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I flew home from New York City the afternoon of September 10, 2001, not knowing that the world was about to change, not knowing that the building where I had given a speech that morning was one sunrise away from becoming Ground Zero for the most devastating terrorist attack in U.S. history.
In the days following the attacks on the World Trade Center, I was grateful to learn that myfellow attendees at the still-in-progress National Association for Business Economics annual meeting, being held at the Marriott World Trade Center Hotel, had all escaped with their lives.
My consolation was tempered by the same feelings that we Americans and all
civilized people across the planet expe-rienced watching events unfold on that
dreadful day: shock, disgust, sadness and unimaginable horror. My other emotion
was great uncertainty about what the attacks might mean for the St. Louis Fed,
the Federal Reserve System and the world economy.
Here at the St. Louis Fed, we thought of the well-being of our Eighth District
colleagues who were working at the New York Fed, just a few blocks away from
the World Trade Center, on September 11. People like Hillary Debenport, Kim
Nelson, Bill Emmons and Ellen Eubank. Thankfully, all of them would return home
safely.
President Bush would tell the press that despite the emotional toll the events
were taking on him, "I have a job to do, and I intend to do it." From
those first harrowing moments, the employees at the St. Louis Fed adopted that
same resolute attitude. Fear, outrage and stress made our jobs more difficult
than ever. But we had a job to do, and we did it. Our job--our responsibility--was
to help ensure the nation's continued confidence in the integrity of the
U.S. payments system. We acted decisively in a number of ways:
• Our Cash Department processed its usual daily volumes of cash, handled
all special requests for cash from financial institutions and made clear to
them that wewere prepared to provide emergency shipments if necessary.
• Our Credit Discount staff stayed on the job long after the normal closing
hour and fulfilled all requests for additional liquidity from District financial
institutions.
• Our Check Department processed high volumes and negotiated alternative
transportation arrangements to ship checks to other Reserve districts in the
absence of air transport.
• Our electronic services operated without a hitch and accommodated all
requests for deadline extensions.
• Our Treasury staff met all processing deadlines for the U.S. Treasury's
tax collection and investment services.
The St. Louis Fed and the entire Federal Reserve System played a significant,
but certainly not the only, role in ensuring the stability of our economy. In
this annual report, we examine four underpinnings of our economic system that,
together, helped our nation absorb the shocks of September 11: competitive markets,
a robust financial system,
a strong government fiscal position and monetary stability.
We make the point that the United States has been able to move forward thanks
to the strongest, most versatile and most balanced economy of any nation on
Earth. The ability to move forward, however, should not lead us to minimize
the impact the attacks have had on our lives in so many ways.
Beyond the tragic loss of life, our economy--as well as our national psyche--took a blow. But as the following essay shows, the deep foundations upon which our economy stands have allowed us to remain firmly on our feet as we clean up our demolished buildings, repair our damaged institutions and meet the threats we face.
St. Louis Fed President and CEO William Poole
A terrorist attack devastates the financial nucleus of a great country, killing
thousands of people and turning skyscrapers into dust and rubble in just a couple
of hours.
The nation's citizens, who have lived their whole lives believing their
homeland was immune to a scene of such horror, are paralyzed with fear. In the
days and weeks that follow, the economic system that people had so comfortably
put their faith in for generations begins to crumble to its own foundations:
• Producers of basic necessities take advantage of the situation to jack
up their prices by as much as 1,000 percent, causing long lines and frayed tempers
at gas stations and grocery stores in every city.
• Massive bank runs deplete scores of depository institutions of their
liquid reserves, while the nation's banking system is unable to replenish
the cash and credit needed to prevent hundreds of banks from failing within
weeks.
• Heeding government warnings of additional terror attacks, people hunker
down in their homes, skipping work and keeping their children home from school;
airlines exhaust their cash reserves and shut down; and the federal government,
grappling with soaring budget deficits and inflation, looks on helplessly, unable
to offer any type of relief package that would prevent hundreds of thousands
of employees from losing their jobs.
In summary, the shocking events of a single day have caused a seemingly strong
nation to begin a plunge toward depression.
While no American will forget the events of September 11, 2001, it is equally
important to be aware of how we avoided the catastrophic economic consequences
described on the
previous pages--to be aware of what makes the U.S. economy so unlike the
fragile enterprise the terrorists mistook it to be.
The U.S. response reflects mutually reinforcing political and economic strengths.
In this essay, we focus on the economic institutions and conditions that allowed
us to successfully adjust to the shock and regain equilibrium. While further
setbacks are certainly possible, the response of our economy to date and its
inherent strengths provide us with great confidence that the final outcome will
be favorable. Four main features of the U.S. economy justify this confidence.
These are:
• Vigorously competitive markets
• A robust financial system
• A strong government fiscal position
• Low inflation and monetary stability
To reflect on these features is a valuable exercise, for they did not arise by accident. Given the routine pressures every family, firm and government faces, it would be all too easy to neglect the investments necessary to build resilient economic institutions. The components of the U.S. economy we discuss in this essay were built over time and with attention to a long horizon. They serve the nation well in ordinary times, but especially so in extraordinary times. In contrast, a country that accepts economic compromises, through an unwillingness to invest in the future, places itself at risk. The defects of a compromised structure usually become painfully apparent in a time of stress, too late to make the long-run investments that would permit a constructive response to the shock.
With high rewards for entrepreneurs, the competitive market systemis the engine of long-run growth and the mechanism by which the economy absorbs short-run economic shocks.
The U.S. economy contains powerful forces that promote growth and full employment.
Our culture and institutions reward entrepreneurial activity. They are intact,
completely undiminished by the events of September, as well as the anthrax scare
that followed in October. People are motivated by the intellectual and financial
rewards of building companies, developing new products and services, and serving
markets. They continually look for opportunities to move the U.S. economy forward.
With high rewards for entrepreneurs, the competitive market system is the engine
of long-run growth and the mechanism by which the econ-omy absorbs short-run
economic shocks.
The role of competitive forces was apparent soon after September 11, as markets
responded to changed demands and firms began searching for technical innovations
to address the new security environment. The travel industry is the most obvious
example: Airlines quickly cut flights and introduced promotional fares, while
hotels and resorts offered discount rates. Other industries followed suit. By
late September, the auto industry was advertising significant savings to consumers
in the form of zero-interest financing. Meanwhile, property insurance companies
increased their premiums on com-mercial policies substantially, expanded deductibles
for such coverage and, in some cases, added clauses to exclude losses resulting
from acts of terror.
The United States is known around the world for its technology. In this time
of stress, consider a few examples of how firms are bringing technology to bear
on the problems we face: Manufac-turers of equipment generally used to prevent
bacterial contamination of food applied electron-beam technology to decontaminate
mail sent through various Washington, D.C., postal facilities. Researchers at
the Mayo Clinic announced the development of an apparently reliable one-day
test for anthrax exposure. And at Saint Louis University, researchers are capable
of adapting their studies of the dispersion patterns of dust and cat allergens
to help determine how biological agents such as anthrax spores are dispersed.
(See sidebar at right.)
Other opportunities abound for new approaches to help solve old problems or
to define solutions for emerging problems. Providing security for our transportation
systems, our food chain, our energy generation systems and our borders is an
area ripe for innovation. For example, in the immediate aftermath of September
11, severe bottlenecks developed at the Canadian and Mexican border crossings
as detailed inspections of thousands of trucks were implemented. Since the passage
of NAFTA, some industries--one being, automobile production--have become
highly integrated across the three North American economies. The traffic jams
that emerged forced the temporary closure of a number of production facilities
because parts could not be delivered "just-in-time." Experts have
concluded that thorough security inspections can not be completed efficiently
at centralized border crossings. If true, then without substantial innovation,
some of the cost savings that we have realized in recent years through reduced
inventories will be lost.
What to do? One possible solution is to adapt satellite tracking technology,
now in common use by trucking companies, to reduce such production disruptions.
Conceivably, entrepreneurs could extend this technology to monitor vehicles
that have been inspected and sealed at dispersed points-of-origin so that full
truckloads can be cleared through border crossings electronically.
Passenger and baggage screening at major airports is another area with considerable
potential for profitable innovation. Airlines now recommend that passengers
arrive at major airports two hours in advance of their departure time to allow
for check-in and security clearance, an increase of more than one hour from
the recommended lead-time prior to September 11. This additional time substantially
increases the cost of airline travel to consumers, above and beyond any higher
ticket prices or user taxes needed to pay for more intensive security screening.
Over the long run, such cost increases, if sustained, can be expected to provoke
significant substitution of other modes of travel, particularly for short- and
intermediate-distance trips. Nevertheless, even after such substitution, the
total costs of travel will be increased. And, to the extent that new security
procedures permanently increase travel time and expense, we can expect to see
people use other technologies, such as video conferencing, more frequently for
conducting business.
Businesses and entrepreneurs working to develop new technologies in this environment
can be successful because of government policies and the structure of our labor
and capital markets. Firms and jobs are created and destroyed continually in
our economy so that ultimately our resources are directed toward the most productive
activities. Experts have noted
this characteristic frequently in explaining why "high-tech" has penetrated
production processes here more quickly and more intensively than in other countries.
In such an environment, the transition to an economy that requires a higher
level of security can be accomplished with little, if any, disruption of the
long-term productivity trends that are the source of our increasing standard
of living.
Compared with other industrialized economies, job entitlements in the United
States are relatively low. Seniority practices, job security provisions of negotiated
labor contracts, plant closure notification laws and the like provide some short-term
job security to workers. However, in the face of a major shock that significantly
shifts demand permanently away from the output of one industry toward another,
these provisions affect only the transition from an old environment to a new
one. For example, in the aftermath of September 11, lighter passenger loads
caused airlines to employ smaller planes more frequently, meaning senior pilots
needed to be re-certified to fly those planes. Once the retraining has been
accomplished, these firms will be able to operate efficiently at the lower level
of demand.
Finally, regulatory conditions also help smooth the economy's adjustment to the new threat of terrorism. A market system works most effectively when prices signal where resources should be used. In our current situation, we are much better positioned than we were in some significant historical situations. (See sidebar at left.) With the outbreak of the Korean War, the federal government instituted price controls and rationed critical materials. One effect of those policies was that investment in large structures and the production of automobiles were disrupted by steel rationing. The government also imposed credit controls on mortgage and consumer credit. All of these regulations interfered with the market system's ability to direct resources to their most productive uses.
Last October, Dr. Roger Lewis listened intently to a radio report about the
anthrax spores enclosed with a letter addressed to Senate Majority Leader Tom
Daschle.
The report mentioned that the anthrax was mixed with a substance called silica.
The next day, Lewis read that the head of the laboratory examining the letter
did not know why the letter contained silica. Lewis did.
An industrial hygienist and associate professor of Environmental and Occupational
Health at Saint Louis University's School of Public Health, Lewis often
uses silica in his experiments with materials like lead, dust mite allergens
and cat allergens. He studies how these particles accu-mulate on surfaces and
become dispersed through the air, how people come in contact with them, and
what are the most effective ways to remove them.
Recalling the events of last Octo-ber, Lewis says: "I phoned Greg Evans,
the head of the bioterrorism center at SLU, and I told him that I know why that
letter contained silica. It's because silica is a drying agent. I have
used it for years to keep dust airborne. It keeps particles aerosolized and
prevents them from clumping. It works fantastic."
To Lewis, the presence of silica in the Daschle letter indicated a highly sophisticated
perpetrator whose intent was for the spores to spread easily and cause as much
harm as possible. Evans reported Lewis' information to the FBI.
Currently, Lewis is working on a two-pronged project funded by the U.S. Department
of Housing and Urban Development: determining the best vacuum cleaning system
for removing leaded dust from carpets and upholstery, and finding the best detergent
for removing these same contaminants from hard surfaces like floors or windowsills.
Lewis says his kind of research could easily be adapted to exploring how anthrax
spores are spread. In fact, Lewis says that he and his assistants considered
halting their current research so they could perform experiments simulating
the dispersal of anthrax spores from opening envelopes. Instead of using actual
anthrax, they would use a safe surrogate that has nearly the same physical properties
as anthrax.
"The only problem is that here at the university we're not top-heavy
with staff; so we can't stop everything we're doing to do this,"
Lewis says.
When his schedule lightens up, Lewis plans to seek government funding to research
and conduct experiments on anthrax spores--though he'd prefer to keep
his distance from the real stuff.
"I'll work with a surrogate, thank you very much," he says.
Photo Caption:
In his experiments on how materials like lead and cat allergens spread, Dr. Roger Lewis of Saint Louis University often uses silica. That same substance was found in the anthrax letter sent to Senate Majority Leader Tom Daschle.
In 1973, the Nixon administration began phasing out the wage and price controls
it had imposed in April 1971. One important control, however, was not lifted.
In response to the oil embargo imposed on the United States by OPEC in October
1973, the administration imposed more stringent price regulations on the oil
industry. The purpose of this complicated set of regulations was to cushion
domestic prices from the full impact of the higher prices on world markets.
The price control system entitled domestic refiners to domestically produced
oil at controlled prices. The impact of the price controls and entitlement system
was that products produced from crude oil were not available throughout the
country to meet the local demand at the controlled prices. Long lines developed
at gas stations, and economic activity was disrupted as households and business
that were last in line or low in the allocation priority were unable to obtain
the energy products they needed. Gas station owners were even arrested for selling
fuel to willing purchasers at prices above the controlled levels.
How did this mess affect the economy in general? Economic activity started slowing in late 1973. And over the next two years, the oil price shock and the disruption of the market system caused by the price controls contributed to what at the time was the worst recession since the Great Depres-sion. Consumer price inflation accelerated to 11 percent in 1974, and the unemployment rate rose to 8.5 percent in 1975.
Although some components of the financial system had their operations shut
down by the collapse of the Twin Towers, most continued to function normally.
The infrastructure of our nation's financial system proved to be vulnerable
to the attacks of September 11. Key operations located at and near the World
Trade Center included stock exchanges, clearing banks, several of the important
dealers who made markets in federal government securities, traders who made
markets in foreign exchange, and brokers who linked the banks that wanted to
borrow and lend federal funds.
Following the attacks, all aircraft were grounded in U.S. airspace, except
for military planes. The government bond market was closed and did not reopen
until September 13. Equity markets were closed until September 17. The clearing
of both wholesale payments and securities transactions was disrupted because
of processing problems experienced by a major New York clearing bank, whose
operations center was located near the World Trade Center. Communications were
affected by the extensive damage suffered at a major telephone-switching center
in Lower Manhattan. Also disrupted was our national system for clearing checks,
a large share of which moves through air transport to the paying banks.
As severe as the interruption was, it is important to note that the vulnerability
turned out to be the physical infrastructure of payments and trading systems,
not the underlying strength of financial services firms. These firms and their
suppliers proved to have the capital and the technical resources to restore
damaged infrastructure. This fact is not a trivial one.
Developments during the first week after September 11 were especially important
in limiting the impact of the attacks on our payments system and financial institutions.
(See sidebar at right.) Although some components of the financial system had
their operations shut down by the collapse of the Twin Towers, most continued
to function normally. The depth of operational resources, the capacity to call
on backup systems, and the role of the Federal Reserve in providing massive
amounts of liquidity reflect the robustness of the U.S. financial system.
The electronic payment networks operated by the Federal Reserve System--Fedwire®
and the Automated Clearing House (ACH)--hummed along without interruption.
These systems facilitated the operation of other segments of the payments system
and the settlement of transactions among financial institutions.
The attacks temporarily disrupted market mechanisms through which banks trade
their reserves, including borrowing in the federal funds market or selling federal
government securities held as secondary reserves. In response, the Federal Reserve
made large loans through its discount window to provide liquidity to banks that
could not raise adequate funds through normal mechanisms. Short-term discount
window loans, which were $99 million on September 5, rose to more than $45 billion
on September 12. By September 26, these loans dropped back to $20 million; the
system had returned to normal.
Extra liquidity injected into the banking system flowed to where it was needed.
Banks increased their loans to other banks substantially. Interbank loans increased
from $300 billion on September 5 to $442 billion on Septem-ber 12. By early
October, interbank loans had returned to about $300 billion. The willingness
of banks to increase their loans to one another by large amounts on short notice
was based on the confidence that they were lending to banks that were strong
financially. (See sidebar at left.) The solid capital positions enjoyed by most
banks permitted them to make it through.
The credit card, debit card and ATM networks functioned normally after the
terrorist attacks. The flow of data among participants in these systems, including
banks and merchants, occurs over electronic communication networks. Participants
in these systems settled their net positions over the Fed's electronic
payment networks in the usual manner.
Operating the nation's check collection system was a greater challenge.
Because banks could not collect checks through air transport, the Fed adopted
a policy to minimize disruptions to the use of checks. The Reserve banks accepted
checks from banks for deposit to their reserve accounts and credited these reserve
accounts for the proceeds of the checks on the usual availability schedule.
"Check float" increased substantially because the Fed could not collect
the checks on the usual schedule. Such float jumped to $23 billion September
12. In comparison, it was only $2 billion a week earlier. The Fed's policy
of accepting checks for deposit and crediting the accounts of collecting banks
on the established availability schedule facilitated the relatively smooth operation
of one important phase in check collection: banks accepting checks from their
customers and crediting their accounts as usual.
Relatively few people withdrew more cash than usual from their accounts. The
Fed was able to help banks meet this demand by providing additional cash from
the vaults of the Reserve banks. Because the banks and the Fed made clear to
the public that cash would remain readily available, an unusual demand for cash
never materialized. What additional demand did surface quickly subsided.
Our nation's financial system returned to more normal operation during
the week after September 11. Although stock market averages declined when the
trading of equity shares resumed, the markets showed no signs of panic selling.
Stock prices tended to change in a rational pattern, with the largest percentage
declines in the share prices of companies that appeared most adversely affected
by the attacks. Settlement of trades occurred in almost the usual orderly fashion.
To provide extra time for processing in the Treasury securities market, trades
conducted on September 13 and 14 were settled three days later, and five days
after for trades made between September 17 and September 21; starting Monday,
September 24, trades were settled on a normal next-day basis.
The large increases in bank reserves during the first days after September
11 were reversed during the following week, as more checks reached the paying
banks and banks repaid their loans from the Fed's discount window. Inter-bank
loans declined as the temporary disruptions in the operation of the financial
markets ended.
One reason why payments systems worked in a crisis situation is that these
systems contain arrangements that limit the risk assumed by each participant
by extending credit to counterparties. In addition, banks have relatively high
ratios of capital to total assets. Although large banks have experienced an
increase in problem loans since 1997, bank capital ratios remain substantially
higher than during the last period of major problems in the banking industry,
in the late 1980s and early 1990s. One of the factors that could have adversely
affected payments arrangements would have been an unwillingness of participants
to
extend credit to one another. There is no evidence that such credit restriction
occurred.
The supervisory authorities in the United States are also committed to keeping
our banking industry in sound condition. Banks that suffer losses that compromise
their capital positions are closed or reorganized unless their shareholders
inject additional equity. The experience of the U.S. savings and loan industry
in the 1980s and of other nations, especially Japan, demonstrates the problems
inherent in the supervisory policy of forbearance when losses deplete the capital
of financial firms. An economy cannot grow if its major financial institutions
remain in weak financial condition for an extended period of time. Moreover,
such firms would not have the strength to withstand a shock of the magnitude
of September 11.
While we cannot know whether we will have more terrorist attacks in our future,
the operation of our payments system and financial institutions after September
11 gives us a basis for optimism about our nation's ability to cope with
future events. This capacity rests on a continuing commitment to two basic principles:
First, the Fed as the central bank must be prepared to inject additional reserves
into the banking system temporarily during a financial crisis. This point is
so well understood, certainly within the Fed, that there can be no doubt that
liquidity would flow freely as needed.
Second, our government supervisory agencies must maintain a commitment to policies that promote the strength of our financial institutions. This strength includes sound capital positions and comprehensive contingency plans for maintaining or restoring operations. The Fed and financial firms across the country had prepared extensively for possible economic disruptions in advance of Y2K. Because of those preparations, the century rollover occurred with practically no problems whatsoever. On September 11, the contingency plans were taken off the shelf. In the days that followed, these plans paid off handsomely.
Photo Caption:
Processing checks is an important, and hectic, component of America's economic engine. At the St. Louis Fed and Reserve banks throughout the country, this task became even more critical after the attacks of September 11. To help maintain confidence at all levels of the payments system, the Eighth District absorbed nearly $800,000 in costs for the month of September. Most of these costs involved float the Fed granted to financial institutions because Reserve banks could not collect checks on the usual schedule for several days after the attacks. Check employees in St. Louis also logged overtime performing activities like processing checks for financial institutions that temporarily closed September 11.
Few, if any, sectors of the U.S. economy were unaffected by the events of September
11.
The charts below show how four economic indicators--depository institutions' reserves, initial unemployment claims, retail sales, and M2 money supply--reacted to the shock. Three of the charts indicate continued turbulence for several weeks or months before leveling off to pre-September 11 levels. The spike in M2 receded quickly and by the end of October, M2 returned to its pre-September 11 trend. The charts report weekly data, and the dashed lines indicate the week of September 11.
During times of crisis, people have often sought security by keeping their
money close at hand.
Panic-stricken, they have rushed to their banks to withdraw cash, an act that
can be detrimental to a bank's operations when performed in large numbers.
Fortu-nately, bank runs did not occur after September 11. Why? Because people
felt confident enough in the stability of the banking system to leave their
money where it was.
Experience during the early 1930s in the United States illustrates what can
happen when people lose confidence in the strength of their banks. Because of
poor monetary policy, the money supply declined sharply during the early part
of the decade, and large numbers of banks failed. Problems in the banking system
reached a crisis stage by early 1933. Several states had declared banking holidays.
During a banking holiday, the government closes all banks temporarily, generally
to stop runs by depositors withdrawing their funds. In addition, customers could
not use the funds they had on deposit to make payments. The banking holidays
also caused a suspension in the operation of financial markets, including the
securities and foreign exchange markets.
Shortly after his inauguration, President Franklin D. Roosevelt declared a federal banking holiday on March 6, closing every bank in the country. Even the Federal Reserve shut down for a few days. The temporary halt to bank operations disrupted commerce throughout the nation. The government began reopening banks a week later, but more than 5,000 banks--out of 17,800 banks as of year-end 1932--remained closed March 15. While many of these banks eventually reopened several months later, many others never did. The experience of our nation during the early 1930s is a reminder of the importance of government policies, including appropriate monetary policy, that keep our nation's banking system strong.
Despite the fiscal policy actions taken in response to September 11, the United
States is very far from being fiscally stretched.
The United States has dealt with the terrorist attacks from a position of financial
strength, namely, historically large federal, state and local government budget
surpluses. Indeed, the ability to marshal significant resources during times
of war is one of our country's great strengths. To be sure, the war on
terrorism is decidedly unlike previous conflicts. No one now knows the scale
of governmental resources that will be necessary to prosecute the war. But because
the nation entered the conflict with a solid government financial position,
the consequences for the economy are unlikely to include large tax increases
and the uncertainty that would accompany them.
The federal government recorded a $69.2 billion unified budget surplus in fiscal
year 1998; by fiscal year 2000, the surplus had grown to just under $240 billion,
or 2.4 percent of GDP. The government attained this budget position through
a combination of fiscal restraint and better-than-expected economic growth.
The higher economic growth rate reflected an increase in the growth of labor
productivity beginning around 1995, which most economists attribute to the marked
rise in investment in high-tech capital equipment. That investment was financed
in part through the surpluses in the federal budget. Paying down federal debt
released funds for private investment.
This virtuous cycle, in which a strong economy increased federal revenues,
and a federal budget surplus helped to support private investment that boosted
economic growth, continued until the recession of 2001 set in, starting in March.
Previous growth had taken the economy to a much higher level than it would have
achieved had growth remained relatively low in the late 1990s; as a consequence,
despite the mild recession, the federal budget was in much better shape than
it otherwise would have been.
In May of last year, passage of the Economic Growth and Tax Relief Reconciliation
Act of 2001, reduced, but did not eliminate, prospective budget surpluses. Consequently,
federal resources were deemed available to deal with circumstances that changed
dramatically after the terrorist attacks. Soon after September 11, President
Bush proposed a $20 billion emergency aid package to assist those individuals,
businesses and government administrators directly affected by the attacks. Congress
quickly doubled the size of this package, which also authorized funds for increased
military and security measures, and then sent it to the president, who signed
the legislation into law September 18. Subsequently, emergency legislation totaling
$15 billion was signed into law to help stanch the losses suffered by domestic
air carriers. Then, Congress passed and the president signed into law the Aviation
Security Act of 2001, which authorized federal oversight and responsibility
of most airport security measures, including inspection of passenger baggage;
increased use of federal air marshals; and awarded grants to air carriers to
improve in-flight security measures. Given that the traveling public will cover
about half of the cost of these measures through increased fees, the Congres-sional
Budget Office estimates the net cost of this legislation over the next five
years at a little more than $9 billion.
Going forward, it is possible that additional monies will be required if the
war extends longer than expected, if threats of additional attacks crop up or
if additional attacks are carried out successfully. Is the federal government
positioned to cope with these new fiscal strains? What about state and local
governments, which also have an important role to play?
The central question in this regard is whether the economy's growth rate
in coming years will be high enough to generate required revenues at current
tax rates. The key issue is the rate of productivity growth, a subject of much
dispute and limited actual knowledge. The prevailing view among most forecasters
and academic economists is that labor productivity has accelerated--perhaps
sufficiently to push the economy's sustainable rate of output growth up
from the roughly 2.5 percent pace that prevailed between 1974 to 1995, to around
3.25 percent. If such estimates are correct, then budget surpluses may still
be more likely than deficits over the next 10 years. Despite the fiscal policy
actions taken in response to September 11, the United States is very far from
being fiscally stretched. (See sidebar at right.) Should substantial additional
security expenditures be required, some combination of modest tax increases
and modest spending restraint in other areas of the federal budget will likely
provide the resources needed to address security requirements.
The United States has benefited from a fiscal policy that focuses on efficient use of federal resources and attention to the policy's effects on economic growth. This policy crosses both political parties and has been maintained over many years. Much more could be done to improve the efficiency of federal spending and tax policies, but the point here is that the strong U.S. fiscal position has served the nation well in dealing with the stresses of the terrorist attacks.
Photo Caption:
"With my signature, this law will give intelligence and law enforcement officials important new tools to fight a present danger."
President George W. Bush signs the Patriot Act, Anti-Terrorism Legislation, October 26, 2001.
In waging the war on terrorism, the U.S. government will spend large sums in
certain areas, particularly domestic security.
Even so, the ratio of debt to gross domestic product (GDP), after rising slightly,
is projected to decline steadily over the next decade. The debt/GDP ratio compares
total government debt with the entire output of the economy in one year.
As the chart shows, the United States emerged from World War II with a debt/GDP ratio well in excess of 100 percent. Over the ensuing 35 years--which included the Korean and Vietnam wars--the ratio declined steadily to below 40 percent; budget deficits were small on average and GDP grew. In the 1980s, deficit spending financed a huge defense buildup. That effort, along with tax cuts, the transition to lower inflation and slow growth, pushed the ratio back up to about 70 percent, still a quite manageable situation. In the 1990s, the ratio fell to under 60 percent in the wake of strong economic growth and budget surpluses. Sustained low inflation contributed to both of these outcomes by increasing economic stability, keeping interest rates relatively low and encouraging a high rate of business investment that contributed to high productivity growth.
That we now take price stability almost for granted is a great strength of
our current condition.
A market system works most effectively when price signals are not confused
by inflationary expectations. Evidence shows that no consumer behavior has seemed
motivated by fear of inflation since September 11. A few lines at gas stations
emerged that day, based on unfounded fears of a physical shortage and sharply
higher prices. In the weeks after the attacks, energy prices fell, reflecting
reduced demand in the face of a global economic slowdown.
Consumer price inflation has not accelerated. Survey measures of longer-term
inflation expectations have remained unchanged. The spreads between regular
Treasury bonds and the Treasury's inflation-indexed bonds--another
measure of inflation expectation--receded after the terrorist attacks and
have remained low.
Indeed, some commentaries in the immediate aftermath of September 11 raised
concerns about deflation. Such fears arose out of short-run data that appeared
immediately after the attacks and out of an inadequate understanding of deflation
in Japan, where wholesale and consumer prices generally drifted downward starting
in the mid-1990s and where asset prices (land and equities) collapsed. A more
complete analy-sis indicates that the U.S. economy is in no danger of replicating
Japan's experience in the 1990s.
One of the great economic accomplishments of the last 20 years is restoration
of a climate of price stability in the United States. During the early 1980s,
the Fed managed monetary policy to stabilize the inflation rate at a much lower
rate than in the 1970s; in the 1990s, the Fed was able to put the inflation
rate on a gentle downward trend. The outcome was accompanied by steadily declining
unemployment, contrary to the forecasts of many.
By the middle of the 1990s, the objective of reducing inflation to a low-enough level that it was largely ignored in the day-to-day decision making of consumers and businesses was substantially achieved. That we now take price stability in this sense almost for granted is a great strength of our current condition. (See sidebar at left.) This environment gives the Fed flexibility in responding aggressively to situations where there is the potential for a liquidity crisis, such as on September 11 and the following days, or where there is evidence of an economic slowdown. As always, the Fed's responses must be tempered by consideration that an overreaction, or a failure to reverse short-run policy actions in a timely fashion, could result in a deterioration of expectations about future inflation.
A little more than 50 years ago, while American forces were engaged in conflict
thousands of miles away, consumers on the homefront were fighting their own
enemy--inflation.
When the Korean War broke out in June 1950, inflation was subdued. The month-to-month
inflation rate was generally in the range of 0 to 5 percent at annual rates.
Inflation, however, began climbing rapidly and jumped to nearly 20 percent by
early 1951. The fear of inflation was so real that people began resorting to
"buy in advance" behavior in an attempt to beat anticipated future
inflation and possible resumption of World War II-style rationing. These fears
complicated the economic and political problems that arose from the Korean War
emergency. The Federal Reserve could not pursue an independent monetary policy
to fight inflation because it was still honoring an agreement carried over from
the war to maintain interest rates on U.S. Treasury securities at fixed, unchanging
levels.
In 1951, the Fed-Treasury Accord was negotiated, re-establishing the independence of monetary policy in the United States. The improved monetary policy helped to reverse inflation's course. Today, the Federal Reserve has both the authority and commitment to limit inflation. Thus, while many fears have gripped Americans since September 11, inflation has not been one of them.
There is no reason to believe that what served us well during this crisis would
abandon us in the future.
The picture we have painted of the U.S. economy in the wake of September 11
is encouraging. Yes, the attacks were damaging. But they were not crippling.
In a society in which entrepreneurial initiative and risk-taking are rewarded,
recovery from disaster is bound to be expedited. When citizens have faith in
the soundness of their financial institutions, they have less reason to panic.
Where a federal government spends taxpayers' monies wisely, a nation shows
resilience during adversity. And where a central bank sets a goal of maintaining
price stability, consumers feel confident that their money will retain its purchasing
power, even in dire circumstances.
The United States embodies all of these qualities. The result? Its economy
is, in many ways, shock-resistant.
Despite the devastating ramifications of the terrorist attacks, many key economic
indicators began to regain equilibrium within weeks. Economic statistics for
the period since September 11 have suggested that the econ-omy is stabilizing
quickly after initial declines caused by the attacks:
• Real GDP increased at an annual rate of 1.7 percent in the fourth quarter
of 2001.
• Productivity in the nonfarm business sector increased 5.2 percent at
an annual rate in the fourth quarter.
• Monthly CPI inflation came in at 0.2 percent in February and 1.1 percent
for the 12 months ending with February.
• Payroll employment rose by 66,000 jobs in February.
• In February, real consumption rose 0.5 percent over January.
In the end, our economy passed one of the most challenging tests in the nation's
history.
The question is, can it pass even tougher tests? Yes. There is no reason to
believe that what served us well during this crisis would abandon us in the
future.
Our competitive markets and strong financial system are deeply ingrained within
our culture. And while government fiscal policy and Federal Reserve actions
evolve over time and depend to some degree upon the individuals in office, the
benefits of prudent budgets and low inflation have become so obvious that they
have become institutionalized within our society as well.
We have known for many years that an economy based on free markets and personal liberty performs better than one based on central planning and government compulsion. We now know also that a market economy and free people are remarkably resilient in the face of a severe shock. We hope that all of the new security precautions will thwart future terrorist attacks in the United States. But whatever the future may bring, we can be confident of our nation's capacity to weather the storm.
William Poole, President and CEO | Charles W. Mueller, Chairman
Thank You
We would like to express our deepest gratitude to those members of our Eighth
District boards of directors who retired in 2001. For their distinguished service,
our appreciation and best wishes go out to:
Roger Reynolds, chairman of the Louisville Board; Orson Oliver and Edwin K.
Page, Louisville Board members; John C. Kelley Jr., Memphis Board member; and
Thomas H. Jacobsen, St. Louis Board member. We also thank Katie S. Winchester,
who served as our District's Federal Advisory Council member.
Walter L. Metcalfe Jr., Deputy Chairman
Chairman
Bryan Cave LLP
St. Louis, Missouri
Charles W. Mueller, Chairman
Chairman and CEO
Ameren Corporation
St. Louis, Missouri
Robert L. Johnson
Chairman and CEO
Johnson Bryce Inc.
Memphis, Tennessee
Bradley W. Small
President and CEO
The Farmers and Merchants
National Bank
Nashville, Illinois
Lunsford W. Bridges
President and CEO
Metropolitan National Bank
Little Rock, Arkansas
Joseph E. Gliessner Jr.
Executive Director
New Directions
Housing Corporation
Louisville, Kentucky
Lewis F. Mallory Jr.
Chairman and CEO
National Bank of Commerce
Starkville, Mississippi
Gayle P.W. Jackson
Managing Director
FondElec Group Inc.
St. Louis, Missouri
Bert Greenwalt
Partner
Greenwalt Company
Hazen, Arkansas
A. Rogers Yarnell II, Chairman
President
Yarnell Ice Cream Co. Inc.
Searcy, Arkansas
Everett Tucker III
Chairman
Moses Tucker Real Estate Inc.
Little Rock, Arkansas
Cynthia J. Brinkley
President
Arkansas Southwestern Bell Telephone Company
Little Rock, Arkansas
David R. Estes
President and CEO
First State Bank
Lonoke, Arkansas
Raymond E. Skelton
Regional President
U.S. Bank
Little Rock, Arkansas
Lawrence A. Davis Jr.
Chancellor
University of Arkansas
at Pine Bluff
Pine Bluff, Arkansas
Vick M. Crawley
Plant Manager
Baxter Healthcare Corporation
Mountain Home, Arkansas
J. Stephen Barger
Chairman
Executive Secretary-Treasurer
Kentucky State District
Council of Carpenters
Frankfort, Kentucky
Thomas W. Smith
President and CEO
Ephraim McDowell Health
Danville, Kentucky
Marjorie Z. Soyugenc
Executive Director and CEO
Welborn Foundation
Evansville, Indiana
Cornelius A. Martin
President and CEO
Martin Management Group
Bowling Green, Kentucky
David H. Brooks
Chairman and CEO
Stock Yards Bank & Trust Co.
Louisville, Kentucky
Norman E. Pfau Jr.
President and CEO
Geo. Pfau's Sons Company Inc.
Jeffersonville, Indiana
Frank J. Nichols
Chairman, President and CEO
Community Financial Services Inc.
Benton, Kentucky
Russell Gwatney, Chairman
President
Gwatney Companies
Memphis, Tennessee
Tom A. Wright
Chairman, President and CEO
Enterprise National Bank
Memphis, Tennessee
Walter L. Morris Jr.
President
H&M Lumber Co. Inc.
West Helena, Arkansas
Mike P. Sturdivant Jr.
Partner
Due West
Glendora, Mississippi
James A. England
Chairman, President and CEO
Decatur County Bank
Decaturville, Tennessee
Gregory M. Duckett
Senior Vice President and Corporate Counsel
Baptist Memorial Health Care Corporation
Memphis, Tennessee
E.C. Neelly III
Management Consultant
First American National Bank
Iuka, Mississippi
David W. Kemper
Chairman, President and CEO
Commerce Bancshares Inc.
St. Louis, Missouri
Paul Combs
Vice President
Baker Implement Company
Kennett, Missouri
Robert A. Cunningham
Valley Farms
Bigbee Valley, Mississippi
Robert Seidenstricker
Hazen, Arkansas
Joseph H. Spalding
Lebanon, Kentucky
Gerald W. Clapp Jr.
President/Owner
Clapp Oldsmobile
Clarksville, Indiana
William D. Crawley
President
Southern Sales & Service
Memphis, Tennessee
Chris Krehmeyer
Executive Director
Beyond Housing
St. Louis, Missouri
Dennis Ott
President/Owner
Dennis Ott and
Company Inc.
Clarksville, Indiana
Ann Ross
Ann's Business Consulting
St. Louis,Missouri
William Poole
President and Chief
Executive Officer
W. LeGrande Rives
First Vice President and Chief Operating Officer
Karl W. Ashman
Senior Vice President
Henry Bourgaux
Senior Vice President
Joan P. Cronin
Senior Vice President
Mary H. Karr
Senior Vice President, General Counsel and Secretary
Robert H. Rasche
Senior Vice President and Director of Research
David A. Sapenaro
Senior Vice President
Richard G. Anderson
Vice President
John P. Baumgartner
Vice President
John W. Block Jr.
Vice President
Timothy A. Bosch
Vice President
Timothy C. Brown
Vice President
Ronald L. Byrne
Vice President
Marilyn K. Corona
Vice President
Cletus C. Coughlin
Vice President
Judith A. Courtney
Vice President
William T. Gavin
Vice President
R. Alton Gilbert
Vice President
Jean M. Lovati
Vice President
Jeffrey L. Miller
Vice President
Michael J. Mueller
Vice President
Kim D. Nelson
Vice President
Michael D. Renfro
Vice President and General Auditor
Steven N. Silvey
Vice President
Randall C. Sumner
Vice President and Assistant Secretary
Daniel L. Thornton
Vice President
Dennis W. Blase
Assistant Vice President
Daniel P. Brennan
Assistant Vice President
James B. Bullard
Assistant Vice President
Martin J. Coleman
Assistant Vice President
Susan K. Curry
Assistant Vice President
Hillary B. Debenport
Assistant Vice President
Michael W. DeClue
Assistant Vice President
Elizabeth A. Hayes
Assistant Vice President
Edward A. Hopkins
Assistant Vice President
Patricia A. Marshall
Assistant Vice President, Assistant Counsel and Assistant Secretary
Jerome J. McGunnigle
Assistant Vice President
John M. Mitchell
Assistant Vice President
John W. Mitchell
Assistant Vice President
Kathleen O'Neill Paese
Assistant Vice President
Frances E. Sibley
Assistant Vice President
Harold E. Slingerland
Assistant Vice President
Leisa J. Spalding
Assistant Vice President and Assistant General Auditor
Jeffrey L. Wann
Assistant Vice President
David C. Wheelock
Assistant Vice President
Carl K. Anderson
Supervisory Officer
Barkley Bailey
Supervisory Officer
Diane B. Camerlo
Assistant Counsel
Michael J. Dueker
Research Officer
Joseph C. Elstner
Public Affairs Officer
Paul M. Helmich
Operations Officer
Joel H. James
Bank Relations Officer
Gary J. Juelich
Supervisory Officer
Visweswara R. Kaza
Operations Officer
Vicki L. Kosydor
Information Technology Officer
Raymond McIntyre
Facilities Officer
Christopher J. Neely
Research Officer
Patricia S. Pollard
Research Officer
Kathy A. Schildknecht
Operations Officer
Philip G. Schlueter
Information Technology Officer
Harriet Siering
Operations Officer
Diane A. Smith
Information Technology Officer
Mark D. Vaughan
Supervisory Officer
Howard J. Wall
Research Officer
Sharon N. Williamson
Human Resources Officer
Glenda J. Wilson
Community Affairs Officer
Robert A. Hopkins
Vice President and
Branch Manager
William D. Little
Assistant Vice President
Todd J. Purdy
Assistant Vice President
Thomas A. Boone
Vice President and
Branch Manager
V. Gerard Mattingly
Assistant Vice President
James E. Stephens
Operations Officer
Martha Perine Beard
Vice President and Branch Manager
J. Allen Brown
Assistant Vice President
John G. Holmes
Assistant Vice President
Summary of Key Operation Statistics for Services Provided to Depository Institutions and the U.S. Treasury
Government Checks Processed: 2001: 28,046,000; 2000: 21,625,000
Postal Money Orders Processed: 2001:229,427,000; 2000:230,133,000
Commercial Checks Processed: 2001:1,168,406,000; 2000:1,087,336,000
ACH Commercial Items Originated: 2001:116,041; 2000:167,204
Currency Processed: 2001:1,101,922,000 1,074,327,000
Funds Transfers: 2001:4,884,980; 2000:4,814,815
Loans to Depository Institutions: 2001:205; 2000:801
Transfer of Government Securities 116,206; 2000:126,077
Food Coupons Destroyed: 2001: 21,039,000; 2000:18,783,000
Government Checks Processed: 2001: $22,710; 2000: $20,151
Postal Money Orders Processed: 2001: $30,461; 2000: $30,036
Commercial Checks Processed: 2001: $623,454; 2000: $547,758
ACH Commercial Items Originated: 2001: $254,231; 2000: $302,412
Currency Processed: 2001: $16,070; 2000: $16,407
Funds Transfers: 2001: $3,542,873; 2000: $3,597,950
Loans to Depository Institutions: 2001: $3,299; 2000: $1,690
Transfer of Government Securities: 2001: $625,845; 2000: $768,228
Food Coupons Destroyed: 2001: $104; 2000: $95
Contributors: Robert H. Rasche, R. Alton Gilbert,
Kevin L. Kliesen and David C. Wheelock
Editor: Stephen Greene
Designers: Joni Williams, Brian Ebert
Production: Barbara Passiglia, Mark Kunzelmann
Photography: Boards of directors,
president and cover–Steve Smith Studios
This annual report is also available on the
Federal Reserve Bank of St. Louis
web site at www.stls.frb.org.
For additional print copies, contact
Public Affairs Department
Federal Reserve Bank of St. Louis
411 Locust Street
St. Louis, Missouri 63102
(314) 444-8809
Federal Reserve Bank of St. Louis
411 Locust Street
St. Louis, Missouri 63102
(314) 444-8444
Little Rock Branch
325 West Capitol Avenue
Little Rock, Arkansas 72201
(501) 324-8300
Louisville Branch
410 South Fifth Street
Louisville, Kentucky 40202
(502) 568-9200
Memphis Branch
200 North Main Street
Memphis, Tennessee 38102
(901) 523-7171
The Federal Reserve Bank of St. Louis is one of 12 regional Reserve banks, which together with the Board of Governors make up the nation's central bank. The Fed carries out U.S. monetary policy, regulates certain depository institutions, provides wholesale-priced services to banks and acts as fiscal agent for the U.S. Treasury. The St. Louis Fed serves the Eighth Federal Reserve District, which includes all of Arkansas, eastern Missouri, southern Indiana, southern Illinois, western Kentucky, western Tennessee and northern Mississippi. Branch offices are located in Little Rock, Louisville and Memphis.