Comments to the 2007 Business Leaders Luncheon

Gary H. Stern
President
Federal Reserve Bank of Minneapolis

Billings, Montana
August 9, 2007

Good afternoon. As President of the Federal Reserve Bank of Minneapolis, I regularly hear from the directors of our branch in Helena, who keep me informed of economic developments in Montana. All the same, I appreciate the opportunity to see for myself and meet face-to-face with business and community leaders at events like this. Through these meetings, the regional structure of the Federal Reserve System, with its 12 independent district banks and their regional branches, contributes to a healthy two-way flow of information between Federal Reserve officials and the American people, and in a few minutes I?ll come back to why that?s valuable. But, first, let me talk about the status of economic education in the United States. Although this may seem to be a completely different topic, I?ll explain why I see connections that are important to all of us.

Yesterday I had the privilege of making some remarks in Washington, D.C., as part of the official release of Nation?s Report Card on Economics. This Report Card is part of a series of similar assessments of elementary and secondary educational achievement that the U.S. Department of Education has conducted for many years in subjects like reading, mathematics, science, and more. However, they had never assessed economics education. That changed in 2006, when over 11,000 twelfth-grade students from 590 public and private schools nationwide were tested on their knowledge of how markets and national and international economies work.

I was happy to take part on the panel marking the release of the Report Card on economics education, for at least three reasons. First, I clearly think that economic knowledge, and hence economics education, are important. Although I am speaking only for myself and not for the Federal Reserve, I will argue that policymaking becomes easier and more effective the better the general public understands economics. Second, like many economists, I think that incentives, and thus accountability, matter. For that reason, I welcomed the Department of Education?s decision to extend its program of educational assessment to include economics.

Finally, and especially, I was pleased that the results of the assessment were better than I had expected. Seventy-nine percent of the students demonstrated at least a basic knowledge of high school economics, and 42 percent performed at a proficient level, including 3 percent who demonstrated advanced knowledge. The assessment also showed that most 12th graders get at least some economics education in high school. Sixteen percent said they?d had an advanced economics course, such as Advanced Placement (AP) economics, and an additional 49 percent had taken general economics. About a quarter of the students had taken a business course, a personal finance course, or a course, such as government, that included a unit in economics. Only 13 percent said they?d had no formal instruction in economics.

Of course, I still see ample room for improvement, and I hope to see even better marks in the next economics report card in 2012. I also hope that the disparities revealed in this Report Card in the achievement levels of students from different backgrounds will shrink and, before long, disappear. Nonetheless, as an economic policymaker, I was encouraged that even now a large majority of American high school seniors have at least a basic understanding of economic principles and that many have achieved a degree of proficiency in economic reasoning. That?s a good base to build on and a credit to the teachers, parents, and others who guide our nation?s youth.

Several of those leaders in economics education are in the room today. I?d particularly like to recognize one of them, our Helena Branch Manager, Sam Gane. You may know that Sam will be retiring soon, after a long and distinguished career with the Federal Reserve in Cleveland, Minneapolis, and Helena. What you may not know is that since 1999 Sam has been a member of the board of directors of the Montana Council on Economic Education and served as the board?s president from 2002 to 2004. At the Branch, he maintained a tradition of partnering with the Council to sponsor the Montana High School Economics Challenge, a statewide economics knowledge competition that completed its 12th year last February. Under Sam?s leadership, the Helena Branch and the Council also co-sponsored last year?s first ever Montana Economic Education Summit, and they are working together on next month?s second annual Summit in Helena as well. Sam, in addition to noting your many other contributions, I want to express a special ?thank you? for your leadership in economic education.

Sam?s upcoming retirement prompts me to make a few comments about our plans for the Helena Branch. First of all, the Branch will remain in good hands. We recently announced that Sam?s successor as Branch Manager will be Paul Drake, the current AVP at the Branch. Paul has a proven record of leadership, having worked closely with Sam for many years and having played a leading role in the difficult but necessary downsizing and restructuring of the Branch over the past two years.

This restructuring is part of an overall Federal Reserve System plan to bring our check processing business not only into the 21st century but also into the black. As one who has been very close to this effort, I can assure you that Helena was not singled out. Due to the rapid decline in the volume of paper checks since 1995, the Federal Reserve has reduced its check processing sites from 45 in 2003 to 19 by the end of this year, and we expect to be down to about 4 sites by 2010. As part of our ongoing national restructuring, we recently announced that check processing at the Federal Reserve Bank in Minneapolis, a large volume site, will be phased out as well, in the fourth quarter of 2009.

Although leaner than before, the Helena Branch will retain key functions in areas such as banking supervision, cash processing, and community outreach and economic education. In addition, the Branch will have a full slate of directors who will continue to play important roles in providing information on economic and banking conditions in Montana and helping us reach the people of the State. In other words, we are committed to maintaining the Branch?s role in the two-way flow of information that I mentioned earlier.

In this regard, I would like to take this opportunity to acknowledge and genuinely thank two Helena Branch directors who will be leaving the Board at the end of the year, namely Joy Ott and Larry Simkins. Thank you for your service, and for the quality of the information you brought to the ?table.? One of the strengths of policymaking in the Federal Reserve is the first-hand, timely economic intelligence provided by directors like Joy and Larry. Their information and anecdotes mean that we are not wholly captive of statistics published with a lag that necessarily provide a somewhat dated picture of business activity.

On that note, let me try to bring some of the strands of my remarks together by reviewing how the public?s understanding of economic principles contributes to good policymaking. As I have discussed at greater length in other contexts, enduring economic progress and prosperity depend on public institutions? ability to commit to policies that are optimal over the long haul, across the temporary ups and downs of the business cycle. In a democracy, such policy commitments can only be sustained with broad public support, and public support for good policies depends, in turn, on voters? competence in basic economic reasoning.

Tangible evidence of the connection between good policies and public understanding can be found in our experience with monetary policy during and after the 1970s. From 1973 to 1981, the U.S. economy experienced a period of sustained high inflation; consumer prices rose by about 9 percent per year, on average, over that period. These high inflation rates distorted economic decisions, hindered growth, pushed interest rates to record levels, and weakened our financial system. Adding to the problem was the widespread view that high inflation was here to stay, a ?fact of life? to be accepted and adjusted to. Today we know that this view was too pessimistic. Under Paul Volcker, the Federal Reserve made a commitment to get inflation down and keep it down. Chairman Volcker kept that commitment, and it has been unambiguously extended by his successors, Alan Greenspan and Ben Bernanke.

Although the Federal Reserve?s firm commitment to a policy of long-term low inflation was essential in this process, support from the public was just as critical. This was especially so during Chairman Volcker?s tenure, when the shift to a consistent anti-inflationary policy entailed painful adjustments for many consumers and businesses. Chairman Volcker?s public statements helped guide the public to a consensus that inflation hurts economic growth and thereby, over time, most citizens. Inflation has now been reasonably well contained for roughly two decades or so, and the firm consensus in favor of price stability has been sustained. One reason, I think, is that under Chairman Greenspan, the Federal Reserve took a series of steps in an effort to communicate more clearly with the public, including financial market participants, about its objectives and its policies. Chairman Bernanke has embraced and extended that effort. As a result, the public continues to understand the long-term benefits of low inflation and thus to support the Federal Reserve?s pursuit of this objective as one element of our dual mandate. I think this is an excellent example of the value of economic knowledge.

The Fed?s commitment to a low-inflation policy, and its increased emphasis on clearly communicating both that commitment and the decisions taken to implement it, are part of a world-wide trend. As explained in an essay by V.V. Chari and Patrick Kehoe in the Minneapolis Fed?s 2006 annual report, central banks around the world seem to have learned some of the key lessons of modern macroeconomic theory. This theory stresses that policymakers must always consider how their current policy choices will affect expectations of future policies. In a sense, this is an old lesson—that policymakers can?t say one thing and do another, and that actions speak louder that words. But modern macroeconomic theory has clarified how these adages specifically apply to monetary policy.

There is insufficient time this afternoon to review the arguments provided in the Annual Report in detail, and I do not want to try your patience excessively. By the way of summary, let me just say that, in effect, modern macroeconomic theory stresses the importance of a high degree of communication and mutual understanding between the central bank and the public. The central bank needs to convincingly convey to the public the substance and logic of a credible long-term commitment to low inflation. Credibility and transparency also require it to explain its other objectives, such as the maximum employment objective that is the second part of the dual mandate of the Federal Reserve.

From this perspective, the importance of economic education is clear. The public?s understanding of basic economic concepts and principles is vital to sustaining sound long-term policies in a democracy. Although citizens can come to a basic level of economic knowledge through many channels, high-quality elementary and secondary instruction in at least basic economic concepts is probably the most efficient and effective method for achieving widespread understanding.

The importance of clear communication about monetary policy also helps us understand some of the advantages of the Federal Reserve System?s regional structure of district banks and branches. On the one side, having directors, advisory councils, meetings like this, and other contacts in our districts (and outside of Washington D.C.) improves both the Federal Reserve?s understanding of economic conditions and the public?s views of our policies and of our credibility. On the other side, a regional presence helps us communicate the substance and rationale of our policy decisions effectively.

So far, I have focused on monetary policy and the benefits of an economically educated citizenry, but the benefits extend to other aspects of Federal Reserve responsibilities. Today we are witnessing some painful and belated learning, by policymakers and consumers alike, in our consumer financial markets. As you are probably well aware, consumers today have access to a wide array of borrowing and savings options. In itself, variety is good, because it expands opportunities and choice. However, variety also fosters complexity, which challenges both consumers in their decision making and financial regulators in their writing and enforcement of rules.

This is not the occasion to go into the details of how the Fed and the other financial regulators are responding, but I would like to use some simple economics to make a connection between financial regulation and economic education. In short, I view regulation aimed at protecting consumers and consumer education as substitutes. If consumers are more educated and able to make good decisions on their own, regulations can be narrower and more focused on clearly abusive practices such as deceit and fraud.

This is valuable, because as the scope of regulation widens, so does the cost. I?m not just referring to enforcement costs, which are high enough. More significant, in my view, are the extra compliance burdens that broad regulations impose on legitimate transactions and the opportunities forgone when legitimate potential transactions are prevented outright. Don?t get me wrong. In some cases it is necessary and appropriate that we bear these costs in order to prevent even greater abuses elsewhere. However, regulation involves a tradeoff between preventing harm to some and allowing innovation, gains from trade, and free choice for others. At any given time, we write our regulations as best we can to balance that trade off. Over time, however, we hope that better economic education will soften the trade off and allow us to rely more on consumers? informed decision making and less on broad, formal restrictions. I see the Economics Report Card that I discussed earlier as setting a good benchmark for measuring progress toward that goal.

I hope my remarks and the examples I have discussed highlight the importance of economic education to good policymaking. I, Sam Gane, and many other Federal Reserve staff are actively involved in supporting economic education. We know that clear communication about public policy and an economically well-educated public are crucial in sustaining good monetary and regulatory policies and, in turn, a prosperous economy. Thank you.

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