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A quick look backward & forward, 1950-2000.

This paper sketches economic events and policies of the past four decades and ventures a forward glimpse at the 1990s. The Federal Reserve's role and performance receive special attention. The 1950s and early 1960s witnessed success in generating growth with price stability. In the late 1960s and early 1970s, Vietnam and the first oil shock (1973) created inflationary forces with which successive Administrations and the Fed coped half-heartedly, but the

second oil shock (1979) and a sharply declining dollar jolted the Fed into a tough and eventually successful anti-inflation stance in 1979-82. The 1980s saw the country's longest peacetime expansion, but the financial system weakened severely through excessive leveraging and imprudent investing. The required restoration and the necessity for increased international policy coordination are key challenges for the 1990s.

THIS HISTORY OF the past four decades is outrageously selective and idiosyncratic. To compound the felony, there will also be some crystal-ball gazing at the next decade.

THE 1950s

Our story starts out with a bang, the Treasury-Federal Reserve Accord of 1951. Prices of government securities had remained virtually stable throughout the early post-World War 11 years after having been fixed for the duration of the war by Federal Reserve action to aid in the financing of the war. Yields on Treasuries ranged from 3/8 of 1 percent for short bills to 2 1/2 percent for long bonds. (The Fed's discount rate was 1 1/2 percent!)

The Federal Reserve had grown increasingly restive in these early postwar years. Wartime-generated liquidity plus heavy additions in 1945-50 led to inflation, in sharp contrast to the much-feared return to prewar stagnation. With the Korean War becoming an obvious aggravation of inflation, the case for restoring flexibility, to monetary policy was overwhelming. The Fed's future chairman, Bill Martin, then an Assistant Secretary of the Treasury, skillfully persuaded a very reluctant President Truman (through Treasury Secretary Snyder, Truman's close friend) that variability of Treasury securities prices was the lesser evil compared with major inflation, and the Treasury-Federal Reserve Accord was struck in March 1951.

The consequences of restoring an active role for monetary policy were certainly beneficial for the country. Economic growth was good and inflation tamed for the remainder of the 1950s, except for the flareup in connection with the Korean War. The Fed was aided, to be sure, by the conservative fiscal policy of the Eisenhower administration (the only two budget surpluses of time postwar era!).

Still, there were shadows. The chief one no doubt was the frequent recurrence of recessions, beginning in 1948-49 and continuing in 1953-54 and again in 1957-58. No one could really explain recessions, and there was a constant and much-discussed fear that the Big One, a la 1929-32, might come back. Under the overwhelming influence of Keynesianism, much of the blame was laid upon fiscal policy, although the Federal Reserve began to make a good scapegoat.

I was convinced then, and remain so to this day, that there is a clash between price stability and full employment that very few in the public arena ever care to address squarely,. In the late 1950s, Charles Schultze began to make his truly deserved excellent reputation by studies of the cost push ("Recent Inflation in the U.S.," joint Economic Committee (JEC) Study Paper #1, Washington, D.C. 1959). In a world dominated by the U.S. on the outside, and heavily influenced at home by politically powerful heavy-industry unions, their wage demands tended to outstrip productivity before full employment was reached, and wage pressure then spread throughout the economy. This clash forced the Fed to make an unpleasant choice between inflation and full employment, but the need for such a choice was not widely acknowledged in Washington. Liberal economists and politicians, sensing the truth but unwilling to face the dilemma squarely, sought an answer in government intervention, i.e., an incomes policy. (In more recent years, the big industrial unions and oligopolistic producers have lost power in an economy open to foreign competition, but the dilemma continues. Services are more important now, and many of the domestic ones, such as hospital, education and civil service work, still have unions that force up wages before full employment is reached.)

The 1960s

At our speed of travel, that brings us to the 1960s, but a decade-by-decade account of history does not work for the 1960s. Instead, the first half of the decade is, in effect, a continuation - perhaps culmination - of the 1950s, while the second half became a prelude to the 1970s. The Vietnam escalation starting in 1965 made the difference.

When John F. Kennedy campaigned in 1960 on the slogan of "getting the country going again," the recession of 1960-61 was the fourth in twelve years. That recession, however, was a turning point in demonstrating the inflation-curbing power of fairly substantial and prolonged unemployment. It would not have been so had the Kennedy Administration not turned out to be quite conservative, unwilling to take chances on an early rekindling of the cost-push inflation of the 1950s. Recognizing, however, that the inflation cure was painful, the search for alternatives led to a combination of jawbone incomes policy with a slow-to-be-fulfilled promise of a fiscal stimulus in the form of the 1964 (post-Kennedy) tax cut.

As these policies finally bore fruit in virtually inflation-free, near-full employment in late 1964-early 1965, the postwar heyday of faith in economic policy was reached. In his Godkin lectures at Harvard, entitled New Dimensions of Political Economy (Harvard University Press, 1966), Chairman of the CEA Walter Heller virtually promised that cyclical disturbances would be sharply diminished as we had learned how to manage the economy.

It was clear to some, however, and particularly so at the Federal Reserve, that each further step toward full employment rendered the wage restraint of admonitions less effective and the recurrence of inflation more likely. Prevalent political phraseology, e.g., that 4 percent unemployment was only an "interim goal" on the road toward full employment, didn't help. At any rate, by mid-1965, even before Vietnam escalated, the Fed was already worried about inflation again. It must be a source of eternal regret that reasonably full employment with price stability, attained gradually and cautiously, without forcing the issue, did not prevail long enough - perhaps and possibly - to improve the terms of this trade-off permanently.

One indication of the conservatism of the Kennedy Administration was the resumption of official U. S. foreign exchange operations in 1961, a process in which I was directly involved at the New York Fed and the U.S. Treasury. The Bretton Woods system of fixed exchange rates, to which U.S. officials were totally committed, was coming under some pressure as European reconstruction neared completion, the international markets were becoming very competitive, and the U.S. had a hangover from the late-1950s inflation. While foreign countries maintained their exchange rates by buying and selling U.S. dollars officially, the U.S. maintained parity by standing ready to sell gold against dollars to official foreigners at $35 an ounce. By 1960, foreign gold orders began to appear with some frequency on the overseas wires of the New York Fed, causing consternation: Why should nonearning gold be preferable to U.S. government securities? You might stop or curb this demand without impairing our gold convertibility commitment if we had foreign currency to sell before the dollar reached its lower support levels against leading foreign currencies.

Robert Roosa, Undersecretary of the Treasury, and Charles Coombs, Vice President in charge of the Foreign Department of the New York Fed, drew up a battle plan for official exchange operations. I served as the provider both of historical research and of what we hoped were conclusive arguments in favor of the operations for use at the White House and on Capitol Hill. We said then that such operations cannot substitute for appropriate domestic policy in maintaining the exchange rate, but can curb speculation against the dollar. We say the same now, except for acknowledging much more plainly that international coordination of domestic policies is the key to exchange rate stability; of course, the exchange rate itself has become one of the variables in policy. Making a suggestion along those lines was regarded a heresy until the Nixon administration closed the gold window in 1971.

At any rate, all of us now know what happened after 1965 to the tranquility of the early 1960s. Vietnam escalation by stealth undermined internal price stability and, eventually, external dollar stability. The secrecy and dissimulation of the Johnson Administration and the President's determination to bring home the bacon, in spite of his inability to enlist domestic and international support for the cause, eventually disillusioned everyone.

One of the minor but important side effects of this conflict was that it facilitated the rise of monetarism. Federal Reserve restraint was insufficient to offset the defense stimulus, and the Administration and Congress were recalcitrant in raising additional revenue. The Fed was partly kept in the dark, partly assaulted politically when it raised interest rates. As inflation took a grip again it became child's play to assert that quantitative restraint rather than interest rate policy should dominate central banking. In 1966, the monetary aggregates crept into Federal Reserve policy, although initially only by the backdoor of internal studies and discussion. Thus, Milton Friedman's cleverness and persistence paid off as and when Fed interest-rate gradualism no longer gave desirable results. (The "pre-money supply" aggregate observed but not targeted by the Fed was bank credit. Broader credit concepts, such as total flow-of-funds credit, were also used and judgmentally followed. It was not until 1970 that "money" became a regular companion of "bank credit" in the operational clauses of FOMC directives, a change that can be traced by comparing the directives for 1969 and 1970 in the Board of Governors Annual Report for these two years. Even so, these concepts were referenced rather than targeted.)

I myself thought then, and now, that interest rate moves sufficient to curb excess demand were available and should be undertaken, in which case money supply restraint would follow. This oversimplifies the problem, both politically and substantively: politically because emphasizing the need for money supply control apparently makes it easier for politicians to swallow high and rising interest rates, as against pushing for such rates directly. This was proved in 1979-82 when the Fed temporarily switched to monetarism and declared a prime rate of 20 percent plus virtually a by product.

On the substantive side, one has to admit that the linkage between money supply and interest rates is not very tight, especially because the demand for money, however defined, is not stable over the cycle and during structural changes such as happened in the 1980s. (The point is pursued in the section on that decade.) Thus, it could be argued in early 1991 that, regardless of how many times the Fed funds rate is pushed down, the Fed will not have eased sufficiently, or achieved its aims in easing, unless the aggregates start rising strongly. (In fact, Fed Chairman Greenspan virtually adopted this argument in Congressional testimony in January 1991, leading to rumors that Fed operating procedures would once again switch toward emphasis on the aggregates.) The simpler (and my own) conclusion is that both types of indicators have to be observed and taken into account. Neither one by itself holds the key to correct policy throughout.

THE 1970s

Our mad dash through history takes us into the 1970s, which surely must be termed the decade of inflation.

Naturally, there is more than enough blame to go around. First there was the corrosive effect of Vietnam-induced budget and balance of payments deficits, which by 1973 resulted in a floating dollar. The introduction of exchange rate instability to the U.S. also brought home the possibility that rising import prices might contribute to domestic inflation, which had previously struck many as an exotic notion; in fact, it would not become fully accepted until the late 1980s.

Next in placing blame, there were the two oil shocks of 1973 and 1979. The pervasive influence of energy costs in a modern economy was amply demonstrated, and the model builders had a field day in estimating near-term and ultimate repercussions of oil shocks on business conditions and the general price level.

There were also several indirect effects of the oil shocks that are felt to this day. The first indirect effect was the deleterious influence on productivity of a major shift in the relative cost of inputs. This effect dampened potential output and income growth in the U. S. It was reinforced by a second one, the substantial transfer of real purchasing power to oil-producing countries, which again made us less well-off for any given amount of economic effort. The third and most deplorable indirect effect of the oil problem was to provide a scapegoat for the poor performance of economic policy in coping with the unpleasant consequences of the price shocks. President Carter's ineffectual attempts to divert public wrath from himself in the 1980 presidential campaign was just one facet of our unwillingness to take a hit without flinching.

Another facet was the habitual overshoot of its own aggregate targets by the Fed under Arthur Burns and G. William Miller. By the mid-1970s, the Fed had adopted "target ranges" for various aggregates. When the "overshoots" occurred, Burns and Miller would typically plead that forcing down future growth rates to conform with earlier targets would put the economy through the wringer without a good cause. This may have been true, but they did not try hard enough to stay within the target ranges while the period in question was ongoing. The excuse was that the aggregates were not fully controllable, which also was true, but which in the absence of an underlying policy bias should have led to roughly equal "undershoots" and "overshoots." The aggregate targets were not taken seriously, I'd contend, until elevated to top rank in the October 1979 switch in operational procedures initiated by the then-new chairman Paul Volcker, to avert an imminent loss of credibility by the Federal Reserve.

Meanwhile and in addition, no one wished to concede that OPEC members had a valid point when they argued that their terms of trade had deteriorated prior to the oil shocks, because the dollar price of oil had not kept up with the dollar prices of U.S. and European manufactured goods. Perhaps 1973 and 1979 would have happened anyway, but surely it should be granted that U.S. inflation is not our own exclusive national concern. Domestic mistakes can be punished by a kick from abroad.

At any rate, wherever the basic responsibility lay, a watershed was reached in the 1970s with respect to inflation. We became reluctant believers in the possibility of continued substantial inflation and consequently saw the need to adapt. There were those of us who fought as a matter of principle against public acceptance of inflation as a way of life. Strangely or not so strangely, the hardest fighters were those who came from the old country men like Henry Wallich, Henry Kaufman, and myself. In an ancillary role, I assisted during my term as president of NABE as the chairman of NABE's Anti-inflation Committee, and by helping to prepare an insurance industry-sponsored study entitled Inflation and National Survival (Academy of Political Science, New York, 1979), with which we hoped to influence public opinion. No doubt the stories told by our parents about the social and economic disaster of Germany's Great Inflation, 1923-24, had something to do with our views.

Meanwhile, the fact of the matter was that the inflation rate continued to vary but that each successive peak and each successive trough was higher than the previous ones, culminating in three years of double-digit inflation, 1979-81. The U.S. financial system was stretched to the breaking point even then, and the seeds of today's troubles were sown.

I had joined private industry in 1967 and was concentrating on helping Equitable adapt to inflation even while fighting it. The disintermediation episodes of 1969-70 and 1973-74 drained policy reserves out of the life insurance industry, and my studies (including some small-scale model building) convinced me of a heiglitened degree of interest sensitivity of the public. Inflation consciousness and the distinction between nominal and real interest rates became pervasive, as shown also by the sudden flourishing of money market funds while depository rates were still regulated.

On the investment side of our business, I helped bring about a drastic shortening of average maturities of bond and mortgage investments, both to strengthen cash flow and to avoid being stuck with interest rates that were falling behind the upward ratchet of inflation. We never reached the stage of fully indexing principal and interest of our loans, because borrowers could not stand the risk.

I also helped open the floodgates to investment-oriented insurance products by assisting in the invention and promotion of variable life insurance (VLI). The original idea of VLI was simplicity itself. Stocks will outperform bonds over the longer term. If you can stand the great volatility of stocks, your policy reserves invested in stocks will do better than in bonds or mortgages. If you have a lifetime's horizon, as many purchasers of life insurance do, you can go for the better investment returns of equities.

As you know, this trend has been extended to include products like universal life and single-premium deferred annuities, through which you can nowadays get a flow through of investment results in fixed-rate instruments, together with reasonable assurance of obtaining current interest rates throughout. Such insurance policies resemble pure financial investments quite closely and therefore have the potential of changing the very character of a life insurance company toward money management and away from protection per se.

All this time, we were asking ourselves what might be happening to traditional long-term investment from both the creditor and the borrower's point of view. "How are public utilities going to be financed?" was a typical question in life insurance association committee meetings. Too late, alas we had to compete in an environment of inflation anticipation and high interest rates. Nothing but a long period of price stability and low interest rates could have reversed the inflation defenses being erected. Certainly the attempts to maintain control of depository rates and of usury ceilings on lending rates were doomed. Washington, including the Federal Reserve, acted like King Canute, attempting to command the waves to recede. Yet, Washington itself had generated the wave of inflation that destroyed financial institution regulation as it had been known since the 1930s.

In particular, the Fed was extremely reluctant to go along with the liberalization and eventual virtual abandonment of interest rates ceilings on deposits. For a number of years in the late 1970s and early 1980s this policy favored large asset holders over small asset holders and contributed greatly to disintermediation into money market funds of hundreds of billions of dollars previously held at depository institutions. Even the Monetary Control Act of 1980, which provided for a phaseout of deposit ceilings, took half a decade to become fully effective. Futhermore, the Fed engaged in a futile exercise in the 1970s to subject money market funds to reserve requirements and other controls that would have put obstacles in the way of paying market rates to consumers. Similarly, the Fed for a time opposed selling directly to the public Treasury securities in denominations below $10,000. These policies might have been tenable in an environment in which high inflation and interest rates were a temporary aberration, but the Fed did not in fact achieve low inflation rates again until the mid-1980s. By that time market rates of interest on small holdings had, in effect, become a consumer right.

THE 1980s

That brings us to the 1980s, and naturally one has to be doubly careful with a period for which we are as yet lacking perspective. Nevertheless, I am reasonably sure that history will describe the decade in terms of extremes of positive and negative economic events. By my particular vision, the positives carry the day for the decade as a whole but I sympathize with the contrary view because the negatives are currently shown to have been monumental.

The positives consist overwhelmingly of the rewards of internationalism. Few people realize, unless reminded, that exports and imports have roughly doubled in their role in U.S. GNP within the past twenty years. All of us, however, are aware of the benefits relatively free trade has brought consumers the world over. International price and quality competition has proved to be fully as meritorious as David Ricardo and his successor advocates of free trade have claimed. National producer and union power has been severely weakened in spite of the continuing rearguard struggle of protectionists. One may be equally enthusiastic about the free flow of capital, especially in New York City where the number of foreign financial establishments has gone from about 100 to over 400 in the past decade, providing much-needed employment to (among others) U. S. economists ! However, all of this would not yet convert the many negatives of the decade to a net positive were it not for the contribution of economic internationalism to the West's clear victory over Communism that became apparent toward the end of the 1980s. In effect, the Soviets and their Empire were outstripped in economic progress on either flank. In the East, the Pacific countries, primarily Japan but also South Korea and Southeast Asia, participated in a sustained exported boom, while in the West the European Economic community gained renewed momentum as a unified trade area moved toward reality in 1992. One could almost sense that the Soviets were throwing in the towel as they abandoned their corrupt satellite surrogates.

This victory, however, Will have mixed consequences to which I shall return when we transition to the 1990s. To anticipate, the problem is the cost of reintegrating the East into a world trading system.

Now let's turn to the domestic story of the 1980s, which we should begin with a salute to the Federal Reserve, and especially to Paul Voleker, for ending the upward spiral of inflation. In effect, the recessions of 1980 and 1981-82 made possible the longest-ever peacetime expansion of the years 1983-90. Never mind that the Fed sailed under the banner of monetarism in 1979-82 and reverted to federal funds pragmatism after late 1982. You don't even have to be cynically results-oriented to applaud.

The fact is that the painfully researched and endlessly argued-about quantitative relationships of monetary aggregates to intermediate targets and to GNP of previous decades no longer held in the 1980s. Any version of monetarism became an unreliable guide to policy. The Federal Reserve Bank of New York has done a thorough study of this subject in a book Intermediate Targets and Indicators for Monetary Policy: A Critical Survey, N.Y., 1990.

The summary by Richard Davis - published in the book and in the New York Fed's Quarterly Review, Summer 1990, shows, through charts and correlations statistics, the drastic deterioration during the 1980s in the closeness of the fit between six monetary aggregates and money GNP. The R2s go from 0.25-0.35 for 1960-79 to virtually zero in the 1980s.)

What then are the negatives of the 1980s for which history will hold us responsible? First and foremost, there is the outright perversion of the concept of conservatism. Fiscal responsibility was abandoned; supply side economics was a mere rationalization of dangerously large tax cuts - a weak excuse that was increasingly exposed as such when full employment was restored in the mid-1980s while the deficits continued. In addition, a large defense buildup was again falsely represented as not requiring a diversion of resources from other uses, which puts the Reagan administration in the same league with Lyndon Johnson's Vietnam story. just read Ben Friedman's Day of Reckoning (Random House, 1988) for a thorough account. Neither Republicans nor Democrats currently offer the country a coherent budgetary philosophy; GrammRudman and similar mechanics are a poor substitute for an acceptable principle. Yearly debates about and changes in the tax code damage the economy by increasing the uncertainty inherent in all private economic decisions. Economists are not doing well either, but I stick to the full-employment balanced budget as a reasonable guide.

Among the studies we should undertake in a further dissection of the relation between fiscal and monetary policy. For now, I maintain the hypothesis that budget deficits had something to do with high nominal and real interest rates in the 1980s. These rates brought in foreign capital to help finance our budget and private savings deficits. However, they also helped aggravate the developing thrift institution problem and, most likely, added to the incentive to substitute debt for equity on private balance sheets because the tax deductions for interest became relatively more attractive than incurring the future cost of nondeductible dividends. Unquestionably, there were other factors contributing to the corporate restructuring binge, but if my reasoning on the increased attractiveness of tax-deductible debt is correct, the budget deficits of the 1980s will be shown to have contributed to private excesses we now deplore.

We are now grimly aware that financial institutions in general on the asset side began to chase returns higher than the elevated cost of investible funds they were incurring on the liability side. This chase degenerated into greedy irresponsibility in the case of many S&Ls. In other cases, such as the upcreep in junk bond holdings of institutional investors, line operators simply felt they had to go for a piece of the action for competitive reasons. As I read about and listened personally to some of the ambitious real estate, M&A and LBO proposals that abounded, thinking that we'd find out soon enough if they were too good to be true, I didn't explain or dramatize sufficiently how painful the adjustment might be. Who wants to be Cassandra? But I admit to regrets anyway. There is a big bill to be paid in the 1990s, even if Alan Greenspan is right in saying that the restructurings of the 1980s on balance improved the efficiency of the U. S. economy. (It helps to read Barbarians at the Gate by Burrough and Helyar, Harper & Row, 1990, and The Money Game, Dutton, 1990 by Ray C. Smith). At any rate, I recommend workout specialist as a top employment opportunity for at least the first half of the 1990s ! THE 1990s

On this note, we slide into a brief forecast for the 1990s. Naturally, this will be a bit different from your usual focus on 1991, because we are here taking matters a decade at a time.

Nevertheless, I should probably begin by referring to the current recession as likely to be of average duration and severity - over in about a year with a peak-to-trough decline in real GNP of perhaps 2 1/2 percent.

Turning now to longer-term questions, there are many reasons to be uneasy about the pace of real economic growth in the 1990s. Much of the total gain in the 1980s occurred only because of growing labor force participation; per capita income gain has been marginal the past fifteen years. Low productivity growth is the basic reason, and that in turn is related to low savings and investment rates, plus grave and possibly increasing educational deficiencies in the labor force. Recognition of these problems is proceeding at a glacial pace, and so is counteraction. Therefore, below-postwar-average gains in real output will most likely continue in the 1990s in this country; other countries may do better, which should be a spur to ourselves.

In addition, there is legitimate concern about the true meaning of real GNP and income growth in view of environmental despoliation. The time is ripe in the 1990s for that problem to be taken seriously in measurement and in theory. It is especially important for economists to do so lest we become dinosaurs in equating GNP growth with human welfare.

At the moment, we count polluting activity as a positive contribution to GNP. The subtraction from welfare through, say, air pollution in the Los Angeles basin is neglected. Then, if an environmental cleanup does happen, that endeavor again becomes a contribution to GNP. Yet, nothing in this combined activity enhances welfare a single bit beyond what it was before the initial pollution took place. As the cost of the environmental cleanup advances from a current 2 percent of GNP toward a likely 3 percent by the end of the decade, we should as a minimum bring these costs out of the Commerce Department's closet and emphasize that there is a difference between GNP and welfare, an issue currently debated by the international statistical community.

(U.S. Department of Commerce, "The U.N. System of National Accounts," Survey of Current Business, June 1990.) Naturally, this doctrine is more readily acceptable to politicians and the public in a full-employment situation than during a recession. "Welfare" as used in relation to environmental concerns must be understood as a concept independent of, or standardized for, any given level of aggregate economic activity.

Next, we should be prepared for continued high real interest rates as large parts of the East seek reintegration into the world economy and require large capital investment. I would not be surprised to see a Marshall Plan for Eastern countries, with perhaps half the burden each falling on the U.S. and on the non-U.S. OECD countries. Such a plan is only partly an expression of humanitarian concern. The key question is whether we can stand (or prevent) a mass migration to the West unless we are prepared to help Easterners in their home countries.

Finally, there is no end to further internationalization of economies, finance, and economic policy. A central bank for Europe is likely. It is expected to be strongly anti-inflationary, and policy coordination with that entity will become a necessity for the U. S. This development and Japan's aversion to inflation strongly suggest that our inflation record will have to improve if the dollar's international role is to be preserved. Coordination is also necessary to prevent the international spread of recessions, e.g., in being able to assume in early 1991 that Germany and Japan will avoid interest rate escalation while we are reducing ours. These brief hints scarcely scratch the surface of the Fed's probably major macroeconomic question of the 1990s. To avoid increased interest and exchange rate volatility under free trade and capital movements, monetary and fiscal policies will have to be not only better coordinated but most likely also more uniform among the major players, as has already happened within Europe. (These issues become clear in the discussion section of the Brookings "Symposium on Europe 1992," Brookings Papers in Economic Activity #2, Washington, 1989).

Meanwhile, the progress of internationalization also suggests that consumer choice in price and quality will continue to be enhanced, and technological progress will surely be helpful again in the 1990s. One of the true wild cards is the degree of evolution of international universal financial institutions. The economic tendency in this direction will clash with strongly held national preferences to the contrary, as in the U.S.

There is a monumental restructuring ahead for the U. S. financial system. The functional distinction between commercial banks and thrifts has broken down and consolidation within and among these groups will be the order of the day in the 1990s. Geographic limitations on depository institutions are likely to have disappeared by the end of the decade.

A much less predictable evolution is ahead in the relationship between depository institutions, investment banking, brokerage and insurance. The advocates of commingling, led by the commercial banks, will be seriously handicapped by public reluctance to expose deposit insurance to additional risk and by the financial industry's general problem of capital inadequacy - a fallout of the mistakes of the 1980s that has to be substantially remedied before large U. S. banks can attract substantial equity for nonbank activities.

It is safe to assume that the Bank for International Settlements' agreed-upon capital ratios - a device for strengthening depositor protection without official funds - will be enforced by all leading financial countries, certainly so by the U.S. The Federal Reserve, including especially Paul Volcker personally, was a leader in decrying and seeking to remedy the excessive leverage of banks (aDd others) that developed in the 1970s and 1980s. It is also safe to assume that the 1990s will be a decade of strengthened supervision although perhaps not of regulation) of most types of financial institutions, including further international coordination of such supervision.

The one thing I'll never predict, nor have much patience for when listening, is that catastrophe is coming. Over the decades, economic and financial collapse toward the 1930s scene (or worse) has been forecast by extreme Keynesians, gold bugs, fervent antitax supply siders and assorted fearmongers. They neglect to account properly for the survival instinct. We may louse things up, but we have an overwhelming incentive and enough intelligence to fix matters before they get out of hand. There has been economic progress over the past four decades in spite of legitimate misgivings with respect to the past fifteen years. So, enjoy the 1990s; the end is not yet.
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Title Annotation:A Review of Federal Reserve Policy
Author:Schott, Francis H.
Publication:Business Economics
Date:Jul 1, 1991
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