Regional President Speech

SILAS KEEHN ocMaovs PUBLIC iSSUES GROU? KENILWORTH UNION CHURCH 2/25/86 I. INTRODUCTION A. APPRECIATE OPPORTUNITY TO TALK A BIT ABOUT FEDERAL RESERVE SYSTEM ? ~-· 1. GREY - t~) - UNKNOWN 2. ANECDOTE B. WILL COVER: l. HISTORY OF CENTRAL BANKING IN U.S. 2. STRUCTURE OF THE FEDERAL RESERVE SYSTEM 3. WHY DOES IT MATTER? II. THE HISTORY OF CENTRAL BANKING IN THE U.S. A. HISTORICAL PERSPECTIVE IS USEFUL TO ANY UNDERSTANDING OF WHY THE FED IS AS IT IS. 1. U.S. WAS ONE OF THE LAST MAJOR WESTERN COUNTRIES TO HAVE A CENTRAL BANK 5 ~ J &s ·1.:: 2. BANK OF AASTERDA-M ESTABLISHED tu-e-t'; BANK OF 'l'f 00 ENGLAND 16~; BANK OF FRANCE 189-T 3. WE HAVE NOT ALWAYS HAD A CENTRAL BANK A. MATTER OF SOME CONTROVERSY 4. FIRST AND SECOND BANKS OF THE UNITED STATES HAD LIMITED CENTRAL BANKING FUNCTIONS - AND LIMITED LIVES A. FIRST BANK 1791 - 1811 B. GAP OF FIVE YEARS C. SECOND BANK 1816 - 1836 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis ?U3LIC ISS~~s =~au~ KENILWORTH UNION CHURCH 2/25/85 PAG~ 2 1) BOTH BANKS INCURR~D POLITICAL OPPOSITION AND 20-YEAR CHARTERS WERE NOT RENEWED (A) FIRST BANK - STRONG DISAGREEMENT BETWEEN HAMILTON, SECRETARY OF TREASURY AND JEFFERSON, SECRETARY OF STATE (1) HAMILTON WANTED A STRONG CENTRAL BANK WITH POWER TO CONTROL MONEY AND CREDIT (2) JEFFERSON FELT THAT A CENTRAL BANK WAS UNCONSTITUTIONAL (B) SECOND BANK OF U.S. BECAME TOO POWERFUL. OPPOSED BY PRESIDENT JACKSON WHO DISTRUSTED THE BANK (1) DID NOT UNDERSTAND THE FUNDAMENTALS (2) VETOED BILL - CHARTER NOT RENEWED 2) NO FEDERAL PRESENCE IN BANKING FROM 1837-1862 5. NATIONAL BANKING SYSTEM ESTABLISHED IN 1863 A. NATIONAL BANK ACT 1) ESTABLISHED STRUCTURE OF NATIONAL BANKING AS WE KNOW IT TODAY B. NOT A CENTRAL BANK Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis PUBLIC ISSUES GROUP KENILWORTH UNION CHURCH 2/25/86 PAGE 3 C. BUT LIQUIDITY PANICS; BANK FAILURES, LOSSES TO DEPOSITORS CONTINUED B. PANIC OF 1907 WAS LAST STRAW - LED TO THE ESTABLISHMENT OF THE FED 1. LARGE NEW YORK BANKS FAILED 2. BANKS FAILED TO COOPERATE AS WELL AS IN SOME PREVIOUS PANICS C. CONGRESS PASSED AN ACT IN 1908 1. CREATED NATIONAL MONETARY COMMISSION TO STUDY FINANCIAL SYSTEM, RECOMMEND REFORMS D. REPORT OF NATIONAL MONETARY COMMISSION IN 1910 RECOMMENDED ADOPTION OF ALDRICH BILL (SENATOR NELSON ALDRICH) 1. CREATION OF COOPERATIVE UNION OF ALL BANKS IN A "NATIONAL RESERVE ASSOCIATION" 2. GOVERNMENT WAS TO HAVE LITTLE ROLE A) CONTROLLED BY BANKERS 3. SIGNIFICANT CONTROVERSY E. FINAL BILL SIGNED BY PRESIDENT WILSON DECEMBER 23, 1913, WAS A COMPROMISE 1. BETWEEN ALDRICH BILL AND BILL FAVORED BY REPRESENTATIVE CARTER GLASS A) CREATION OF CENTRAL BANK WITHOUT DOMINATION BY BANKERS Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis PUBLIC ISSUES GROUP KENILWORTH UNION CHURCH 2/25/36 PAGE 4 B) BETWEEN CENTRALIZATION AND DECENTRALIZATION C) BETWEEN CONTROL BY GOVERNMENT AND BY PRIVATE BANKERS 2. MAGNIFICENT BILL - WELL STOOD TEST OF TIME F. EVOLUTION OF FEDERAL RESERVE POLICY 1. FROM 1917 TO 1919 THE FEDERAL RESERVE WAS CAPTIVE TO THE TREASURY AND BOUGHT LARGE AMOUNTS OF GOVERNMENT SECURITIES TO FI NANCE WORLD WAR I A) ESTABLISHED A PRECEDENT 2. FIRST REAL TEST OF SYSTEM -TO 30'S - DEPRESSION AND BANKING COLLAPSE REVEALED BASIC FLAWS OF POLICY A) FED CREATED TO PREVENT CRISIS B) FAILURE TO PREVENT CRISIS AND BANK FAILURES C) ALLOWED MONEY SUPPLY TO FALL SHARaLY D) IN LATE 1930S FED PREOCCUPIED WITH INFLATION DESPITE MASSIVE UNEMPLOYMENT, RAISED RESERVE REQUIREMENTS 3. DURING WORLD WAR II AND UNTIL 1951, FED PEGGED BOND PRICES, ALLOWED RAPID INCREASE IN MONEY - INFLATION RESTRAINED BY WAGE AND PRICE CONTROLS Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis PUBLIC ISSUES GROUP KENILWORTH UNION CHURCH 2/25/86 PAGE 5 A) ANOTHER CHAPTER IN THE PRECEDENT JUST MENTIONED 4. POSTWAR INFLATION LED TO TREASURY-FED ACCORD OF 195: THAT FREED FED TO OPPOSE INFLATION 5. DUR I NG 1950s AND 1960s FED EVOLVED MONET ARY POLICIES BASICALLY FOCUSED ON MONEY MARKET CONDITIONS AND INTEREST RATES RATHER THAN OF STABILIZING MONEY SUPPLY AND ECONOMIC ACTIVITY 6. MONEY GROWTH GRADUALLY. ACCELERATED FROM 2-3% A YEAR lN EARLIER 1960S TO DOUBLE-DIGIT LEVELS IN LATE 1970'S. EXPERIENCED ALARMINGLY HIGH RATES OF INFLATION-~ IN LATE 1970'S. 7. MAJOR CHANGE IN OPERATING PROCEDURES - 1979 A. FOCUSED MONETARY POLICY ON GROWTH OF: 1) RAPID INCREASE IN INTEREST RATES, AGGREGATE (A) SUPPLY/DEMAND . 2) VOLATILITY 3) RECESSION 1981-82 4) RATE OF INFLATION DROPPED G. THAT'S THE HISTORY OF CENTRAL BANKING IN THE U.S. 1. HAS NOT BEEN A PERMANENT THING A. CHICAGO BUILDING AND ANECDOTE B. NOT SUGGESTING DEMISE OF THE SYSTEM Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis PUBLIC ISSUES GROUP KE~ILWORTH UNION CHURCH 2/25/86 PAGE 6 2. HAVE BEEN USED TO ACCOMMODATE TREASURY DEBT 3. INDEPENDENCE HARD WON - NOT ALWAYS POPULAR III. STRUCTURE OF THE SYSTEM -- ORGANIZED GEOGRAPHICALLY A. 12 DISTRICT BANKS WERE ESTABLISHED TO ENSURE SOME DECENTRALIZATION - GOVERNMENT CORPORATIONS - STOCK l. BOARDS OF DIRECTORS (9) A. MAJORITY OF DIRECTORS ELECTED BY MEMBER BANKS OF DISTRICT (6) B. BOG (3) - STAN COOK /, C. REPRESENTATIONAL ASPECTS B. BOARD OF GOVERNORS (7) - APPOINTED - CONFIRMED l. SPACED TERMS - 14 YEARS A. CHAIRMAN/VICE CHAIRMAN - 4 YEARS C. FEDERAL OPEN MARKET COMMITTEE - T~!RD ELEMENT 1. IS KEY POLICYMAKING BODY 2. CONSISTS OF 7 GOVERNORS, PRESIDENT OF NEW YORK DISTRICT BANK, AND 4 PRESIDENTS OF OTHER DISTRICT BANKS SERVING ON ROTATING BASIS 3. MEETS ABOUT 8 TIMES A YEAR TO SET MONETARY POLICY D. INTERLACING OF CHECKS AND BALANCES WITHIN THE SYSTEM - BUREAUCRATIC 1. PREVENTS MONETARY POLICY FROM COMING UNDER CONTROL OF NARROW GROUP - CRITICAL POINT Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis --- PUBLIC ISSUES GROUP KENILWORTH UNION CHURCH 2/25/35 PAGE 7 2. COMPOSITION OF DISTRICT BANK BOARDS BALANCES PRIVATE AND GOVERNMENTAL INFLUENCES 3. INDEPENDENCE OF SYSTEM IS MAINTAINED BY SEVERAL DEVICES A. 14-YEAR STAGGERED TERMS OF GOVERNORS B. FREEDOM FROM FEDERAL BUDGET - COMMENT LATER C. ABSENCE OF TREASURY REPRESENTATIVE ON BOARD OF GOVERNORS (SINCE 1935) 4. CREATED BY CONGRESS/CONTROLLED BY CONGRESS .r A. IN SHORT - WAS NEED TO HAVE INDEPENDENCE TO PURSUE APPROPRIATE POLICIES IV. REASONS FOR EMPHASIS - WHY DOES IT MATTER A. THE ECONOMIC OUTLOOK FOR 1986 REMAINS POSITIVE - WE HAVE ENTERED THE FOURTH YEAR OF AN ECONOMIC EXPANSION - ECONOMIC CLOCK 1. WE ANTICIPATE THAT REAL GNP WILL GROW AT A RATE APPROACHING 3 PERCENT, MODERATELY FASTER THAN 1985' S 2~ PERCENT GROWTH 2. INFLATION, AS MEASURED, IS EXPECTED TO RUN ABOUT 3.5 PERCENT, PERHAPS MODESTLY HIGHER THAN 1985 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis PG5LIC ISSUES GROUP KENILWORTH UNION CHURCH 2/25/85 PAGE 8 3. THE UNEMPLOYMENT RATE MAY WELL MOVE DOWN MODESTLY FROM THE YEAR-END 1985 LEVEL OF 7 PERCENT 4. COMPARATIVELY - VERY ST~0~G C~C~: B. DESPITE THIS POSITIVE OUTLOOK, THERE ARE SOME NAGGING RISKS ON THE HORIZON. THESE AREAS OF RISK ALL STEM FROM A COMMON ELEMENT - SIGNIFICANT - BUILDUP OF DEBT ACROSS ALL SECTORS OF OUR ECONOMY - CUR I OUS - INFLATION UNDER BETTER CONTROL - BETTING ON INFLATION 1. LET ME START WITH THE KEY ELEMENT IN DEBT PICTURE - THE ONE THAT PERVADES VIRTUALLY EVERYTHING THAT l AM TALKING ABOUT - NAMELY THE FEDERAL BUDGET DEFICIT A. THE COMMON DENOMINATOR OF ALL OF OUR PROBLEMS B. OBVIOUSLY A CURRENT AND TOPICAL ISSUE - LITTLE l CAN ADD C. DEFICITS OF CURRENT MAGNITUDES AT THIS STAGE OF THE ECONOMIC EXPANSION ARE UNPRECEDENTED 1) NOT AT ALL UNUSUAL TO RUN SIGNIFICANT DEFICITS AT THE TIME OF RECESSION OR OTHER ADVERSE EVENTS Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis KENILWORlH UNION CHURCH 2/Z=/86 PAGE 9 2) BUT WE ARE NOW WELL INTO THE 4T:-i YEAR OF AN ECONOMIC RECOVERY AND ',JE HAVE BEEN RUNNING DEFICITS AROUND 5% OF THE GNP FOR 4 YEARS NOW A) WE'VE NEVER DONE THIS D. IN THE LONG HISTORY OF OUR COUNTRY WE HAVE ALWAYS MANAGED TO BRING OUR BUDGETS IN BALANCE 1) AFTER AN ADVERSE EVENT HAS PASSED r THAT CAUSED THE DEFICIT - CONGRESS HAS TAKEN CORRECTIVE ACTION TO BRING THE BUDGET IN BALANCE - RECORD IS CLEAR 2) INDEED, IN THE EARLY 1830'S CONGRESS NOT ONLY FULLY REPAID THE THEN OUTSTANDING TREASURY DEBT - BUT RAN SURPLUSES WHICH WERE DISTRIBUTED BACK TO THE STATES 3) IN 1967 WE UNDERWENT AN IMPORTANT CHANGE - FROM THIS POINT FORWARD WE AGREED TO RUN DEFICITS FOR THE NORMAL OPERATION OF OUR SOCIETY - TO DEAL WITH AN ADVERSE EVENT - THAT REALLY IS THE ISSUE - ENORMOUS POLICY CHANGE Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis ------ - PUBLIC ISSUES GROUP KENILWORTH UNION CHURCH 2/2~/86 PAGE 10 E. DI FF I CULT TO FORECAST HOW THE GRAMM-RUDMAN COMPLICATIONS WILL WORX .... :IT -~...., J , BUT MOVING ASIDE IN THE LEGAL AND PROCEDURAL RAMIFICATIONS - THE POLICY ISSUES ARE ENORMOUS 2. FEDERAL DEFICITS RESULT IN TREASURY DEBT A. RISING AT AN ALARMING RATE B. "- DEBT .;J:;:JL IN 1975 $500 BILLION - ~SSEB $2 TRILLION LAST YEAR - RISING INEXORABLY C. OVER $750 MILLION EVERY WORKING DAY - SOME $3.9 BILLION PER WEEK 3. TO SOME VERY LARGE EXTENT, THESE FISCAL DEFICITS ARE BEING SUPPORTED BY THE INTERNATIONAL MARKETS A. OUR TRADE DEFICIT LAST YEAR - A RECORD OF rM~ $150 BILLION B. WE HAVE NOW BECOME A NET EXTERNAL DEBTOR Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis PUBLIC ISSUES GROUP KENILWORTH UNION CHURCH 2/251?5 PAGE 11 C. THIS POSITION IS NOT INHERENTLY i✓HILE WRONG, IF THE FUNDS ARE BEING USED FOR PRODUCTIVE PURPOSES WHICH GENERATE THE REPAYMENT CAPACITY TO SERVICE THE DEB:. IT IS WRONG TO USE THE FUNDS FOR CONSUMPTION PURPOSES - AND THAT BASICALLY IS WHAT IS GOING ON D. AS A RESULT OF LARGE PURCHASES OF U.S. DEBT BY INTERNATIONAL MARKETS (JAPAN) - ;PRESSURE ON U.S. MARKETS - RATES 1) IF THERE IS A CHANGE IN SENTIMENT 2) FINANCE DEFICIT FROM DOMESTIC SOURCES 3) RATE PRESSURE 4) EFFECT ON ECONOMY 4. CONSUMER INSTALLMENT DEBT HAS ALSO RISEN TO RECORD LEVELS RELATIVE TO DISPOSABLE INCOME A. THOUGH THERE ARE SOME MITIGATING CIRCUMSTANCES WHICH MODERATE THE SHEER MAGNITUDE OF NUMBERS, NONETHELESS, PERSONAL DEBT LOADS HAVE BECOME VERY, VERY HEAVY - THAT RAISES THE QUESTION AS TO THE SUSTAINABILITY OF ECONOMIC EXPANSION Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis PUBLIC ISSUES GROUP KENILWORTH UNION CHURCH 2/25/86 PAGE 12 B. WILL THE CONSUMER CONTINUE THESE HIGri PURCHASING LEVELS SUPPORTED BY INCREASING LEVELS OF DEBT C. AND WILL THEY BE ABLE TO HANDLE THIS DEBT IF PERSONAL INCOMES BEGIN TO FALL 5. CORPORATE DEBT HAS ALSO INCREASED VERY RAPIDLY OVER THE PAST FEW YEARS A. IN 1984 CONSOLIDATED CORPORATE DEBT ISSUED BY NON-FINANCIAL CORPORATIONS INCREASED BY OVER $180 BILLION - A RECORD B; •T HE 1985 NUMBER WAS SOMEWHAT LESS BUT SECOND ONLY TO 1984 C. EVEN MORE DISTRESSING IS THE RAPID RETIREMENT OF EQUITY THAT HAS BEEN TAKING PLACE OVER THE PAST TWO YEARS D. CORPORATE AMERICA HAS BEEN DECAPITALIZING ITSELF ON AN ABSOLUTE BASIS E. EXACERBATED BY LEVERAGE BUYOUTS, MERGERS, TAKEOVERS, AND ACQUISITIONS F. AS A CONSEQUENCE, CORPORATE DEBT RELATED TO NET WORTH HAS INCREASED VERY SHARPLY 6. THE VERY LARGE EXTERNAL DEBT POSITIONS OF SOME OF THE LESSER DEVELOPED COUNTRIES ARE AN IMPORTANT ELEMENT IN THIS DEBT ISSUE Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis P!!3LIC ISSUES GRCL!? KENILWORTH UNiON CHURCH . L~ i ..:... ~, _ .. ; PAGE 13 A. PARTICULARLY SO FOR COUNTRIES THAT ARE DEPENDENT ON THE EXPORT OF PETROLC:0M PRODUCTS TO GENERATE DOLLAR RESERVES TO SERVICE THEIR DEBT B. MANY OF THE MAJOR FINANCIAL INSTITUTICNS I N OU R CO UN T RY HAVE. S I GN I F I CA N T COMMITMENTS IN MANY OF THESE DEBT POSITIONS C. WORKING THROUGH ·THIS PROBLEM WILL BE VERY CHALLENGING 7. AGAIN, THIS BUILDUP OF DEBT ACROSS ALL SECTORS OF OUR ECONOMY, NATIONALLY AS WELL AS INTERNATIONALLY, IS OF GREAT CONCERN A. A DESTABILIZING ELEMENT - VULNERABILITY OF THE DEBTORS TO SERVICE THE DEBT - MAINTAINING AN ENVIRONMENT OF GOOD ECONOMIC GROWTH IS CRITICALLY IMPORTANT B. MARGIN FOR ERROR VERY NARROW V. WHY DOES IT MATTER - WHAT'S THE REAL RISK A. THE SOLUTION TO THESE DEBT PROBLEMS 1. HOW DO YOU SPELL RELIEF - INFLATION B. ALL OF THESE DEBT PROBLEMS JUST DISCUSSED REPRESENT A GROWING CONSTITUENCY FOR REFLATION 1. IT WOULD BE SO EASY Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis PUBLIC ISSUES GROUP KENILWORTH UNION CHURCH 2/25/86 PAGE 14 2. JUST A BIT - JUST FOR AWHILE 3. JUST ENOUGH TIME TO WORK OUT A PROBLE~ 4. VERY SLIPPERY SLOPE 5. WE'VE BEEN THERE C. THE POLITICAL PRESSURE WILL GROW 1. PARTICULARLY AS FISCAL DEFICIT BECOMES INCREASINGLY INTRACTABLE 2. THE INDEPENDENCE OF THE FED WILL BE THREATENED 2. WE ARE NOT TALKING ABOUT A TURF ISSUE D. THE EARLY S,I GNS 1. THE BUDGET PROCESS - VERY PEDESTRIAN G~~I~? f~ ✓t--lp:i.? A. B. SELF-DETERMINATED C. APP?OPRIATION PROCESS - BILL INTRODUCED 2. MONETARY POLICY IS AT THE ROOT OF THIS THE WEDGE B. WE WOULD FALL UNDER CONGRESSIONAL CONTROL (1) PRESSSURE TO REFLATE DIFFICULT TO RESIST (2) EXAMPLES - HARDLY INSTRUCTIVE E. THIS BRINGS US BACK TO BOTH THE HISTORY AND THE STRUCTURE OF THE FEDERAL RESERVE SYSTEM THAT l NOTED EARLIER Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis PUBL1C ISSUES GRCU? KENILWORTH UNION CHURCH 2/25/35 PAGE 15 1. PRESSURES TO REFLATE (MONETIZE) ARE NOT UNICGc A. HISTORY IS REPLETE WITH EPISODES WHERE INFLATION ~~AS THE POLITICALLY EXPED:~~n POLICY COURSE TO CHART B. BUT THE DRAFTERS OF THE LEGISLATION CREATING THE FEDERAL RESERVE SYSTEM WERE WELL AWARE OF THIS HISTORY AND FOR THAT REASON PROVIDED FOR AN INDEPENDENT FED 2. ONLY AN INDEPENDENT · FED CAN RE I NFORCE GRAM~-RUDMAN TYPE LEGISLATION A. ONLY AN INDEPENDENT AGENCY REASONABLY INSULATED FROM DIRECT POLITICAL ?RESS0~E CAN TAKE DIFFICULT PUBLIC POLICY POSITIONS F. WE STAND IN THE BREACH 1. IF THE CONCEPT OF AN INDEPENDENT FEDERAL \/::"'JV !'"'IC·":! • -··· ! •• RISK OF EMULATING BRAZIL OR BOLIVIA A. l.M.F. - BRAZIL/ARGENTINA 2. CONVERSELY, IF FED INDEPENDENCE IS MA I NT AI NED, THEN RESPONSIBLE MONETARY POLICY CAN SERVE AS A USEFUL REMINDER ABOUT THE ~ISKS OF DEBT EXPANSION AND COAX US A NATION TO MAKE THE SHORT-RUN POLITICALLY DIFFICULT BUT LONGER-RUN Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis PUBLIC ISSUES GRC ? 1 KENIL~CRTH UNION nu~c~ L, ~-· uO PAGE 16 BENEFICIAL NECESSARY STEPS TO PUT OUR PRIVAT: AND PUBLIC BALANCE SHEETS IN ORDER - THOSE ~RE THE CHOICES. 3. CONFIDENCE - BUILDING PROJECT * * * * Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis

Silas Keehn (1986, February 24). Regional President Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/regional_speeche_19860225_silas_keehn

@misc{wtfs_regional_speeche_19860225_silas_keehn,
  author = {Silas Keehn},
  title = {Regional President Speech},
  year = {1986},
  month = {Feb},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/regional_speeche_19860225_silas_keehn},
  note = {Retrieved via When the Fed Speaks corpus}
}