EconSouth (Third Quarter 2006)
Volume 8, Number 3
Third Quarter 2006
Fed @ Issue
|Jack Guynn is president and chief executive officer of the Federal Reserve Bank of Atlanta. After 42 years at the Atlanta Fed, Guynn retires on Oct. 1.||Reflections on
Four Decades in Central Banking:
Lessons for the Future
When I graduated from Virginia Tech back in the mid-1960s, many of my friends and family were surprised when I took a job with the Federal Reserve Bank of Atlanta. A number of my classmates were going into more glamorous fields such as aerospace or computer design. In their minds, I was condemned to life in a stodgy, backwater field. But, as it turned out, the financial services industry went through a revolution.
During the past 40 years, technology, competition, and a growing demand for information have been catalysts for dramatic change. I believe that banking’s transformation into a dynamic industry had a profound impact on our personal and business lives and is a major part of our nation’s economic success.
A hands-on job for a time
When I started at the Fed, I worked in “back office operations”—the payment systems that most people take for granted. During the 1960s, our Atlanta office employed hundreds of people who worked around the clock sorting endless bundles of checks and cash by hand. As more powerful technology became available, we realized that one computerized check sorter could do the work of 40 or 50 manual processors. Also, instead of relying solely on trucks, the Fed began to charter airplanes to carry checks long distances overnight and speed check collection.
Computers also enabled new electronic payment systems such as the automated clearinghouse, which facilitates transactions like direct deposit of payroll checks. During that period of computerization, credit cards also became more popular. This transition to electronic payments has taken decades, but change is occurring more rapidly now as credit and debit card usage increases and businesses convert check payments to electronic entries at the point of sale.
The challenge of competition in banking
During my career, the entire banking industry has experienced upheaval. When I joined the Fed, banks were subject to rigid controls imposed by the states and Congress during the Great Depression. The idea was to maintain financial stability by restricting competition—both along product lines and geographically.
During the early 1980s, with high and rising inflation, the old bank regulatory framework began to unravel. About this time, I took over the Atlanta Fed’s supervision function, and we had some challenges as many financial institutions failed during that decade.
The number of bank failures declined in the 1990s and has stayed low. In turn, we saw the rise of well-capitalized megabanks that leveraged technology to cut costs and offered diverse and sometimes complex new products in competition with investment banks and insurance companies. Now it’s often hard to tell the difference between banks and nonbanks.
Is all of this competition a good thing? All in all, I’d say the answer is yes. This competitive fray directly benefits today’s consumers and businesses, who enjoy lower-cost financial services, more choices, and better access to capital. While I sometimes worry about the sheer size of some financial institutions and certain untested financial products, I believe today’s financial markets are better than ever at allocating risk to those with the greatest appetite for it. So I would have to say that our economy is much stronger and more resilient today because of our financial sector’s adjustments to competition.
Learning our lessons in monetary policy
Good economic outcomes depend on good monetary policy, where I’ve spent the past 10 years of my career. Recent experience in this area offers several important lessons. In the 1970s, policymakers tried to insulate the economy from relative price movements in one important commodity—oil. The big mistake in this policy was the failure to recognize that controlling inflation was a necessary first requirement for sustaining long-term growth.
After the 1970s’ oil price shocks, it was fashionable to embrace the false notion that one could improve economic outcomes by trading a bit of inflation for growth. As we should now know, a bit of inflation can get out of hand quickly, especially when consumers and businesses expect more price increases, waste time and effort trying to beat inflation, and then rush to spend more money in a vicious inflationary cycle. The consequences of high inflation are economically poisonous: increased uncertainty and risk, the added incentive to consume instead of invest, cost-of-living adjustments, and other marketplace distortions.
During the early 1980s, Fed Chairman Paul Volcker and his Fed colleagues broke the back of high inflation by raising interest rates well into double digits. Our economy endured two painful recessions. Along with the run-up in bank failures that I just mentioned, entire industries such as homebuilding collapsed. Because of our tough policy, the Fed was suddenly thrust into the public limelight.
By 1996, when I became Atlanta Fed president and part of the Fed policymaking group, inflation expectations were once again under control. About that time, the federal budget deficits were reined in. With the fortuitous convergence of low inflation and rapid growth, we enjoyed the longest economic expansion in U.S. history.
Increasing Fed transparency
The last decade, under the leadership of former Fed Chairman Alan Greenspan, also brought about major changes in how the Federal Reserve communicates our monetary policy actions and thinking. As amazing as it may sound today, until 1994 there was no announcement about the direction of monetary policy—not even after Federal Open Market Committee (FOMC) meetings.
Now, after each FOMC meeting, we not only announce our action but also provide brief comments on the economy and potential risks to the outlook. Our new Fed Chairman, Ben Bernanke, has talked about the need to make our policy goals even clearer. And the Fed is now studying and debating the limits to what we should say about the outlook and possible future policy actions.
As thinking about transparency evolves, I expect the Fed to keep trying new and different ways to communicate important views and actions, including perhaps establishing targets for acceptable levels of inflation.
Navigating the global flow
Looking ahead, our financial system and our economy will continue to become more interconnected. The march of globalization is relentless, and businesses will have to keep spending more on technology to improve productivity. The fastest-growing fields—financial services included—depend on knowledge, not physical labor.
Every moment of every day, vast sums of money zip around the world. Nine years ago a financial panic in Asia quickly led to financial market repercussions around the world. And with the emergence of China and India and increasing U.S. indebtedness, the global flow of funds will continue to grow, and our economy will depend more and more on events and decisions that occur outside our national borders.
Monetary policymakers must continue to account for all of these changes and others we can’t envision as technology advances and shocks occur. I’m leaving the FOMC confident in the Fed’s commitment to keep inflation at bay. I’m sure future policymakers will remember the lessons we learned in the past 40 years about what happens when you start down the slippery slope of trading inflation for growth.
For a long time, I’ve enjoyed an up-close and personal view on banking and the economy. Looking ahead to the next four decades, I think we all have good reason to expect our financial system and our economy to remain strong and continue to be the envy of the rest of the world.
This column is condensed from an Aug. 22 speech by Jack Guynn.