policy; (2) Services to the U.S. Treasury and Other Government
Agencies; (3) Supervision and Regulation of Financial Institutions; and (4)
Services to Financial Institutions and the Public. All support and overhead
costs are fully redistributed or allocated to these four major service lines.
PACS provides productivity statistics (primarily unit cost and items per
manhour), environmental statistics (to clarify the differences between Banks1
operating environments) and quality statistics. PACS also allows for separate
accounting and reporting of project costs that are not involved in routine
production of activities and services.
The PACS system was designed prior to passage of the Monetary Control Act
which required pricing of the Federal Reserve's payment services. Since then,
PACS has been modified to reflect the need for different and changed
information regarding priced services. It continues to serve as the
fundamental accounting system for all services the Federal Reserve Banks
provide, priced and nonpriced.
Over time, the PACS process has beer* studied by government agencies,
private organizations, the General Accounting Office and outside public
accounting firms, The PACS system has been judged to be very effective and
several agencies have studied its design for their own use.




-3The Board periodically audits Reserve Bank compliance with the PACS
instructions through on-site operations reviews. These audits have affirmed
Reserve Bank compliance with the PACS instruction. Similarly, independent
examinations have determined that PACS is an appropriate and effective
accounting mechanism for the Federal Reserve.
Impact of Pricing on Process
The Monetary Control Act of 1980 (MCA) had a much larger impact on the
System's planning, budgeting and control process than just its impact on the
PACS system. Before pricing, the sole objective of the budget prxess was to
control resources and minimize the growth of expense. Reserve Banks were
encouraged to compete against each other to realize the lowest expense and
greatest productivity increases.
With the MCA, the process had to be adjusted to include other objectives
such as the legislated mandate of full cost recovery for priced services
Beginning in 1983, the planning, budget and control process was divided into
two primary areas for compilation, reporting and analysis purposes—Central
Bank and Treasury Services and Priced Financial Services.
Essentially, the more traditional approach used in Federal Reserve
budgeting continues to be applied to services in the Central Bank and Treasury
Services sector; the emphasis remains on holding down expense growth and cost
minimization. District trends are carefully compared to System trends. For
priced services, an approach more akin to that employed by private business is
utilized—with emphasis on recovery of costs and achievement of business

^ Comptroller General of the United States, Report to the Chairmanfi
Committee on Banking, Housing and Urban Affairs, United States Senate, 'An
Examination of Concerns Expressed about the Federal Reserve's Pricing of Check
Clearing Activities." January 14, 1985.
Arthur Andersen & Co., "Federal Reserve System: Report on Pricen
Services Activities.11 Forthcoming, 1985.



-4objectives. The planning process now includes business planning for priced
services, and necessarily, the control process includes monitoring Reserve
Banks1 cost recovery performance for priced services.
In addition, the MCA has resulted in changes to the System's management
process. Reserve Banks are now required to have their financial plans and
prices for their priced services reviewed by Product Directors and a Pricing
Policy Committee as well as the Board of Governors.
The Budget Schedule
At the beginning of each calendar year, the budget planning process
begins with the development and approval of budget guidelines based on an
assessment of workload and productivity changes forecasted for the budget
year. The annual budget objective includes these guidelines and is used by
the Reserve banks in the development of plans and budgets. In addition, a
strategic directional statement covering three years is developed to guide the
Reserve Banks in the development of priced service business and financial
plans. In the spring, the Reserve Banks develop their own goals, objectives
and strategies and begin their budget process. During the summer the budgets
are reviewed at the Reserve Banks, and in the fall the Board of Governors
reviews and approves the Reserve Bank budgets.
The Reserve Banks1 Planning Process
System Level
Senior management officials of the Reserve Banks and Board staff discuss
significant issues in the course of meetings throughout the year. These
discussions focus management attention on key issues and the need to make
effective use of resources to meet agreed upon objectives. The annual Reserve
Banks* Budget Objective and the strategic guidelines for priced services are
additional elements for planning at the System level.



Reserve jank^ Level
Planning occurs at each Reserve Bank as well as at the System level.
Although the services provided by each Reserve Bank are similar, the
conditions confronting the Reserve Banks differ markedly. Some are located in
areas in which unit banking predominates; others serve large branch banking
organizations-

Rates of regional economic growth differ markedly among the

Reserve Banks, as do wage levels, labor skills and prices of other inputs.
The importance of these differences in environmental conditions has increased
with the advent of pricing. Effective resource control thus makes it
essential for individual Reserve Banks to engage in detailed planning.
The Budget Process
For nonpriced services, the Board of Governors each year formally
approves a budget expense limit in the form of a percentage increase over the
expense level in the current year. The process begins early in the calendar
year when an advisory group is formed under the Conference of First Vice
Presidents to make recommendations to the Conference (and ultimately to the
Board of Governors) on basic budget assumptions for the upcoming year. The
Budget Objective Advisory Group makes economic assumptions for the budget
year, and assesses major legislation and other factors influencing the
System's responsibilities. An aggregate expense guideline is established for
the total of all Central Bank and Treasury (nonpriced) Services; and the cost
recovery objective for priced services is reaffirmed. The Advisory Group's
recommendation is forwarded to the Conference of Presidents and the Conference
of First Vice Presidents prior to submission to the Board.
At the Board, a thorough review is conducted of the assumptions made and
a budget objective is approved by the Board of Governors in an open Board
meeting. The budget objective is then sent to the Reserve Banks and serves as




-6the overall top management guide for formulating Reserve Bank budgets* The
budget objective serves as a challenging goal for the Reserve Banks and helps
ensure that financial planning among the Reserve Banks is consistent. During
the Board's subsequent review and approval of Reserve Banks1 budgets,
compliance with the Budget Objective is carefully considered.
An example of the process used by a Reserve Bank follows:
At the onset of the budget cycle, a Reserve Bank initiates planning
efforts to direct upcoming events. Senior management (President, First Vice
President, and other senior level officers) identifies and/or modifies the
broad strategic direction for the next few years. Senior management also
establishes for Bank operations a District Budget Objective for central bank
and Treasury services (nonpriced areas) that reflects the System Objective as
well as any other factors unique to the Reserve Banks. For priced services,
the primary objective is to match costs with revenues. The strategic
direction, coupled with the Bank's own Budget Objective, sets the stage for
the budget process.
Based on the strategic direction, middle management develops more
detailed plans for each of its functions. The budget numbers are then based
on these detailed plans.
For expense budgets, management of each department is asked to budget for
nearly all expenses. Wherever possible, departments are expected to zero-base
the estimates, especially for expenditures such as travel, training and
education, etc*

In those instances where technical expertise is required the

budget estimates are developed centrally for the entire Bank. For example,
the budget estimates for automation expense are developed by staff experts
familiar with the Bank's systems and with anticipated changes 'in the
industry. The total estimate is then apportioned to departments based on
anticipated usage. In some cases, departments use a urriforrn budget assumption



-7provided by a central area to ensure bank-wide consistency, e.g., a department
applies a factor for an expected office supply cost increase (developed by the
purchasing function) to its usage-based estimate.
Because salary and benefit expense accounts for a large part of a Bank's
expense budget (about 60 percent), Bank management closely scrutinizes the
salary plans. Each Division's management estimates its staffing needs for the
remainder of the current year and for the upcoming calendar year. Senior
management reviews proposed staffing changes, which are sometimes reduced as a
result. To achieve consistency, the personnel function develops the Bank's
estimates related to administration of the salary program for merit and other
salary increases. The Fed does not have any automatic cost of living
increases. The analysis includes a projection of the effect of turnover rates
and lags in filling open positions. Much attention is also devoted to
evaluating the predicted salary movements in other local corporations as well
as the salary conditions and guidelines set forth in the System Budget
Objective. The overall Bank projection is closely reviewed by the First Vice
President and, upon approval, applied to each department's budget.
Department management is responsible for reviewing its budget increase
against the Bank's objective and for justifying any exceptions to the
guideline. Finally, a central budget analysis function compiles all the
budget data, makes comparisons with historical trends and notes any
questionable areas requiring senior management's attention. The budget staff
often presents budget alternatives for senior management's review. A summary
of all budget data by major responsibility is then presented to the First Vice
President for review. Each division head and branch manager must present
his/her budget, staff projections, and supporting rationale to the First Vice
President. As a result of this close scrutiny, adjustments to the budget data
are sometimes required.



-8Once the necessary adjustments are completed, an executive summary of the
overall budget is prepared and forwarded to the Bank's President and First
Vice President. Following their approval, the budget package is sent to an
Executive Committee of the Board of Directors. After the Committee's review,
the budget is presented for approval to the Board of Directors with the
Executive Committee's recommendation for action. The final step is to secure
approval from the Board of Governors.
During the budget year, senior management closely reviews actual
performance against the budget on a monthly basis. Depending on the results
of these monitoring efforts, it is sometimes necessary to adjust spending
plans for the rest of the year.
System Projects
Certain Reserve Bank expenditures are associated with major research and
development projects undertaken for the benefit of the entire System;
therefore, all Districts must bear a share of the costs incurred. Budgets
must be prepared and approved for these shared costs so that each Reserve Bank
can include its portion of the shared cost in its annual budget.
Budgets for such projects are reviewed by the sponsoring Conference of
First Vice Presidents1 Subcommmittee/Committee, Board staff and other
responsible System groups. After these reviews are completed, the budgets are
approved by the Conference of First Vice Presidents and the allocated costs
forwarded to the individual Reserve Banks for inclusion in their respective
budgets. This process occurs between March and July of each year and affords
an extra level of scrutiny on significant projects underway in the System.




The Reserve Banks1 planning, budgeting and control process includes the
preparation, review and approval of capital outlay schedules. Reserve Banks
annually evaluate needs for building, furniture, furnishing and fixtures, land
and automation equipment. In accordance with generally accepted accounting
principles (GAAP), depreciation of capital assets is included in Reserve
Banks1 expenses. All large capital expenditures undergo a thorough review
separate from the actual planning, budgeting and control process.
Acquisitions of mainframe computers and peripheral equipment, at certain
dollar levels, must be approved by the Board of Governors on a case by case
basis.
The Board has established detailed, comprehensive guidelines for
preparation of Reserve Banks1 proposals for the purchase of capital assets,
In a new building program, these guidelines are exhaustive and compose more
than 70 pages in a Facilities Planning Manual. The Board must approve the
project at various stages of construction. The Automation ProcjiremejT_t
Guidelines cover the procedures for justifying acquisitions in this category•
Expert technical staff at the Board review all proposals and make
recommendations to the Director of the Division of Federal Reserve Bank
Operations or to the Board of Governors, depending on the approval level. The
Board considers these procedures extremely effective in controlling Reserve
Banks5 expenses.
Federal Reserve Bank^Budget Review at the Board of Governors
Reserve Bank budgets are forwarded to the Board in the fall. Budget
analysts at the Board review the budgets and note significant Systemwide
issues which r*eeA to bo addressed during the budget review, Reserve Bank
budget data are received at the Board via automated transmission a M are thus



-10easily aggregated and subjected to analysis. The narrative justifications of
the budget data, particularly the executive summaries and the statements of
objectives, are analyzed in terms of the Bank's own trend in past years, the
level of increase in specific areas compared to that of other Districts, and
in terms of compliance with the System Budget Objective and cost recovery
objectives for priced services.
Budget data consist of the major expense objects which comprise the total
budget such as salaries, equipment, supplies, etc., the major service lines
and services, as well as revenue and volume estimates. From each Reserve
District information on about 19 expense objects and 49 services are received
and reviewed at the Board. Employment data for the 49 services are also
received and analyzed as are data on the following:
a)

system projects

b)

salary expense components

c)

benefits

d)

selected volume and unit cost estimates

e)

capital outlays (by eight classes)

f)

costs and revenues by priced services

g)

priced volume projections

In conjunction with the budget analysts, personnel in the Division of
Federal Reserve Bank Operations who are expert in particular services
performed at Reserve Banks review each Reserve Bank§s budget as it relates to
their area of expertise. These persons identify questions regarding budget
objectives and initiatives and evaluate the resource requirements budgeted in
light of their special knowledge of services and problem situations at
particular Banks.
In addition, staff of the Board's Personnel Division carefully review
sections of the budget related to salaries and benefits. This staff is also



responsible for the review of salary and benefit admirp strati on at the Reserve

-11Banks throughout the year and are knowledgeable about local business
environments. Budget proposals are reviewed relative to local labor market
data, known problem areas and specific administration considerations.
Also, the Product Directors, the Pricing Policy Committee and the Board
review Reserve Bank priced service budgets and process proposed for the budget
year. This combined review successfully accomplishes the integration of price
and budget review into one overall review of Bank objectives. The various
reviews yield issues and questions to be explored at the budget meetings held
in the fall with the Reserve Bank Presidents and the Committee on Federal
Reserve Bank Activities (consisting of three Governors),
The budget analyst assigned to the particular Reserve Bank assembles all
issues and questions raised during the review phase. These questions, which
m^y be as high as 50 in number, are wired to the Reserve Banks and written
explanations are received and analyzed to determine if further review is
necessary.
The most important issues become the agenda for the Reserve Bank's budget
meeting, which is scheduled with each Reserve Bank President and the Committee
on Federal Reserve Bank Activities whose function it is to critique the
Reserve Bank budget being proposed. The staff briefs Committee members on the
important issues and problems to be discussed with the Reserve Bank
President. Board staff will often make recommendations to the Committee
regarding actions the Reserve Bank President should be asked to take before
final budget approval by the Board of Governors.
At the budget meeting, the First V«ce President and the Reserve Bank's
Senior Financial Officer usually assist the Reserve Bank President. Although
there is no set format for each meeting, each party usually has time to make a
summary statement before spec iff-; issues, problems, and questions are
addressed*



Fundamentally, the budget meeting serves as the occasion when the

-12top management of the Reserve Banks and the Board of Governors reach consensus
on that particular Reserve Bank's plans and budget for the coming year. After
the 12 District budget meetings, the Reserve Banks make whatever changes the
Committee requires and a new iteration or final District budget is
determined. Board staff receives the final budget and reviews it for
compliance with the agreements reached during the budget meeting.

When the Committee on Federal Reserve Bank Activities is satisfied with
each Reserve Bank's budget, these budgets are sent to the Board of Governors
for approval. Budgets are reviewed and approved at an open meeting of the
Board of Governors. Subsequently, a letter is sent to each Reserve Bank
President stating the budget level approved by the Board and any budget
conditions placed on this budget level.
Th_eJjon^tori^ng and^ Control Process
District expenses are monitored and controlled at both the Reserve Banks
and the Board of Governors. The Reserve Banks are permitted flexibility to
move approved levels of spending within expense and services structure;
however, the Board guidelines require notification on significant
realisations of approved budget levels. Careful monitoring minimizes
overruns and increases flexibility by permitting transfers.

Because the Reserve Banks budget and report expense in the same cost
components (FAGS), a comparison of budget to actual spending is possible at
the lowest level of budget detail* Expenses are reported on a quarterly basis
to the Board, and, as soon as possible following receipt of actual data, a
comparison of actual expense to budgeted expense is made.



-13Priced Services
The establishment of prices for Federal Reserve services mandated by the
MCA has resulted in additional review of Reserve Bank expenses. Detailed
product level information is needed as well as timely monitoring of
performance, A cost/revenue/volume reporting process collects and records
financial data relative to priced services. The establishment and approval of
prices and the effective monitoring of priced services performance are key
elements in the overall management of Reserve Bank resources. However, market
discipline is the focal point when costs of Federal Reserve priced services
are considered. Full costs must be recovered in the marketplace or the
service must be eliminated. This discipline helps guarantee that costs in the
priced services areas are no greater than necessary.
Board staff also prepares an annual report to the Board of Governors on
Reserve Bank budget, employment, unit cost and volume performance. As needed,
a detailed mid-year review is sometimes conducted to ensure that budget levels
are being achieved*
II. BOARD OF GOVERNORS
The Board has an annual planning, budget and control process that
involves all Divisions at the Board and all management levels. The Chairman
has appointed the Administrative Governor to assume oversight responsibility
of Board administrative and management matters. The Administrative Governor
has a key role in the entire Board process in ensuring that all elements of
the process are coordinated, that responsibility for all objectives is
complete, that resources are adequately provided, and that duplication of
effort is avoided.
In addition, activities of each Division and Office are divided into
groups called Programs. These Programs are the level at which resource
planning is conducted, plans are approved and budgets are prepared.




-14The Board's Program Structure
The Board of Governors has adopted a Program Structure which reflects
Board resources by categories along functional lines consistent with System
responsibilities. Both expenses and employment are organized into four major
areas: (1) Formulation of Monetary Policy; (2) Supervision and Regulation of
Financial Institutions; (3) Financial Services to the System, the Government,
and the Public; and (4) System Policy Direction and Board Support. Data
processing costs are distributed to the four major areas based on usage.
Other support and overhead responsibilities are included in category four.
The Budget Schedule
The Board of Governors budgets on an annual calendar year basis. At the
beginning of the year, the staff seek guidance from the System's strategic
planning sessions and from legislative and economic developments and use this
information to develop budget guidelines. In the spring, a budget target is
established to guide budget development. The Divisions prepare their budget,
including program objectives and expense and employment requests, during the
summer. In the fall, the Division budgets are submitted to the Office of the
Controller, which along with the Staff Director for Management, reviews each
budget. In addition, the Board Oversight Committees review their respective
Division budgets. And finally, the Administrative Governor reviews the budget
and forwards it to the Board of Governors for approval in December prior to
the beginning of the calendar year.
The Budget Process
The budget process at the Board of Governors begins with the
establishment of a budget expense limit in the form of a percentage increase
over the current year's estimated expenditure.



-15In early spring each Division is requested to review current and future
resource needs, Each Division's management prepares a statement of major
events that could be expected to materially affect the Divisions budget and
provides i n i t i a l estimates of budget increases or decreases associated with
those events.
In addition, the Office of the Controller prepares a "current level of
operation" budget target.

This target takes into account known or anticipated

factors such as the planned federal government general pay increase, retirement
costs, hospital and medical costs, inflation, etc., and results in a projected
increase in expenses over the current year estimate.

Along with the Division's

input, this current level forms the basis for further review and setting of
the final guideline used for developing the budget. The Chairman of the Board
approves the final guideline, which is then sent out to the Divisions for use
in developing their budgets. The major responsibility for formulating budget
requirements rests with the Program Managers. Program Managers undertake a
comprehensive process starting with identifying new initiatives as well as
reevaluating ongoing activities.

The budget includes a description of the

program's objectives and projects undertaken to accomplish objectives, the
resources needed to accomplish objectives and projects, and an indication of
the priority of each project.
The Program Managers forward their budget, in the form of decision
packages, to Division management for evaluation and coordination. The
administrative assistant in each Division reviews the submission for
completeness and conformity to the Board's budget guidelines which allow
Division management to focus attention on the substance of the requests.
Upon completion of the review session with all the Program Managers and
agreement at the Division level on the level of activity and funding necessary
for activities, the Division Director submits, in September, the Division's



proposed budget to the Controller's office.

-16Capital Budget Process
Historically, the Board of Governors has followed the same accounting
practices as the federal government; that is, it expenses rather than
depreciates capital assets. However, it is now making the transition to GAAP
(generally accepted accounting principles). This approach more closely
resembles those of private sector concerns, rather than that of the federal
government. The Reserve Banks currently follow GAAP.
An important part of the Board's planning and budget process is the
planning and budgeting for major capital acquisitions. In the case of major
building or renovation programs, such as the construction of the Martin
Building in the early 1970s, a multi-year plan and budget were prepared and
approved by the Board of Governors. Similarly, major purchases of large
mainframe computers have occurred only after detailed cost/benefit analyses
and lease/purchase analyses are prepared and reviewed.
The Board must approve all major capital acquisitions*

In the case of

smaller capital items, such as furniture and equipment, the various Divisions
include in their budget their resource requests and these are reviewed during
the normal budget process.
Centrally Provided Services
Because of the size of the Division of Data Processing's expenditures
and the support characteristics of this Division's work, special processes
have been established to plan, review and control data processing expenses.
Each Division or Office at the Board that uses data processing resources must
provide, as part of its budget submission, its expected use of data processing,
In addition to requests for anticipated data processing resource
utilization, Divisions are requested to provide expected usage data to those
Divisions with responsibility to provide specific services. (For example, all
books are budgeted in the libraries of the Research and Statistics and Legal




-17Divisions*) These data allow the Division providing the services to prepare
its own budget* The purpose of these requests is to ensure that centrally
provided services are budgeted in accordance with the expected pattern of use.
Board Review Process
Division budgets are reviewed at various management levels.

The

Controller's Office analyzes each Division's submission to determine that the
cost justification is adequate, that objectives are consistent with the
Division mission and goals* and that the proposed resource levels are
appropriate for effective and efficient accomplishment of objectives.
Technical questions and initial revisions for change are handled between the
Controller's Office and the Division.
discussion*

Key issues are identified for further

The Controller's Office and the Staff Director for Management

hold budget meetings with each Division Director to communicate their
analysis, request further information, if necessary, and receive answers to
questions raised.
budget.

These meetings usually result in reductions to Division

Each Division budget, as adjusted, is then reviewed with the

Administrative Governor or the appropriate Board Oversight Committee.
Board Approval
A consolidated budget document is prepared and submitted to the Chairman
via the Administrative Governor prior to the Board's full consideration.
review often results in further reductions to Division budgets.

In early

December, the Controller's Office prepares the Board budget for review and
approval by the Board of Governors at a public Board meeting.

An official

record of the Board's budget (the Official Budget Book) is prepared
summarizing Division objectives, initial budget submissions, changes made
during budget reviews, and the approved budget.




This

Board expenses are monitored and reviewed throughout the budget year by
all levels of Board management. To facilitate this monitoring, each Division
at the beginning of the year allocates its approved budget into quarterly
plans, which show by quarter, the funding for each object and sub-object class
of expenditure in each program. The Office of the Controller produces reports
throughout the budget year to the lowest level of accounting detail. The
Office of the Controller uses these reports to monitor actual performance
against budgeted targets and alert management on a timely basis of any
problems.
Formal performance reports are submitted to the Board on a quarterly
basis* Each July Division budgets as of June 30 are formally reviewed in
meetings with the Controller and the Staff Director for Management. Prior to
the meetings, projections for the remainder of the year are made by the Office
of the Controller and discussed with administrative personnel from the
Divisions. Significant changes to the original budget must be approved by the
Board or by management (below the Board level) under delegated authority.
Early in the following year, a comprehensive report discussing the previous
year's performance employment and expense trends, and attainment of
objectives, is presented to the Board for review.
Requests for changes to budget are very carefully evaluated by the
Controller's Office, and in most cases, by the Staff Director for Management.
The review process is similar to the budget review process. Of course only
very significant and important resource problems are dealt with by changing
approved budgets. In most cases, Divisions must find offsetting decreases to
fund unanticipated needs.




Appendix D: FEDERAL RESERVE SYSTEM EXPENDITURES, EMPLOYMENT AND PRODUCTIVITY
Table of Contents
Page
Overview
I.

Total System
A. Monetary
B. Services
C. Services

1
Expenses and Employment by Program
and Economic Policy
to the Treasury and Government Agencies
to Financial Institutions and the Public

6
6
8
9

D. Supervision and Regulation

12

II. Reserve Bank Expenses and Employment

14

Reserve Bank Expenses and Employment by Service Line

17

A. Service Line I: Monetary & Economic Policy
B. Service Line II: Services to the Treasury
and Government Agencies
C. Service Line III: Services to Financial
Institutions and the Public

19

D. Service Line IV: Supervision and Regulation

31

III. Board of Governors1 Expenses and Employment
Board Expenses and Employment by Program Structure
IV. PACS Performance Measures

23
27

33
35
37

Productivity
V.




39

1985 Federal Reserve Budgets

41

Appendix D

FEDERAL RESERVE EXPENDITURES, EMPLOYMENT AND PRODUCTIVITY

Overview
Over the 1974-1984 period as a whole Federal Reserve System expenditures
grew at an average annual rate of 0*7 percent in real terms and employment
declined by 3671, or 13 percent. Table 1 indicates important variations in
the rate of spending growth over time. For example, the 1974 to 1979 period
was characterized by improved productivity in many of the operating functions
at the Reserve Banks and by a multi-year cost control program at the Board and
the Reserve Banks. In real terms, costs actually declined from 1977 through
1979. However, the implementation of the Monetary Control Act in 1980
resulted in significant transitional costs in the monetary and economic policy
area and increased expenditures in Supervision and Regulation. The Act also
had a profound impact on the Federal Reserve's role as a service provider,
since it required the System to explicitly price the services it provides to
depository institutions rather than to supply them without explicit charge,
and also permitted nonmember institutions access to Federal Reserve services.
At the beginning of 1984, the System adopted contemporaneous reserve
requirements, further increasing expenses in data- reporting—which comprises
40 percent of all expenditures in Monetary and Economic Policy*

Note: Throughout this document, real dollars are on the basis of GNP
implicit price deflator (1972 = 100).
1 Reserve Bank and Board expenses exclude the cost of currency because
the Fed reimburses the Bureau of Printing and Engraving for their total costs
of producing Federal Reserve notes. See Table 1.




Table 1
Total System Expenses in Actual and Constant Dollars'
(dollars in millions)

2

Year
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
Av>].
Annual
Growth

Reserve Banks
Expenses Real 5
519.0
562.1
609.6
626.9
654.6
693.9
792.8
886.1
973.6
1028.5
1067.8

7.5%

450.9
447.2
460.8
447.8
435.2
424.7
444.4
453.0
469.4
477.7
478.0

.6%

3

Board
Expenses Real 5
31.6
36.0
40.4
45.6
49.5
53.9
60.4
62.4
67.9
72.2
77.9

9.4%

27.4
28.6
30.5
32.6
32.9
32.9
33.9
31.9
32.7
33.5
34.9

2.4%

Banks + Board
Expenses Real $
550.6
598.1
650.0
672.5
704.1
747.8
853.2
948.5
1041.5
1100.7
1145.7

7.6%

478.4
475.8
491.3
480.4
468.1
457.6
478.2
484.9
502.2
511.2
512.8

.7%

Percentage
Change
Real $
-0.5

3.3
-2.2
-2.5
-2.2

4.5
1.4
3.5
1.8
0.3

FR Currency
Expenses Real $
30.2
37.2
48.8
55.0
60.1
68.4
73.1
82.9
98.4
152.1*
162.6

26.2
29.6
36.9
39.3
39.9
41.9
41.0
42.4
47.4
70.6*
72.8

18.3%

10.7%

Total System
Expenses
Real 5
580.8
635.2
698.8
727.5
763.2
816.2
926.3
1031.4
1139.9
1252.8 4
1308.3

504.6
505.3
528.2
519.6
507.4
499.5
519.2
527.3
549.6
581.9*
585.6

8.5%

1.5%

Percentage
Change
Real $

0.1
4.5
-1.6
-2.3
-1.6

3.9
1.5
5.94

0.6

8

ro
i

1/ Data for Reserve Banks and the Board of Governors are not collected through the same accounting system. Total
System expenses are defined as Reserve Bank expenses, including depreciation, Board of Governors1 operating expenses and
estimated depreciation, and FR currency expenses. Constant dollar data is deflated by GNP Implicit Price Deflator
1972=100.
2/ Any differences between total expenses as reported in the Board's Annual Report and total expenses as shown on this
table are due to the exclusion of cost of earnings credits in PACS reports and other minor timing adjustments.
3/ Any differences between expenses as reported in the Board's Annual Report and expenses shown on this table are due
to netting of minor receipts against expenses for performance reporting compared to the Annual Report which reveals gross
receipts and expenditures. Also, the Board's current budgeting and accounting procedures do not recognize a capital items
category, All items purchased are expensed in the year they are received. Since this can distort the trend in operating
expenses when large capital items (buildings and computers) are involved, the Board's operating budget shows these items
separate from operating expenses. In the treatment here, an estimated depreciation schedule was developed covering the
Board's large capital items over the previous decade. The laFge items depreciated in the estimate include costs for the
Martin Building, for renovating the Eccles Building, and purchases of computer systems and upgrades.
4/ As a result of an accounting change in 1983, $30,442,000 of prior year currency expenses were recognized in 1983.
Also, 1983 F.R, currency costs include the full cost of $30 million of equipment purchased by the Bureau of Engraving and
Printing in 1983. This equipment is expected to benefit the Federal Reserve over future periods. Excluding the full
mn-time impact of the accounting change and apportioning the cost of currency printing equipments over the future years
of benefit would reduce 1983 currency costs to $94,693,000 and total System expenses to $1,195 billion, respectively.




-3-

The System employment trend mainly reflects developments at the Reserve
Banks since Bank employment makes up 94 percent of System employment.

As

shown in Table 2, employment declined for five years after 1974, when a total
of 3,377 employees or 12.1 percent of total employment were cut from the
payroll.

In 1980 and 1981, employment increased 2.6 percent and 1.1 percent,

respectively, largely as a result of the Monetary Control Act, but in 1982 and
1983 employment again declined, reflecting cutbacks in response to significant
volume l o s s e s , largely in check processing.
Table 2
Total System Employment
Year

Reserve Bank^

1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984

26,567
26,341
25,186
24,300
23,479
23,104
23,682
23,989
23,230
22,883
22,669

Avg. Annual
Growth Rate

-1.6%

Board
of Governors^
1,361
1,443
1,446
1,473
1,469
1,447
1,516
1,491
1,525
1,583

7,588
1.6%

Total System
27,928
27,784
26,632
25,773
24,948
24,551
25,198
25,480
24,755
24,466
24,257

Percent Change

6.6
-0.5
-4.2
-3.2
-3.2
-1.6

2.6
1.1
-2.9
-1.2

-0.9

-1.4%

^ Average number employees and officers as reported in the Functional
Expense Accounting System from 1973-1976, and in the PACS system from
1977-1983.
2 Employees at year-end.




-4Total Federal Reserve spending comprises three broad categories:
expenditures by the Board of Governors, expenditures by the Reserve Banks, and
the purchase of Federal Reserve currency. Reserve Banks account for about 84
percent of total spending outlays, Board expenses for about 7 percent and
Federal Reserve currency for 9 petxent on average for the 1974 to 1984
period. For analytical purposes, the Federal Reserve usually evaluates
Reserve Bank expenditures minus currency costs, since the Reserve Banks
reimburse the Bureau of Engraving and Printing for its total production costs.
Figure 1 shows the distribution of Federal Reserve expenditures by major
service line in 1977 compared to 1984. The year 1977 is used as the base
period since it is the first year for which PACS data on expenditures by
service line are available. The most notable change is the decline in the
share of expenses for services to financial institutions and the public, from
approximately 70 percent of the total in 1977 to about 60 percent in 1984.
Following the MCA, the priced services component of Federal Reserve activities
declined from an estimated one-half of total Federal Reserve spending to
approximately 40 percent. This decline in the share of services to financial
institutions and the public was offset by increases in the shares of Monetary
and Economic Policy and Supervision and Regulation.




-5Figure 1

SYSTEM EXPENSES BY MAJOR PROGRAM
1977

POLICY (7.6%)

SUP&RBG (8.9%)

SMEV.TREAS (12.0%)

SEEV.FIN.INST (71.4%)
1B84

SUP&RBG (13.7%)

U&B POLICY (f 1.3%)

SERV.TREAS (11.3%)

SXRV.FIN.INST (63.6%)

Note: System policy and Board support, which accounts for approximately 2,3%
of total expenses, has been allocated by expense. PACS data are not
available for the Board of Governors so its cost distribution has been
 estimated*


Total System Expenses and Employment by Program
The data given in this section for System Functions include both expenses
incurred at the Reserve Banks and at the Board of Governors• The data are
derived from two separate accounting systems• The Reserve Bank portion of the
combined System data includes all direct costs as well as fully allocated
support and overhead costs. The Board of Governors portion of the System cost
includes direct plus data processing costs* Expenses for "System Policy
Direction and Board Support/1 and estimated capital depreciation have been
distributed into the four major service lines used by the Reserve Banks*
A. Monetary and Economic Policy.
Expenditures in monetary and economic policy had the second fastest rate
of increase over the last seven years f growing at an average annual rate of
6*6 percent in real terms. As Figure 2 indicates, the bulk of this increase
occurred from 1981 to 1983. Approximately 40 percent of direct activity costs
in this area are for data collection and preparation. In large part the
growth in monetary and economic policy spending was a result of an increase in
the number of institutions reporting deposit data and reserve requirements
from about 5,500 before passage of the MCA to more than 17,000 aftenvards.
This increase improved the System's ability to measure changes in the monetary
aggregates. Expenditures on Monetary and Economic Policy began to moderate in
1982. More than half of the relatively small increase for 1983 was
attributable to the cost of implementing contemporaneous reserve requirementsf
a change made to improve monetary control. In 1984 expenditures declined
slightly.




-7Fivjure 2

MONETARY & ECONOMIC POLICY
11

Avg. Annual Growth Rate
Nominal 13.9%
Real
6.6%

83

77
D

NOMINAL

+

84

REAL

Table 3
Monetary and Economic Policy
System Expenses and Employment 1977-1984
(dollars in millions)
Year

Total
Expense

$52. 30
54. 50
59. 70
84. 20
108. 10
121. 50
130. 90
130. 20
Avg. Annual
Growth Rate
1977
1978
1979
1980
1981
1982
1983
1984




Percent
Expenses
Change Constant Dollars

4.2
9.5
41.0
28.4
12.4
7.7
-0.5
13.9

$37.36
36.14
36.54
47.20
55.27
58.58
60.80
58.28

Percent Change
Constant Dollars
-3.3
1.1
29..2
17..1
6.0
3.8
-4.1
6.6

Total
Percent
Employees Change
1,220
1,184
1,180
1,247
1,335
1,360
1,414
1,417

-3.0
-0.3
5.7
7.1
1.9
4.0
0.2
2.2

-8B.

Services to the Treasury and Government Agencies

One of the responsibilities Conyress gave the Federal Reserve was to act
as fiscal agent for the U.S. Government.

In this role the Federal Reserve
»

provides a number of services to the Treasury and other government agencies•
For example, the Federal Reserve issues and redeems Treasury and some other
government agency securities. Through their electronic book entry system, the
Reserve Banks also maintain bookkeeping records for government securities. In
addition, a number of other services are provided, such as redeeming and
destroying food stamps for the Department of Agriculture. As Figure 3
indicates, over the last seven years significant year-to-year changes took
place in expenditures; to some extent this is a result of fluctuations in the
purchases of Treasury securities by the public* and procedural changes
requested by the Treasury. Over the period as a whole, expenditures in real
dollars were flat. Employment fell by 206 or 10.3 percent between 1977 and
1984.




Figure 3

SERV. US TREASURY & AGENCIES
ISO
120 110 100 90 -

Avg. Annual Growth Rate
Nominal 7.0%
Real
0.1%

80
7080 6040
77

73

79

—r~
SO

T

81
YSAX

NOMINAL

I

82

as

MEAL

84

Table 4

Services to U*$o Treasury and Government Agercies
System Expenses and Employment
1977-1984

Total

Year

1977
1978
1979
1980
1981
1982
1983
1984

$80.6
84.2
85.9
95.1
95.6
117.9
123.2
129.4

Avg. Annual
Growth f *ate

C.

(dollars in millions)
Percent
Expenses
Percent Change
Total Percent
Change Constant Dollars Constant Dollars Employees
4,5
2.0
10.7

0.5
24.0

4.5
5.4

$57,6
55.8
52.6
53.3
48.9
56.9
57.2
57.9

2,004
1,919
1,883
1,946
1,881

-3.0
-5.9
1.4
8.3

16.3

1E851
1S839
1,798

0.7
1.2

7.0

0.1

-4.2
-1.9

3.3
-3.3
-1.6
-0.6
-2.2
-1.5

Services to Financial Institutions and the Public

Prior to passage of the M A about 5,000 banks, mostly larger institutions,
C
were eligible for Federal Reserve services*

More than 7s700 depository

institutions now use Federal Reserve services*

The objectives of the pricing

provisions of the Monetary Control Act were to improve efficiency in the
payments system through enhanced competition, while assuring that an adequate
level of payment services was available nationwide.

The Act also required that

over the long run, fees for priced services be established on the basis of all
direct and indirect costs actually incurred in providing the services, including
the cost of float and an allocation of imputed costs (taxes and the cost of
capital) that would have been incurred had the services been furnished by a
private business firm*

The l a t t e r comprises what is known as the Private Sector

Adjustment Factor, or the PSAF,2

2 Board of Governors of the Federal Reserve System* The
Svstem - Purposes and Functions, Washington. D.C. 1984, p7T(T47




Beginning in 1981 and throughout 1982 the Reserve Bauks experienced a
significant decline in the demand for some of their services, and for
commercial check processing in particular.

The i n i t i a l result was that

Federal Reserve expenditures on priced services were greater than the income
generated by fees.
The Reserve Banks began to make resource adjustments to reduce costs
almost immediately*

For example, total employment in this service l i n e

declined 1.4 percent in 1981 and 9.5 percent in 1982.
alone, employment declined by 833.

"Fixed cost" adjustments took longer to

make but by 1983 they were well underway.
increase revenues*
float

In commercial checks

Prices were also changed to

Beginning in 1983 an imputed cost for Federal Reserve

was also included as a component of total costs.

By 1984 the market

test of pricing required by the Monetary Control Act was being met, and a l l
costs including f l o a t and the PSAF were f u l l y recovered.

As Figure 4

indicates, total expenditures in this area, including priced and nonpriced
services, decreased in real terms at an annual average rate of 0.7 percent
between 1977 and 1984.

3

Float, which occurs primarily in the prxess of collecting commercial
checks, is created when the Federal Reserve credits a payee i n s t i t u t i o n for
i t s collections before i t debits the account of the payor i n s t i t u t i o n . In
effect, float is an interest-free loan from the Federal Reserve. Prior to
1933 float was not priced but was instead reduced through operational
improvements. Starting in 1983 the cost of f l o a t calculated on the basis of
the federal funds rate has been included in Federal Reserve prices*




-11-

Figure 4

SERV. TO FINANCIAL INST.
760
700660

Avg. Annual Growth Rate
Nominal 6.2%
Real -0.7%

600
660
600
460 400360 900

I

77

78

79
D

80

NOMINAL

61
YEAR

+

82

88

84

REAL

Table 5
Services to Financial Institutions and the Public
System Expenses and Employment
1977-1984
(dollars in millions)
Total
Expense

Year

$479.20
497.40
523.90
575.50
632.30
668.30
699.30
728.20

1977
1978
= 979
•

1980
1981
1982
1983
1984
Avg.

Annual
Rate

 Growth


Percent
Expenses
Change Constant Dollars

3.8
5.3
9.9
9.9
5.7
4.6
4.1
6.2

$342.29
329.84
320.62
322.59
323.26
322.23
324.80
325.96

Percent Change
Constant Dollars
-3.6
-2.8

0.6
0.2
-0.3

0.8
0.4
-0.7

Total
Percent
Employees Change
10,355
9,958
9,894
9,731
9,591
8,682
8,559
8,535

-3.8
-0.6
-1.7
-1.4
-9.5
-1.4
-0.3

-2.7

D,

Supervi s1gjl

Supervision and regulation was the fastest growing area of Federal Reserve
expenditures over the l a s t seven years p increasing by an average annual rate
of 7.4 percent in real terms,

(See Figure 5.)

accounted for by an increased workload.

Much of this rise was

For example* the number of bank

holding company Inspections rose at an average annual rate of 17.4 percent
over the period.

Similarly, the number of bank holding company applications

per year more than doubled, as did the number of financial institutions
monitored.

The number of cease and desist orders issued per year tripled.

To some extent this increase in workload reflects the increase in bank
holding company formations, the accelerating pace of change in the financial
sector following elimination of interest rate ceilings on deposits, and deregulation in general.

The M A also contributed to the increase in spending on
C

Supervision and Regulation through an increase in monitoring Reserve accounts.
Additionally, legislation such as the International Banking Act, the Community
Reinvestment Act, and the Financial Institutions Regulatory and Interest Rate
Control Act also increased the Federal Reserve's responsibilities.
Figure 5

SUPERVISION & REGULATION
160

1



Avg. Annual Growth Rate
Nominal 14.8%
Real
7.4%

YKAR

-13-

Table 6
Supervision and Regulation
System Expenses and Employment
1977-1984
(dollars in millions)
Year
1977
1978
1979
1980
1981
1982
1983
1984

Total
Expense

$60.20
67.70
78.60
98.30
112
133
147
158

Avg. Annual
Growth Rate




70
70
20
10

Percent
Expenses
Change Constant Dollars

12.5
16.1
25. .1
14. .7
18.6
10.1
7.4
14.8

$43.00
44.89
48.10
55.10
57.62
64.46
68.32
70.77

Percent Change
Constant Dollars

4.4
7.2
14.6
4.6
11.9
6.0
3.6
7.4

Total
Percent
Employees Change

1,501
1,579
1,668
1,856
2,001
2,069
2,152
2,186

5.2
5.6
11.3
7.8
3.4
4.0
1.6
5.5

-14-

II. Reserve Bank Expenses and Employment
Reserve Bank expenses (excluding currency) show an average annual growth
of 7.5 percent (0.6 percent in constant dollars), while employment decreased
at an average annual rate of 1.6 percent. However, as indicated by Figures 6
and 7, significant changes in expenses and employment took place at the same
time.
Figure 6

TOTAL EXPENSES
FEDERAL RESERVE BANKS
1.1

1 -

ft?

Avg. Annual Growth Rate
Nominal 7.5%
Real
0.6%

0.80.7 -

0.6 -

0.6 -

0.4
74

76

76

77
D

78

NOMINAL*

79

YEAR

80

81

82

83

84

REAL*

Note: These data are derived from PACS1 highly detailed accounting and
management information system. It is important to point out that the
PACS reports themselves are much more disaggregated. Data on spending
are published quarterly at each Reserve Bank office, by a number of
subservice lines and by object of expenditure. These data are
available to the public.



-15Figure 7

TOTAL EMPLOYMENT
FEDERAL RESERVE BANKS

2?
28.6
28-

-1.6% Avg. Annual Growth Rate

26.6 26 24.6 2423.6 23 -

22.6 -f
74

76

78

77

79
YEAR
ANP

81

82

88

84

In the early seventies, the Reserve Banks carried out a systemwide program
to improve the nation's payment mechanism system by establishing Regional
Check Processing Centers (RCPCs) to achieve more timely check clearing. While
most RCPCs were in house, a major shift from daytime operations to nighttime
operations took place. In addition, 11 offsite RCPCs were organized and
staffed. The improved timeliness and service the RCPCs offered brought in
additional volume. With their establishment, there was a determined effort to
make efficiency and productivity gains by using improved automated equipment
and emphasizing cost restraint. Employment at Reserve Banks was reduced



-16by 3,463 or 13.0 percent (from 26,567 in 1974 to 23,104 in 1979) and expenses,
in constant dollars, decreased over the period from $451 million in 1974 to
$425 million in 1979, an average annual decline of 1.2 percent. These
reductions were made in spite of continued expansion in volumes processed*
(Volume growth in check processing, the largest operating area, averaged 6.8
percent per year over this same period.) When the Monetary Control Act (MCA)
was passed in 1980, virtually no resources at the Banks could be redirected to
accomplish the new requirements placed on the System by the Act. Resources
had to be expanded, which reversed the trend in expenses and employment in
place since 1974.
Adjusting to the requirements of the MCA is clearly the most important
factor affecting Reserve Bank operations• Previously, reserve requirements
had been imposed only on member banks. The new legislation, however, resulted
in a great increase in the number of depository institutions reporting deposit
data and maintaining reserve accounts at the Reserve Banks.
Another feature of the MCA which had a major impact on Reserve Bank
resources^ was the requirement that the Federal Reserve price explicitly
certain services provided to depository institutions. Heretofore, these
services were provided to member banks at no explicit cost. Thus, the Reserve
Banks had to establish new operations for pricing, billing, and customer
servicing in response to passage of the MCA.
MCA requirements led to an increase of 578 staff members in 1980,
reversing a five-year period of decline. In the following year an additional
307 staff were added bringing Reserve Bank employment to 23,989. This level
was still 2,578 or 9.7 percent below the 1974 staff level of 26,567. However,
as pricing resulted in volume loss, the Reserve banks adjusted rapidly. Staff
was reduced throughout 1982 (by 759) and during 1983 (by 347). The 1984
Reserve Bank staff level of 22,669 was the lowest in the decade.



-17Yhe trend in expenses also shows the impact of the MCA. Expenses
increased 14.3 percent in 1980, the largest annual increase since 1974.
(Adjusted for inflation the increase was 4.5 percent, also the highest since
1974.) Year-over-year increases have been lower since 1980; 11.8 percent for
1981 over 1980 (2.3 percent adjusted for inflation); 9.9 percent for 1982 (3.6
percent adjusted for inflation); and 5.6 percent for 1983 (1.3 percent
adjusted for inflation), and 3.8 percent for 1984 (0.1 percent adjusted for
inflation).
Reserve Bank Expenses and Employment by Service Line
Tables 7 and 8 show Reserve Bank expenses and employment by PACS service
lines from 1977 through 1984. Although numerous accounting changes took place
over this six-year period, the general trends are captured in the statistics.
For example, Reserve Bank expenses and employment have grown more rapidly in
monetary and economic policy (16.4 percent and 3.7 percent average annual
growth rate (AAGR), respectively) and supervision and regulation (15.1 percent
and 5.8 percent AAGR, respectively) than in other areas during this period.




-18Table 7
Federal Reserve Bank Expenses by PACS Service Line
1977-1984
(dollars in thousands)

Year

Economic
Pol icy

Services
to the U.S.
Treasury 4
Gov't. Agencies

Svcs. to 1
Financial
Institutions
4 the Public

1977
1978
1979
1980
1981
1982
1983
1984

$34,247
34,876
38,244
59,567
81,163
93,010
100,443
99,351

$78,569
82,072
83,536
92,486
93,401
115,126
120,256
126,307

$461,365
479,353
504,371
554,686
611,698
646,151
675,918
701,453

$52,698
58,291
67,754
86,068
99,863
119,316
131,848
140,690

$626,881
654,592
693,904
792,804
886,125
973,603
1,028,465
1,067,802

16.4%

7.0%

6.2%

15.1%

7.9%

8.9%

O.U

-0.7%

7.6%

0.9%

Monetary

and

Avg. Annual
Growth Rate
Constant
Dollars 2

" Excludes FR currency costs.
1
2

Supervision

and
Regulation
of Banks

Total

See page 1 .

G P Deflator 1972=100.
N
Table 8
Federal Reserve Bank Employment by PACS Service Line
1977-1984
Monetary

and
Year

Economic
Pol icy

1977
1978
1979
1980
1981
1982
1983
1984
Actual
% Change

641
610
597
618
717
743
804
826
185
29%

Avg. Annual
Growth Rate




3.7%

Services
to the U.S.
Treasury &

Services to
Financial
Institutions

Gov't. Agencies

& the Public

2,004
1,919
1,883
1,946
1,881
1,851
1,838
1,798
-206
-10.3%

10,246
9,850
9,790
9,614
9,480
8,566
8,424
8,395
-1,851
-18.1%

-1.5%

-2.8%

Supervision
and
•Regulation
1,273
1,337
1,411
1,589
1,733
1,796
1,862
1,885

612
48%
5.8%

Support

Overhead

4,292
4,146
4,055
4,238
4,434
4,599
4,367
4,340
48

5,858
5,616
5,367
5,680
5,745
5,676
5,589
5,424
-434
-7.4%
1. 1%

•2%

-1.1%

-19A. Service Line I - Monetary and Economic Policy. The PACS accounting system
captures in service line I all costs associated with determining and achieving
the monetary policy of the System. Table 9 depicts expenses and employment
from 1977 to 1984. Expenses are broken out by cost of activities (all direct
costs including data processing and occupancy costs), System projects (major
systemwide development efforts)* and overhead cost allocations, such as
administration, personnel, accounting, etc. Employment data are for direct
activities only since support and overhead employment are not allocated to
output areas*

Table 9
Monetary and Economic Policy (Service Line I)
Expenses and Employment All Reserve Banks
(dollars in thousands)

Year

Cost of
Activities

1977

$23,662

1978

Expenses
System
Projects Overhead

Empi oyment
Total

% Change

Employees

% Change

641

67

$10,518

$34,247

24,894

32

9,950

34,876

1.8%

610

-4.8%

1979

26,380

112

11,752

38,244

9.7

598

-2.0

1980

29,214

16,,580

13,768

59,567

55.7

618

3.4

1981

36,093

29,,108

15,962

81,163

36.3

717

16.2

1982

45,492

20,,851

26,677

93,010

14.6

743

3.6

1983

51,185

21, ,194

28,064

100,443

8.0

804

8.2

1984

55,055

13,,975

30,320

99,351

-1.1

826

2.7

Avg. Ann e
Growth
Rate
Constant
Dollars

12.8%
5.6%

$

114. 5%

16. 3%

16. 4%

100. 7%

8. 9%

8. 9
%

3.7%

Note: Support and overhead costs have been allocated into the four output
service lines.




-20From 1977 to 19848 expenses In monetary and economic policy increased
16.4 percent on an average annual basis, (8,9 percent In constant dollars)
employment increased by 3,7 percent*

In 1978, total employment declined by 31

or 4,8 percent, and in 1979, total employment declined by 13 or 2.1 percent.
Beginning in 1980 and continuing throughout 1983, however, expenses and
employment grew substantially in monetary and economic policy for numerous
reasons.

Large expense increases occurred in System project and overhead

areas, and in the data reporting area.
System Projects
A System project cost increase of $21.1 million from 1977 to 1983 occurred
between 1979 and 1983. This increase results directly from the passage of the
Monetary Control Act of 1980 (MCA).

All costs of meeting M A requirements
C

were accumulated in a System project and allocated to this service l i n e .
Following are the actual costs of implementing the MCA:
Table 10
M A System Project
C

T9lSPr
Year

Amount

1980
1981
1982
1983

$16 ,459 ,690
28 ,122 ,193
14 ,•562 ,922
5 ,646 ,490

TOTAL

$64,791,295

Other System projects related to the System's long-range automation
program were allocated to this service l i n e during this period.

Also, since

1982 the cost of moving toward contemporaneous reserve requirements (CRR) was
allocated entirely to this service line*
implementing CRR:




Following are the costs of

-21Table 11
C R System Project
R
1982-19S4
Year

Amount

1982
1983
1984

$ 89,613
6,499,389
5,708,901

Overhead

A sharp increase in overhead allocations occurred in 1982 when costs
increased $10,7 million or 67J percent. This increase resulted primarily
from a thorough review of the PACS accounting system methods for allocating
overhead. The review was conducted in order to achieve overhead allocations
which would associate costs more closely with benefits. For example,
beginning in 1982, cost of the Research Library at Reserve Banks was allocated
entirely to service line I - monetary and economic policy, whereas before
1982, these costs were spread to all services on a ratio basis.
Data Rejp_ortjjia
As discussed previously, expenses of statistical reporting to the Board
grew at an average annual rate of 18.1 percent from 1977 to 1984.
The cost of data reporting increased sharply in 1980, and is attributed to
several pieces of legislation which affected the .volume and complexity of data
reports.
o

The Depository Institutions Deregulation and Monetary Control Act of 1980
(MCA), which applied Federal Reserve requirements to all U.S. depository
institutions with certain types of accounts, greatly increased the number
of depository institutions reporting monetary aggregates data to and
maintaining reserve accounts with the Federal Reserve.




0

The

InternationalA^JM_M1 of 1978 (IBA) created an 1creased need for

supervisory, regulatory * and financial information and resulted in large
>
increases in the number of respondent institutions reporting deposits and
financial data. In 1980, previous reporting instruments were replaced
with the far more detailed quarterly Report of Assets and Liabilities of
U.S. Branches and Agencies of Foreign Banks, and the quarterly Report of
Condition for Edge Act Corporations.
o

In 1981, the Board of Governors8 authorization of International Banking
Facilities (IBFs) resulted in the implementation of a number of new
statistical reports on IBF activities designed to monitor IBFs and to
interpret changes in the monetary aggregates. In addition, IBFs reporting
on the Treasury International Capital series, which the Federal Reserve
handles on behalf of the U.S. Treasury, have increased greatly.

o

Passage of the Garn-St G_ej^a1n_Act of 1982, and related actions by the
Depository Institutions Deregulation Committee (DIDC), led to the
deregulation of deposit accounts, reporting changes and significant
workload increases associated with the monetary aggregates data flows.

o

And finally, the change from lagged to Contemporaneous Reserve
Requirements (CRR), which was implemented on February 2, 1984, resulted in
significant preparatory system development costs in 1983, and on a
continuing basis has resulted in an increased workload associated with the
required additional monitoring of reserve calculations and reserve
position performance, the processing of reserve statements, as well as the
added complexity of the monetary aggregates data flows. These amounts
direct results of volume increases pursuant to mandate and changes in
reserve administration.




-23In interpreting these increases, i t must be recognized that the workload
associated with the volume increases is not s t r i c t l y additive.

The need to

assure data quality* which includes comparisons between multiple report series
f i l e d by the same i n s t i t u t i o n s , requires that each additional piece of
information be run against other data reported by the i n s t i t u t i o n *

Therefore,

overall workload and costs are expanded to a greater degree than would have
been the case for simple collection of the additional data*
B.

Service Line I I - Services to the U.S. Treasury and Government Agencies,
Service l i n e I I in the PACS system includes Reserve Bank

costs for acting as fiscal agent for the U.S. government as well as performing
other operations for governmental agencies*

Examples include issuing,

servicing and redeeming savings bonds and other instruments of public debt;
processing government agency coupons; processing food coupons; performing
Treasury tax and loan accounting; and maintaining the Treasury's general
account.

Workloads are largely determined by policies of the governmental

agencies involved.
As shown on Table 12, from 1977 to 1984, expenses in services to the
Treasury and government agencies grew at an average annual rate of 7.0 percent
and 0,1 percent in constant dollars.
percent.




Employment declined by 206 or -10.3

On an average annual basis, employment dec lined by 1.5 percent.

-24Table 12

Services to the U.S. Treasury and Government Agencies (Service Line
Expenses and Employment All Reserve Banks
(dollars in thousands)

Employment

Expenses

Cost of
Activities

Year

1977
1978
1979
1980
1981

$51,751
55,197
54,644
58,933
60,472
66,898
71,083
76,083

1982
1983
1984

Avg,
5.7%
Annual
Growth Rate
Constant
-1.1%
Dollars

System
Projects
$

Percent
Change

Overhead
$26,263
26,520
27,966
31,420
30,837
42,076
42,265
43,210

555
355
925

2,133

2,092
6,152

6,908
7,014

Total
$78,569
82,072
83,536
92,486

4.5%
10
1.
23.3
4.5
5.0

93,401
115,126

120,256
126,307

43.7%

7.4%

7.0%

34.4%

.5%

Employees

'Percent
Change

2,004
1,919
18883
1,946
1,881
1,851
1,839
1,798

-4,2%
-1.9
3.3
-3.3
-1.6
-0.6
-2.2

.1%

-1.5%

In the late 1970s the volume increase was due primarily to high interest
rates. The rapid increase in workloads in the fiscal agency forced many
Reserve Banks to increase staff in the short term and undertake automation
efforts for the long term. A long-term automation development effort to
standardize the securities transfer and safekeeping systems (SHARE) among the
Reserve Banks also began in 1980. Table 13 below shows the costs of this
program from 1980 to 1984. This development effort has been primarily
included in service line II.




Table 13
SHARE Costs
1980-1984 ( i n thousands)
Year

Amount

1980
1981
1982
1983
1984

$2,381
1,448

626
1,670
3,881

Treasury changes in the savings bond program also increased workload
levels and complexity in 1980. These changes involved the introduction of a
new series of savings bonds and the accelerated remittance of savings bond
sales* The Reserve Banks, as fiscal agents, were required to increase the
level of accounting detail, process more frequent remittances from issuing
agents and operate under additional9 more complex savings bond issuing
procedures. The changes also required the recall f reconcilement, and exchange
of unissued series of savings bond stock from over 40,000 issuing agents. As
a result, the Reserve Banks found it necessary to increase staff in this area
in 1980 and undertake automation efforts*
In 1981 a general decline in Treasury volume of 11.4 percent resulted in
Reserve Banks reducing employment by 3.3 percent in this area and holding
expenses flat (1.0 percent increase). The dramatic drop in volume caused unit
costs to increase by 12.2 percent even though expenses increased only 1.0
percent. The decline in volume occurred mainly in the marketable security
area where volume dropped by 34,9 percent. Volume also declined in the
savings bond area by 5.9 percent.
In 1982, expenses increased by 23.3 percent, employment and volume
continued to decline (1.6 percent and 6.2 percent, respectively), and unit
costs increased by 32.5 percent.
Of the 23.3 percent or $21.7 million increase, direct and support costs
rose only 10.6 percent; however, System project and overhead costs increased
46,5 percent, A fundamental revaluation of several System project and
overhead allocations in 1981 associated overhead costs more closely to
benefiting activities and resulted in significant changes effective January
1982. These changes increased overhead allocations to service line II
substantially. (For example, protection costs were directed toward service



-26line II because of the valuables handled in the fiscal services*) The unit
cost increase of 32.5 percent is a direct result of the continuing volume
declines and the increased overhead allocations.
In addition, 1n 1982 the Federal Reserve Banks were called upon to
provide fiscal services to additional government agencies as well as increased
services to existing customers. The Treasury also requested procedural
changes in the savings bond program, federal tax deposit (FTDs) accounting*
and some automation changes. The savings bond stock monitoring program,
initiated as a result of 6A0 recommendations, required more frequent
reconcilements, at a greater level of detail, of unissued stock held by
issuing agents; many Reserve Banks automated their stock monitoring systems.
FTD reporting and reconcilement procedures were also changed as were the
Fedwire/TFCS programming edits, both requiring additional resources at Reserve
Banks.
In 1983, expenses increased by 4.5 percent and employment declined by
0.7 percent. Overall, volume continued to decline by 3.3 percent resulting in
a 7.3 percent rise in unit costs. However, Reserve Bank efforts to improve
automated systems continued to be a major factor. During 1983, the Treasury
began working with the Reserve Banks to develop a Treasury marketable
securities book-entry system for individual investor accounts. The Reserve
Banks were also in the process of completing automation efforts in the savings
bond program as well as servicing the growing needs of government agencies.
In general, from 1979 to 1984, the Reserve Banks steadily reduced staff
levels in fiscal services, maintained small to moderate cost growth, automated
several fiscal agency functions and successfully responded to rapidly changing
workloads and major Treasury program changes*




27

The Federal Reserve Banks perform fiscal agency services for the U.S.
Treasury, government, quasi-government and international agencies* As fiscal
agents, the Reserve Banks perform services as directed under specific
statutory authorization. Although the Reserve Banks perform a variety of
fiscal agent functions, program responsibility and authority remain with the
principal.
Reimbursement for fiscal agent services is obtained through statutory
requirements or negotiation with the principal. However, principals are
responsible for securing adequate funds to fulfill their statutory program
responsibilities*
C.

Service Line III - Services to Financial Institutions and the Public,
Service line III in the PACS system includes Reserve Bank costs for

providing services to depository institutions and the public. In 1984, this
service line amounted to 65.7 percent of total Reserve Bank expenses.
Commercial check operations is the largest service in this service line (and
in the Reserve Banks). In 1984, check costs represented about 48 percent of
total service line costs (and about 31 percent of total 1984 expenses).
Currency operations are the second largest group of activities and comprised
about 18 percent of the costs of service line III.in 1984. Other services and
their percentage of service line costs in 1984 are: coin (5 percent),
electronic funds transfer (13 percent), government checks and postal money
orders (2 percent), securities (4 percent), loans to depository institutions
(1 percent), non-cash collection (2 percent), public programs (5 percent), and
other activities (3 percent).




-28In 1984, about 65 percent of service l i n e I I I expenses were devoted to
providing priced services (some began in 1981 and 1982).

Virtually all

operations in commercial checks, securities, and non-cash c o l l e c t i o n are
priced.

Selected operations are priced i n the currency, coin* and electronic

funds transfer areas.

Overall, from 1977 to 1984, expenses increased at an

average annual rate of 6.2 percent while employment declined by 1,851 or 18.1
percent.
Table 14
Services to Financial I n s t i t u t i o n s and the Public (Service Line I I I )
Expenses and Employment (All Reserve Banks)
(dollars in thousands)
Expenses

Employment
Percent
Empi oyees Change

Year

Cost of
Activities

System
Projects

1977

$316,326

$ 2,564

$142,477

$461,367

1978

327,419

4,513

147,422

479,354

3.9%

9,840

-3.9%

1979

355,428

4,773

144,171

504,371

5.2

9,790

1.1

1930

386,511

9,271

158,903

554,686

10.0

9,614

-1.8

1981

429,757

15,673

166,268

611,698

10.3

9,480

-1.4

1982

448,073

13,850

184,228

646,151

5.6

8,566

-9.6

1983

468,134

20,390

187,394

675,918

4.6

8.424

-1.7

1984

483,768

23,873

193,813

701,453

3.8

8,395

-0.3

Avg. Annual
Growth Rate
Constant
Dollars

Overhead

"Percent
Change

Total

10,246

6. 3
%

37. 6
%

4. 5%

6. 2%

6%

28. 7%

- 2 . 2%

-2.8!I-

7%

From 1979 to 1980, volume in a l l areas grew substantially,
declined slightly and unit costs increased in most areas.
and throughout 1982, the effect of pricing was evident.

employment

Beginning in 1981
A 15J percent decline

in check volume in 1982, in addition to the 5,1 percent decline in 1981,
resulted in an increase in unit costs.




The Reserve Banks reduced variable

-29resources in response to the decline in volume.

Total employment declined 1.4

percent and 9.6 percent in 1981 and in 1982, respectively and in coraiercial
checks alone, employment declined by 833 employees.
fixed costs took longer.

However, the adjustoent to

In 1983, expenses increased only 4.6 percent,

employment continued to decline (1.7 percent), volume had stabilized and unit
costs were again within acceptable levels.

In 1984, expenses increased only

3.8 percent and employment continued to decline.
The M A has added greater discipline to the Federal Reserve's budget
C
process by requiring matching of costs with revenues for priced services.
Reserve Banks cannot budget cost increases unless sufficient revenue can be
generated to cover those incremental costs.
costs i f volume declines.

Also, Reserve Banks must reduce

This provision adds a market discipline test on

existing programs as well as on potential new programs*

Also, urier i t s

earlier mandate to provide services to member banks, the Federal Reserve was
mainly dealing with wholesale financial institutions since member banks tended
to be larger banks.

Now, however, the number of institutions with access to

Federal Reserve services has increased from 5,000 to 40,000, thus increasing
the costs of operation considerably.
eliminate or price for f l o a t .

In addition, the System has had to

This requirement has led to the implementation

of many operations to reduce f l o a t levels thereby-increasing unit costs.
Moreover, the M A has led the System to a revaluation of services provided:
C
1) certain d i s t r i c t s have dropped the cash transportation service because the
private sector can provide i t more e f f i c i e n t l y ; 2) some d i s t r i c t s are
developing plans to phase out the definitive securities business because i t is
not cost j u s t i f i e d ; and 3) in many instances the Banks have enhanced a number
of service offerings which have been favorably received by customers.




-30Under the joi.it discipline of MCA requirements and the market for banking
services, the Reserve Banks have made substantial improvements to the
efficiency of the payments mechanism process (despite significant declines 1n
average personnel):
o

Acceleration of check collection has shifted check volume of about
$2 billion daily from two-dsy collection to one~d§y collection.

o

Daily average check float has been reduced by $3.3 billion or 73
percent between 1980 and fourth quarter 1983* and has continued to
decline in 1984.

o

The Fed has expanded on-line electronic access to approximately 4,600
depository institutions.

o

A high dollar group sort program has been designed to reduce
incentives for remote disbursement by banks*

o

Non-cash availability has improved.

o

New net settlement arrangements have been developed.

It is apparent that the Federal Reserved current production and
development expenses are well within the market range. By 1984 the market
test of pricing required by the Monetary Control Act was being met, and all
costs including float and the PSAF were fully recovered. Total expenditures
in this area, including priced and nonpriced services, decreased in real terms
at an annual rate of 0.7 percent between 1977 and 1984.
In order to retain its position as a viable provider of priced services
as the MCA requires, the Federal Reserve must continue to adhere to the market
discipline which it has followed for the last several years. By being a
market participant, the Reserve Banks must exercise cost restraint in service
line III and make staff reductions when required, The Reserve Banks have
demonstrated their ability in cost containment as indeed they must in order to
continue to act as a provider of payments mechanism services*




-31-

Service Line IV i n the PACS system includes Reserve Bank costs related to
the supervision and regulation of depository institutions*
classified into three services:

Operations are

1) supervision of d i s t r i c t financial

institutions - includes costs for a l l on-site examinations and inspections of
commercial banks, international banking organizations, bank holding companies,
e t c . ; 2) administration of laws and regulations related to banking contains
costs for processing banking organization and holding company applications,
processing condition and other s t a t i s t i c a l reports, and monitoring reserve
accounts; and 3) banking and financial market structure studies capture costs
assxiated with research and analysis of the structure of banking markets.
Legislative actions and the rapidly changing environment in the financial
industry have had a substantial impact on this service l i n e .
As shown in Table 15, total expenses increased $87.9 million or 15.1
percent on an average annual basis from 1977 to 1984.
employees.

Employment grew by 612

O an average annual basis, employment increased 5.7 percent per
n

year.

Table 15
Supervision and Regulation (Service Line IV)
Expenses and Employment (All Reserve Banks)
(dollars in thousands)
txpenses
Year

Cost of
Activities

Sy stem

Projects

1977
$36,849
$ 101
1973
40,683
107
! 979
45,393
313
1980
3 ,437
55,057
1981
2 ,009
66,210
1982
6 ,981
77,091
1983
87,824
,320
1984
95,554
6 ,653
Average Annual
Growth Rate 14.6%
81. ,9%

Percent
Change

Overhead

Total

$15,748
17,496
22,048
27,574
31,644
35,244
36,204
33,481

$52,698
58,291
67,754
86,068
99,863
119,316
131,848
140,690

13.6%

15. 1%

Constant

Dollars



7.2%

70. 2%

6.3%

7. 7
%

Employment
Percent
Employees Change

10.6%
16.2
27.0
16.0
19.5
10.5

1,273
1,337
1,411
1,589
1,733
1,796
1,862

6.7

1,885
5.7%

5.0%

5.5
12.6

9.1
3.6
3.7
1.2

-32System project costs rose significantly from 1977 to 1983* In 1980 the
credit control program accounted for an increase of $2*7 million* while the
1982 increase reflects a change in cost allocations. In 1980 total expenses
rose by $3.9 million and 96 ^employees were added to monitor the new reserve
accounts.
Throughout this period, various legislative actions and regulatory
changes had substantial impact on this service line. The Depository
Institutions Deregulation and Monetary Control Act of 1980 meant universal
reserve requirements, the phasing out of interest rate regulations and
Increased access to the discount window. As a result, oversight, monitoring,
rule-making and enforcement responsibilities grew. The Garn-St Germain Act
resulted in an increased number of mergers involving extraordinarily complex
legal, financial and competitive issues^ The International Banking Act
broadened examination responsibilities for supervising U.S. branches and
agencies of foreign banks. Ongoing supervision of domestic banks in recent
years has involved substantial monitoring and surveillance of credits
associated with distressed industries and foreign borrowers. The Community
Reinvestment Act meant new responsibility for evaluating lending records of
and working with state member banks to ensure that they are meeting the credit
needs of their communities. Several other consumer protection laws were
enacted, each mandating specific examination procedures.
Also, the workload in the monitoring of reserve accounts has expanded
significantly over the last several years due to: (1) the implementation of
the Monetary Control Act of 1980, causing a net increase in the number of
reserve accounts to be monitored; (2) substantially more institutions
requiring closer monitoring and counseling; (3) the increase in the number of
problem banks requiring closer monitoring; and (4) the implementation of a new
reserve reporting system.



• Board of Governors1 Expenses and Employment
During the 10-year period 1974 to 1984, operating expenses for the Board
increased at an average annual rate of 9*4 percent (2.4 percent in constant
dollars). Employment increased by 227 employees or 1.6 percent on an average
annual basis. Howeverf as indicated by the following figuresf the composition
of expenses and employment during the last decade changed significantly*.
During the period 1974 to 1977, employment at the Board of Governors
increased by 112 employees or 8.2 percent and expenses grew by $13.4 million or
44.7 percent. This growth period was a direct result of several legislative
initiatives in the area of consumer regulation. For example, the Board
established a new division during this period ~ the Division of Consumer and
Community Affairs — to respond to legislatively mandated responsibilities.
Legislation included the Home Mortgage Disclosure Act, the Equal Credit
Opportunity Act and the Fair Credit Billing Act.
From 1977 to 1979 Board employment fell by 26 or 1.8 percent and expenses
increased $3 million or 18 percent. No significant legislative requirements
were being placed on the Board and, therefore, through productivity
improvements, employment actually declined.
From 1979 to 1980, 69 employees were added, an increase of 4.8 percent.
This growth can be directly attributed to the impact of the Financial
Institutions Regulatory and Interest Rate Control Act which greatly increased
the Board's supervision and regulation responsibilities, primarily in the area
of bank holding companies.
From 1980 to 1981, the Board undertook a position control program similar
to the program in place throughout the federal government, leading to a reduction of 25 employees. However, with the passage of the Monetary Control Act of
1980$ the smaller staff gave the Board inadequate resources to carry out its
responsibilities under the Act* Therefore, employment increases were necessary
both in 1982 and 1983. Employment increased by only 5 from 1983 to 1984.



-34Figure 8

TOTAL EXPENSES
FEDERAL RESERVE BOARD

80

70-

60 A

i

Avg. Annual Growth Rate
Nominal 9.4%
Real
2.4%

60-

40 REAL 2.4%
•—+-

90 -

ZO
74

76

76

77
D

78

NOMINAL*

79

60

YEAR

63

81

84

REAL*

Figure 9

TOTAL EMPLOYMENT
FEDERAL RESERVE BOARD

1.6 -r
1.68 1.66 -

A v g . Annual Growth R a t e 1 . 6 %

1.641.62 1.6 1.48 1.46 1.441.42 1.4 1.38 1.36 •*

74



76

—r~
76

—r—
77

78

79

80

YEAR
END OF YEAR EUPL.

81

82

88

84

-SBExpenses increased at a greater rate than employment in the l a s t two
years due to purchase and lease of automation equipment designed to enhance
productivity.

In addition* the System's long-range automation program and the

M A required the Board's computers to be upgraded and more staff were added to
C
the Division of Data Processing to support the long-range automation program.
Board Expenses and Employment by Program Structure
Expenses and employment from 1977 to 1984 by the major functional
categories of the Board program structure are discussed below.

Expenses in

the largest category, System Policy Direction and Board Support were
$18.5 million and employment totaled 543 in 1977.

From 1977 to 1984, expenses

grew by a moderate 6.9 percent, or -0.1 percent in constant dollars, while
employment grew by 13 or 0.3 percent per year.

Expenses in this category

fluctuated greatly during the period primarily because of wide swings in the
cost of living adjustment for retirees.
Cost containment measures for u t i l i t i e s , mail and facilities support held
the increase in controllable expenses to minimal levels during the period and
employment actually was lower in 1982 than in 1977.

Expenses and employment

grew at a faster rate in the last three years of the period because of the
data processing costs resulting from the administration information retrieval
system, a program designed to integrate administrative data bases, reduce
duplication of effort, and lower costs.
The Formulation of Monetary Policy Category is the second largest at the
Board.

In 1977, expenses totaled $16.3 million with 579 employees.

From 1977

to 1984, expenses increased 7.9 percent—or 0.9 percent in constant
dollars—on an average annual basis and employment increased 0.3 percent.




The

-36expenses and employment levels for this category increased at a very low rate
from 1977 through 1979 (8.4 percent and 0.3 percent, respectively). The
Credit Restraint Program and Monetary Control Act of 1980 resulted in
significant increases from 1979 to 1981. Expenses and employment increased on
an average annual basis by 11.4 percent and 3.0 percent, respectively. The
increases were primarily associated with new data processing reporting
series. Employment actually declined from 1981 to 1984 (-27 or 4 percent) and
the rate of increase in expenses declined to 5.3 percent, primarily reflecting
the completion of developmental work for data processing projects to support
MCA.
The Supervision and Regulation Function has been the fastest growing area
at the Board since 1977. Expenses have increased at an average annual rate of
12.3 percent per year from 1977 to 1984, or 5.1 percent in constant dollars,
and employment rose by 73 or 4.1 percent on an average annual basis. Consumer
legislation in the early years of the period and, more importantly, the
Financial Institutions Regulatory and Interest Rate Control Act in 1978
resulted in steady increases in expenses and employment from 1977 through
1980. Problems of financial institutions, and research to keep ahead of
changes in the banking industry also led to sharper increases in employment
and expenses from 1980 through 1984 than the rest.of the Board experienced.
Expenses and employment in the Financial Services to the System,
Government and Public Function grew at moderate pace from 1977 through 1982.
Expenses increased on an average annual basis by 2.8 percent and employment
increased by 7 or 1.3 percent per year. In 1983 and 1984, expenses increased
by 20 and 17 percent respectively, in response to requirements to oversee
System efforts in pricing. These are expected to moderate considerably. In
the 1977-1984 period expenses grew at an average annual rate of 7.0 percent or
0.1 percent in constant dollars,




-37
Table 16
Board Expenses and Employment by Major Function
(dollars in millions)
Suparvisien
Monetary Policy
& Regulation
Financial Services
System Policy
Exp.
Emp.
1977

$16.3

579

$5.8

228

$5.0

109

$18.5

543

1978

17.9

574

7.5

242

4.4

108

19.7

545

1979

19.1

583

8.4

258

4.9

103

21.5

497

1980

21.7

629

9,5

268

5.1

117

23.8

502

1981

23.7

618

10.1

268

5.7

111

23.0

494

1932

25,0

617

11.1

273

5.8

116

26.0

524

1983

26.8

610

11.8

290

6.9

134

26.7

549

591

13.0

301

8.1

140

29.3

556

1984
27.6
Avg.
Annual
7.9%
Growth
1977-1!978
Constant
Dollars 0.9%

12.3%

4.1%

7.0%

5.U

0.1%

3.6%

6. 9%

.3%

-0. ,1%

Note: Service lines have been adjusted to include the same services for
comparability over time and include estimated capital depreciation.

IV. Description of PACS Performance Measures
Starting iu 1978, the Federal Reserve implemented an approach for
summarizing its costs per unit of output in individual activities to provide a
bottom line for operations. Summary measures are produced both of change in
cost of the System and individual districts, and of comparative levels of cost
among Districts.




-38Two main benefits are provided by these summary measures. First, senior
management can use them to track and communicate the total results of
operations. Second, the summary measures put in perspective cost levels
achieved in each individual activity, with small activities receiving
relatively little weight and larger activities receiving proportionately
greater weight.

Two 1ypes of cost measures are provided—a time-series scale measure and a
cross-sectional or i n t e r - D i s t r i c t measure.

The time series measure compares

the expense of producing this year's volume of products with last year's cost
levels, and is expressed as a percent change in cost.

The cross-sectional

measure compares each D i s t r i c t ' s expense with that of producing the D i s t r i c t ' s
volume at System-average cost levels.
Relation to PACS
The summary cost measures are constructed from the Federal Reserve's cost
accounting system—PACS.
D i s t r i c t ' s performance.

They summarize, in dollar and percentage terms, each
The measures may be used alone, or in conjunction

with the detailed cost accounting information which they summarize.
Analytical tables are produced which t i e the summary measures back into each
individual activity and type of expense.
The summary measures include total costs. PACS also provides narrower unit
cost concepts such as production costs and productivity measures such as
output-per-manhour.

These additional measures of cost and productivity may be

summarized into aggregate measures.




ProductiyHy^
An aggregate unit cost index, composed of more than 20 activities with
measurable volume outputs, may be the best overall measure of operating
efficiency. This statistic is a weighted index and accordingly is more
heavily impacted by developments in the larger operating units, especially
commercial check operations, the largest single operation of the Reserve Banks,
Due to changes in accounting methods, and in operations themselves, a time
span limited to five years is utilized for the time series. Expenses for
monetary & economic policy and supervision and regulation are not included in
the index because there is no suitable measure of volume output.
Table 17 shows the pattern of year-to-year changes in the aggregate volume
of Reserve Bank operations, as well as aggregate unit costs adjusted for
inflation. As Table 17 and Figure 10 indicate, following passage of the MCA
and the imposition of pricing, aggregate volumes in the services to financial
institutions area declined in 1981 and 1982. While resource adjustments were
made, unit costs increased somewhat in 1981 and markedly so in 1982, largely
because of the difficulty of reducing fixed costs in the short run. However,
over the last two years—partially as a result of increased volumes as well as
resource adjustments—unit costs have declined significantly, a pattern that
is expected to continue in 1985.
Table 17
Aggregate Unit Cost and Aggregate Volume 1979-1983
(Time Series 1979=100)

Year
1979
1980
1981
1982
1983
1984




Aggregate Volume
PercerfE
Change
Index
100.00
108.41
104.92
98.07
102.02
108.78

8.4%
-3.2
-6.5

4.0
6.6

Real Aggregate Unit Cost
Percent
Change
Index
61.19
58.53
60.14
66.91
65.80
62.12

-4.3%

2.8
11.3
-1.7
-5.6

-40Figure 10

REAL AGGREGATE COST INDEX
UWEX 1979-100; GNP DEFLATOR 1972-100

l




O

YEAR
AQG COST INDEX

-41 ~
IV. The Federal Reserve System's 1985 Budget
In late 1984 the Board of Governors approved 1985 budgets for the Reserve
Banks and the Board with total spending of about $1.2 billion. Actual
spending in 1984 totaled $1.14 billion. Thus the 1985 budget provides for a
maximum increase of about 5 percent (See Table 18). Given expected increases
in workload, this 5.1 percent budget increase will require significant cuts in
some areas. The budget increase is for all Federal Reserve services, priced
and nonpriced, including Reserve Banks and the Board of Governors. After fees
for services to depository institutions, expenditures are expected to grow by
about 3.6 percent.
System employment is projected to increase by 82, or 0.3 percent in 1985.
Table 18
Federal Reserve System Expenses
1984 Actual - 1985 Budget
1984

Monetary & Economic Policy
Services to Treasury
& Government Agencies
Services to Financial
Institutions
Supervision and
Regulation
TOTAL
NOTE:




1985

% Change

130.2

131.7

1.1

129.4

140.6

8.6

728.2

757.9

4.1

158.1

174.4

10.3

1145.7

1204.4

5.1

These data are for Reserve Banks and Board of Governors expenses
excluding currency costs. As discussed previously the data are
derived from two separate accounting systems. For comparability
over the time periods estimates were made to allocate expenses
into major programs and for the Board of Governors which accounts
for only 7 percent of the total expenditures.

-42Table 19
Federal Reserve System Esspl oyment
1984 Actual - 1985 Budget
% Change

1984
22,669

22,809

0.6

1,588

Reserve Bank^

1985

1,530

-3.7

24,257

24,339

0.3

Board of Governors^
TOTAL

1 Average number of personnel.
2 End of year employment.
This overall increase provides significant variation in budgeted
expenditures among functions. For example, spending on monetary and economic
policy is expected to increase by about 1.0 percent in 1985. This continues
the pattern of reduced spending in this function that started 1n 1984 after
the cost bulges resulting from the Monetary Control Act and contemporaneous
reserve requirements had been absorbed. As explained earlier the largest
single component of costs in this area is for data collection and preparation.
Expenditures in services to financial institutions and the public are
expected to grow by about 4.1 percent. Approximately two-thirds of
expenditures in this area are for priced services and are budgeted to rise by
4.4 percent. Just as in 1984, all costs associated with priced services
including the cost of float and the PSAF are expected to be recovered.
Expenditures in the nonpriced component of services to financial
institutions and the public are budgeted to increase by-about 3.4 percent.
The principal reasons for this growth in spending are increases in the volume
of currency and coin handled by the Reserve Banks and the rise in postal costs.




-43Spending on services for the U.S. Treasury and other government agencies
is budgeted to grow by 8.6 percent. More than two-thirds of this anticipated
increase is the result of a new system which will provide computer automated
recordkeeping for Treasury notes and bonds held by individuals. This "book
entry" approach is alreadfy used for Treasury securities held by institutions
and for Treasury bills held by individuals. Its extension to Treasury notes
and bonds held by individuals is expected to yield substantial savings to the
Treasury. This new approach will also provide improved service to individuals
buying Treasury notes and bonds and eliminate the need for safekeeping actual
paper instruments.
Reserve Banks
The 1985 Reserve Banks1 budget allows for an overall increase of $54.5
million* or 5.1 percent, and an employment increase of 141 or 6.2 percent.

Table 20
Reserve Bank Expenses by Service Line^
1984 Actual - 1985 Budget
1984

Monetary & Economic Policy
Services to Treasury
& Government Agencies
Services to Financial
Institutions
Supervision and




% Change

99.4

98.4

-1.0

126.3

137.0

8.5

701.5

730.3

4.1

140.7

1-56.7

11.4

1067.8

Regulation
TOTAL

1985

1122.3

5.1

Includes support and overhead a l l x a t i o n .

Table 21
Reserve Bank Employment by Service Line*
1984 Actual » 1985 Budget

1984

_12§L

JL£!l!"J£

TOTAL

.826

833

.8

1,798

1,825

1.5

8,395

8,441

.5

1,885
4,340
5,424

1,903
4,390
5,417

1.0
1,2
-0.1

22,668

Monetary & Economic Policy
Services to Treasury
& Government Agencies
Services to Financial
Institutions
Supervision and
Regulation
Support
Overhead

22,809

0.6

Expenses i n the Hqnetai^_and Ec^oiiiic Policy service l i n e are budgeted t o
decline by approximately $1 m i l l i o n or f«0 percent 9 and s t a f f i s expected t o
increase by 7 or 0.8% above the 1984 l e v e l .

The expense decrease i s a r e s u l t

of declines i n overhead and System p r o j e c t costs^ p r i m a r i l y due t o completion
of the Contemporaneous Reserve Requirement (CRR) System Project*

The d i r e c t

and support expense increases r e f l e c t expanded o f f i c e automation projects i n
most d i s t r i c t s and increased automation e f f o r t s f o r economic modeling and
forecasting.
Expenses i n Services t o the U.S. Treasury and Government .Agencies are
budgeted t o increase by $10.7 m i l l i o n or 8.5 percent over the 1984 l e v e l *
S t a f f i s expected t o increase by 27 or 1.5 percent.

Of the expense and

employment increases, $5.3 m i l l i o n and approximately 33 personnel are
associated w i t h the Treasury Securities Access Book Entry System (T-DAB).
Expenses i n Services t o Financial I n s t i t u t i o n s and the,jPub1ic» both
priced and nonpnced^ are budgeted t o increase $28.8 m i l l i o n or 4.1 percent*
and employment i s expected t o increase by 46, or 0,5 percent.

Nonpriced

services 3 expense and employment ircreases are p r i m a r i l y due t o volume
increases i n both currency and c o i n , and the impact of open access p o l i c y ,
Priced services expense increases are p r i m a r i l y i n commercial check, t r a n s f e r
of account balances, and automated c l e a r i n a house operations.




-45-

Expenses In Supervision and Regulation 1n 1985 are budgeted to Increase
$16 million of 11,4 percent over the 1984 level.
increase by 8, or 1.0 percent*

Employment Is expected to

The rise In expense will result frorr? an

increase in the allocation to Supervision and Regulation of the Integrated
Accounting System projects; however, this increase is offset by several
Districts 8 plans to reduce staff*

Board of Governors
Total expenses for the Board of Governors are projected at $3.9 million,
or 5 percent increase* over the 1984 level. These figures include a $4.75
million depreciation expense. Employment is expected to decrease by 58, or
3*7 percent.
Table 22
Board of Governors Expenses'
1984 Actual - 1985 Budget
1984

1985

Monetary & Economic Policy
Supervision and
Regulation
Financial Services
System Policy and
Board Support

27.6

29.9

8.3%

13.0
8.1

13.3
8.8

2.2%
9.3%

29.3

29.9

1.9%

TOTAL

78.0

81.9

5.0%




% Change

Includes depreciation expense. Figures may not add due to rounding.
Table 23
Board of Governors Total Employment
1984 Actual - 1985 Budget
1984

J985

% Change

1.5S8

1,530

-3.7

-46Expenses in the Monetary and Economic Policy category at the Board will
rise $2.3 million, or 8.3 percent. The largest elements of this increase are
associated with the development costs of the resource shared application
project (STAT) and the allocation of costs, including depreciation, for the
contingency processing center*
Expenses in the Supervision and Regulation category are budgeted to
increase by $300,000 or 2.2 percent. Increases in this area are being offset
by reductions in the volume of work of the Division of Consumer and Community
Affairs and a decrease in the use of data processing resources.
The financial services categories are budgeted to increase by $700,000 or
9.3 percent. The major cause of the increase is the improvement to the
planning and control system (PACS), which will facilitate comparison of
revenue and expense projections with actual data as they become available.
System Policy and Board Support costs are budgeted to rise by $600,000,
or 1.9 percent. The relatively modest size of the increase is associated with
reduced nonpersonal costs in 1985 for publications and repairs and alterations
for the Board's facilities.