Full text of Statements and Speeches of Preston Martin : "Monetary Policy in an Environment of Change" : Address before the 72nd Annual Convention, New Mexico State Bankers Association, Albuquerque, New Mexico

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For release on delivery
12:00 Noon E.D.T.
Saturday, June 11, 1983

"Monetary Policy in an Environment of Change"

Address by

Preston Martin
Vice Chairman, Board of Governors of the Federal Reserve System




before the

72nd Annual Convention
New Mexico State Bankers Association
Albuquerque, New Mexico

June 11, 1983

It

is

a

pleasure

to

be

here

today

with

you.

I

am

particularly pleased to have this opportunity for a discussion with a
group of bankers because each of you —
deeply

and

services,
tomorrow.

swiftly

affected

changes that

by changes

large and small
in

the

-- is being

provision

of

banking

are here today and will certainly not be gone

On the contrary, tomorrow’s banking environment is bound to

be different to a startling degree in the services banks provide to the
public, how they provide those services and the rising competition from
outside of commercial banking that must be dealt with successfully, as I
believe your bank will, in order to continue to serve the public.
On several occasions, we have all discussed these changes at
some

length,

—

in

the

financial

context

altering

our

system

system.

Today I want to

look

of

as

a bird's-eye

they affect

at the other

overview

the nation's

of

forces

financial

side of the coin:

the

implications for monetary policy of the swift evolution or revolution
that is transfiguring the financial
can be no mistake:
banking,

more

For there

change is thrust upon us by the deregulation of

the coming metamorphosis

something

system of this nation.

competitive,

your

of

a segment

entry

into

of the
fields

industry

into

previously

the

exclusive preserve of contiguous financial industries, and the provision
of banking services by powerful nonbanking institutions.

You recognize

the march of events that is moving us toward a breakdown of the barriers
to interstate banking -- these forces and factors are all shaped by the
transformation in the scope and reach of services made possible by the
onrushing information-handling revolution.
trends,

reinforcing

each

other,

have

profound

making and effectuation of monetary policy.




I deeply believe that these
implications

for

the

A

A further current complication to the economic stabilization
job of the monetary authority must be considered

the unprecedented

funding requirements arising from the megadeficits in the federal budget
in coming years.

Consider with me today the relation to monetary policy

of three

of events:

streams

the upheaval

in the financial

services

landscape, the many suggestions, in part resulting from those upheavals,
for altering supervision and regulation of the financial system, and the
nation's economic agenda as set forth in the federal budget.
In

the

last

several

years,

private

financial

management

has exhibited agility and innovation in the presence of a severe need
for both qualities.

Much of the impetus for change can be traced to

innovators surmounting the artificial

obstacles to the market's will;

that is to say, the cost of circumventing aging statutory constraints —
such as "regulatory" ceilings on interest —

have become far less than

the gains in market share and profitability likely to be realized.
This relationship between the costs,

including opportunity

costs, to your customer of continuing to honor outmoded and uneconomic
constraints and the benefits they were invented to bestow half a century
ago,

has

not

changed

simply due to the corrosion

of

time.

It has

changed because market and attitudinal circumstances have changed.

The

extreme heights to which inflation rose, and with it interest rates, in
recent

years,

swiftly brought

has

been

a major

and

about an education

focusing

factor.

in the public,

These

events

which realized the

extent to which the statutory limitations on deposit interest rates were
damaging

-- to both

heightened
their cash.



consumer

individuals
and business

and business

-- and has resulted

sophistication

in the management

in
of

Technological

progress

has

both

enhanced

and

validated

change giving the public an adequate real return and breaking the old
statutory

bonds.

Several

examples

illustrate

the

point.

Deposit

interest rate ceilings that fell far behind increases in market yields
inspired a whole new industry, money market mutual funds.

These funds

provided access to highly liquid assets carrying market yields.

This

industry grew from $10 billion in assets in 1978 to over $200 billion in
assets by the end of 1982.

The prohibition of interest

payments

on

demand deposits led banks and their customers to find new instruments -NOW

accounts,

sweep

arrangements

transactions balances,
with

savings

--

to

reduce

the

costs

of

holding

and gave transactional capabilities to balances

characteristics.

In

the

process,

the

traditionally

distinctive functions of commercial banks were called into question, and
the

demarcation

financial

firms

interstate

of who

does

what

was

used their financial

marketing

systems

to

blurred

further

and technological

offer

bank-like

as

nondeposit

expertise

services.

As

and
two

examples of this trend among many, the CMA account developed by Merrill
Lynch provides ready access to credit and checking, while debit cards
offered by various vendors serve a payments function.
The banking regulators, with the help of Congress, have met
these challenges to the traditional and statutory restraints of banking
by a massive program of deregulation under the Depository Institutions
Deregulation

and Monetary Control

provided

this

by

legislation,

the

Act

of

1980.

regulators

have

With

the

freed

authority
up

banking

substantially, notably in the deregulation of deposit interest rates and




-4-

the

granting

of

broader

powers

to

depositories.

It

is

highly

significant that as of the end of April, nearly $400 billion of the $1.1
trillion

outstanding

in

small

time

and

savings and loan associations and mutual
that did not exist before 1982.
liberalized
banks

by

the

constraints

permitting

commercial

loans

them

and

other

deposits

at

banks,

savings banks was in accounts

The Garn-St Germain legislation also

on
to

savings

savings
issue

and

loans

demand

assets.

deposits

We may

should have been married to gradualism.

and mutual

opine

and

savings

to

that

acquire

deregulation

However, you will be able to

compete and I believe management can use the new tools effectively in
communities of various sizes.
As
particularly

more

financial

firms

services,

and

payments

offer

as

bank-like

more

deposit

services,

accounts

and

instruments compete freely with open market yields, the implications for
the

setting

These

and

changes

implementation
affect

shorter-term monetary
economic
ability

expansion
of

the

the

transmission

growth

targets

and price

central

of monetary policy grow more serious.

intended

stability.

bank

to

mechanism

carry

to promote

They
out

for

also

its

achieving
sustainable

impinge

crucial

upon

role

the

as

the

ultimate source of assured liquidity for business and finance.
Implementation
complicated
deposits

held

in

environment.

A

policy

large

has

variety

of

become
new

more

types

of

and the old distinctions drawn among them thereby become

Liquid money substitutes permit the public to minimize amounts
more

large-scale




this

monetary

is filling the continuum between "transactions" and "savings"

instruments,
cloudy.

in

of

traditional

change

in

the

transactions
way

the

accounts.

public

—

both

This

rapid

and

individual

and

-

5-

corporate -- holds its money and performs transactions means many things
to many people.

To the monetary authority it means a number cf things

also, but, probably most important,
"money"

to spending

it means that the relationship of

and to income has become altered

-- diminishing,

certainly at least during a transition period, the reliability of past
behavior

as

There

little doubt

is

a mechanical

influence

growth

product.

Extensive

taking

place

in

guide

that

to monetary

growth

nominal

in monetary

aggregates

study within

to quantify further

policy

these

the

aggregates

including

and outside

for

the

affect

gross

the Federal

relationships

present.
and

national

Reserve

and

their

is

lead

times.
For one thing, complex issues arise to the extent that money
substitutes are held in nondepositories that are not required to post
reserves at the Federal Reserve.

Ideally, any balances functioning as

transactions accounts would be subject to uniform reserve requirements.
All issuers of such accounts would thereby have an equal "cost" of doing
business

and

the

impact

of

monetary

policy

as

transmitted

reserve positions would be evenhanded and more predictable.
has

taken

us

far

afield

from

this

ideal

balances are lodged in interest-bearing

world;

some

through

Innovation
transactions

"sweep" receptacles,

some are

now held outside depository institutions, and some are in highly liquid
instruments that are converted readily to transactions
these are not the only,
The

success

of

monetary control
financial system.




these

accounts.

But

or perhaps even the most important, results.
innovations

and equity,

bears

implications

not

only

but also for the element of risk

for

in the

-6-

So much for -- very briefly put —

some of the complications

for monetary policy of banking deregulation,

the future coalescing of

commercial

and

bank

and

savings

institutions,

the

rapid,

massive

innovations in the way money and credit can be held and used.
I

want

now

to

turn

to

my

second

and

related

changes that have been made in recent years and others that are being
put forth or considered in the relationship of the central bank to the
Congress —

which is the central bank's creator and to which the central

bank is subordinate.

Much of the attention focused on the central bank

concerns its responsibilities for economic stabilization.

Understand­

ably,

the global

as our economy has

economy,

become more

interdependent with

as fiscal policy has been rethought and reevaluated and with

the drastic

alteration of the financial

system, questions have arisen

that fall into a general category of "How can we make the central bank
function

better

and more responsively?"

That

is,

plainly,

a loaded

question with everything depending on your definition of "better"
"responsively."

Nevertheless,

that

and

is a question that must be dealt

with.
Section 12 of the Federal Reserve Act, better known as the
Humphrey-Hawkins amendments, passed in 1978, reflects this emphasis.

It

requires the Federal Reserve to maintain a rate of growth of money and
credit over time that advances the economy's long-run potential, and to
report semiannually to each house of Congress on monetary and credit
aggregate

ranges.

This

focus

on

the

Federal

Reserve's

economic

stabilization function in no way diminishes the Federal Reserve's vital
function as provider of essential liquidity to the economy.




subject:

-7-

The

latter

role

framers of the Federal

was

most

prominent

in

the

minds

of

the

Reserve Act of 1913, who had seen the economy

reel from repeated banking "panics" in which a key factor was the lack
of any institutionalized

and adequate means of providing liquidity in

the face of contraction.

The Act describes the Federal Reserve's

primary

functions

establish

as

a more

"to

furnish

effective

an elastic

supervision

of

currency.

banking

. . (and)

. . . .

to
The

establishment of the Federal Deposit Insurance Corporation in the 1930s
was

another

response

interruption

in

to

the

the

ability

debilitation
of

banks

of

to

the

economy

discharge

and

their

an

payments

responsibilities and preserve depositor wealth.
From
government
designed
could

this

legislative

regulation

to

minimize

jeopardize

and
the

the

history

supervision
possibilities

payments

came
of

of

system,

efficient functioning of financial

growth.

Regulation

of

nondeposit

somewhat different purpose:

various

depository
large-scale

the

markets,

and industry and the increase in jobs and

the

public's

forms

of

institutions
failures

that

savings,

the

the expansion of commerce
income dependent upon that

financial

institutions

involves

a

it is focused on protecting the public from

misuse of resources and abuse of trust, but the safety and soundness of
these

institutions

insurance

in the

institutions.
bear

a

larger

depositories.

are

not

same way

protected

of

supervision

and

as the safety and soundness of depository

When weak firms fail,
share

by regulation,

the

the private sector

consequences

Along with regulations

than

intended

is

is liable to

the

to protect

case
the

with
public

against undue concentration of resources, regulation of banks and other
depositories clearly reflects the special

place

accorded

them

as the

center of the financial system, the institutions whose primary function
is to provide the seminal credit that is the lifeblood of industry and
commerce.



-8-

For some years to come, the share of various payments system
"markets"

served by nonbanks will

financial

services

"transactions"

provided

services

remain moderate.

Likewise

by banks will

build

over

"commercial",

e.g.

short

and

the years,
term

lending, will be particularly your province as bankers.
side,

the greatest

volume of

private

international

nonbank
but

business

On the asset

credits

are more

likely to be provided by commercial bankers than by investment bankers
or

thrift

executives.

degree than others.

Euromarkets

will

serve

bankers

to

a greater

The interbank markets are not likely to become the

interinsurance company markets.

In sum,

we must

recognize

both

the

coalescing toward a common center and the residual core of functional
differences among types of institutions.

"Broader powers" newly on the

statute books do not become instant assets on the balance sheet.
Deposit
normal

insurance

discount window

source of

liquidity —

depository.

and

and

as

the

Federal

Reserve's

role

at

the

lender of last resort -- the ultimate

recognize the special

nature

of

the

bank

as

Deposit insurance was designed to promote confidence that

wealth stored in depositories would be available when desired.

It is

appropriate today to review its role and what part market discipline
could play.

The presence of deposit insurance eliminates credit risk

from covered

deposits

institutions

at interest costs below those

intermediaries.
reflect this

and thereby allows the operation of depository

Yet money market deposit

advantage.

Obviously, you

paid

by other,

uninsured,

account pricing has yet to

in banking need to recapture

market share lost to money market funds, and future MMDA rates could be
set in differing relationships with competitive rates.

There is little

question

to

in

beneficial.



my

mind

Further,

that
I

do

restoring
not

your

accept

the

ability

argument

compete
that

is

smaller

-9-

institutions cannot survive and pay market rates.

Regulation Q was not

promulgated by the Roman Emperor Diocletian (Price control was, and it
wasn't effective then, either).
The Federal Reserve exercises its lender of last resort role
through the discount window to assure that financial
institution

does

liquidity.

Through

eligible

not

impair

the

depositories

systemic

discount

to

permit

functions

window,
them

funds

to

meet

weakness

due

can

to

be

in one

lack

of

disbursed

temporary

to

liquidity

shortfalls that they could not cover from other sources.

And it is also

understood

channel

through

that

the

depositories

Federal

Reserve

to nonbank

stands

borrowers

ready

to

in extreme

funds

situations

that

threaten to carry repercussions throughout the financial markets— as in
the case, for example, of the Penn Central bankruptcy a decade ago.

Reserve

Through

its

regular

influences

the

general

open

market

liquidity

of

operations,
capital

the

Federal

markets

on

a

continuing basis.
We welcome the review that is in progress, in and out of the
Congress, of developments in recent times in the financial markets, and
their

relation

to the central

bank.

Re-examination

of the existing

legislative framework is beyond doubt an urgent matter.

Much of the

institutional change that has taken place is innovative and needed, and
has come about through a combination of technological developments, and
market

innovations,

plus the opportunities opened

up by deregulation.

However, we are anxious that this review should take a broad perspec­
tive, considering the total domestic financial and payments systems, and
the interrelation of the various aspects of the international financial
system and of the economy at large.



-

We
account,

in

10

-

strongly

suggest

that

a balanced

fashion,

all

the

on-going

review

of the central

take

bank's

responsi­

bilities for economic stabilization and liquidity of the economy.
clear

that

the

process

of

recommended

for

many years

deregulation
--

has

--

evolved

much

of

to meet

into

which

It is

we

certain

have

specific

objectives.

We are now at a stage in which broad considerations

appropriate.

How do particular regulatory/supervisory measures fit into

the fundamental requirements of monetary policy?
a safe and stable financial
competitive

access to

preservation

of

system?

services

effective

To the maintenance of

To an assurance of equitable and

by consumers

means

are

for

and businesses?

transmitting

the

To the

influence

of

monetary policy to the economy at large?
An
relationship —
of

monetary

ancillary,

but

important

sometimes doubted —

policy

with

the

consideration

is

the

of the formulation and effectuation

regulation

and

supervision

of

banking

in this

area is

institutions.
One of
that the

the most

important considerations

achievement of particular

objectives

in

the

regulatory

and

supervisory area, should be conditioned by a view of these objectives
linked to a wide perspective of financial markets, and an appreciation
of the more generalized effects likely to result from actions directed
at individual

depositories.

This requires

the direct

knowledge of the complex interactions among financial
markets,

and

a sensitivity to

the

interdependence

sectors, including the international funds markets.




and

up-to-date

institutions and

among

markets

and

-

11

-

Supervision of depository institutions puts the governmental
supervisor

in

direct

case-by-case basis.

and

frequent

At one level,

regulations

contact

with

depositories

on

a

such contact provides assurance of

compliance

with

designed

to

serve

a

desired

overall

objective.

At another, that contact provides a flow of information back

to policymakers and yields important feedback on the efficacy of policy
actions and any strains that might be arising.
Actions in the supervisory, regulatory and monetary policy
realms tend to affect one another.
comes

from

values,

the

and

the

An example of this interdependence

effect

of

monetary

policy

on

level

of

economic

activity;

interest
these

rates,

effects

asset

in

turn

obviously may affect the condition of depository institutions and may,
in this way, also have secondary effects on the economy.
Awareness of this interdependence affects
considerations,

such

short-run policy

as the speed with which monetary aggregates

are

returned to target paths, or decisions whether, or in what degree, to
accommodate
conditions.
design

of

near-term

liquidity

It also bears
monetary

needs

in

light

of

implications for the

policy,

as

a

healthy

longer-run

financial

increases the flexibility available to monetary

financial

system

market

strategic
obviously

institutions,

through

which monetary policy is transmitted directly to other sectors of the
economy.
Regulation
another

example

of

and
the

supervision

of

interdependence

bank
of

holding

the

companies

Federal

is

Reserve's

responsibilities for the overall functioning of the financial system and
the safety and soundness of individual
holding companies

banks.

An

expansion

of

bank

into a new area may have implications not only for

those holding companies and their affiliates directly involved, but also




-

12

-

for other participants in the financial markets that may be competing
with

these

institutions

or

using

the

services

they

provide.

Bank

holding company developments can affect the entire financial system by
the way in which financial business is transacted, the geographic scope
of

competition

in financial

services,

the

degree

of

interdependence

among major market participants, and the strength and stability of those
participants.

It is essential that bank holding company regulation be

formulated not only in light of potential

effects on the competitive

position of the organizations directly involved, but also in light of
its effect in shaping a financial system that can adapt to innovations,
absorb occasional

shocks,

and convey monetary policy intentions

in a

predictable way to other sectors of the economy.
The changes pervading our financial system are profound and
exciting.
won't.

Some will

withstand

Unfortunately,

this

the

test

period

of

the marketplace,

coincides

with

federal

others
budget

deficits so huge as to be likely to exert unprecedented strains on the
financial

system after current economic slack has been taken up.

The

Federal deficit is expected to average 5% to 6% of 6NP both this year
and next, and despite a continuing recovery, remain in that range during
1985 and 1986.
five

years

The prospect of persistent megadeficits over the next

implies

regulatory system.
monetary policies
price

stability.

considerable

risks

and

major

challenges

for

our

Moreover, those deficits alone promise to complicate
designed
Nominal

to promote economic
interest

rates

have

growth

and reasonable

remained

at

elevated

levels relative to the current pace of price inflation, inhibiting the
capital

formation

necessary

vigorously in world markets.




to

improve

productivity

and

compete

-13We are pleased that the ongoing reviews inside and outside
the Congress

that

I have referred to are being undertaken.

They are

needed to unshackle us from past provisions of law and regulation that
have become hobbles.
will

At the same time, we recommend that these reviews

result in a modernized legislative and regulatory framework

that

has certain clear characteristics that have been important in the past
and
that continue to be important.

Among these are:

--

Recognition of the
depositories play;

unique

role

in

the

economy

that

—

Flexibility of law sufficient to permit financial
institutions to adapt smoothly to innovation but that
also permit regulation and supervision of the financial
system of a scope and kind calculated both to let the
market do its work and to give every reasonable
protection to the safety and soundness of our financial
institutions;

--

Recognition of the many inter-connected roles the
central bank plays, and the need for the central bank to
be free to come down on the side of policies aimed at
lasting economic growth and prosperity in real terms.

Such a framework is essential, in my view, to the stability
of our financial markets, and to the full functioning and effectuation
of monetary

policy

in

its

basic

roles

as

promoter

of

a

sound

and

productive economy and protector of the economy's liquidity.
If
forth

indeed

in the end,

long-lived

period

this

we shall
of

high

is the
have,

kind

of

reformulation

that

issues

in my opinion, opened the way to a

employment,

high

productivity,

profitable

business, small as well as large, and safe and profitable investment of
our savings and profits.