The Region

Shared Responsibility

A smooth transition to the year 2000 is not only the responsibility of banks and federal regulators, but of consumers, too.

Cathy E. Minehan | President, Federal Reserve Bank of Boston

Published March 1, 1999  | March 1999 issue

If the Federal Reserve could instill just one message into the hearts and minds of the U.S. public about the upcoming century date change (or the so-called Y2K problem), it would be not to panic. Prepare, if you will, but keep your preparation in perspective. The financial industry and federal regulators have been working for more than two years to get ready for Jan. 1, 2000, and individual consumers and businesses now have an important role to play: Keep cool-an overreaction will only create new problems.

And this doesn't amount to a plea for blind faith. As the following brief discussion will show, the Fed and other agencies—as well as their counterparts in the private sector—have been thoroughly preparing for any problems that might occur. This doesn't mean that glitches won't occur. In fact, glitches occur every day in a wide variety of automated operations but they are normally addressed quickly and resolved. This is likely the case with Y2K. Reserve banks are becoming ever more confident that the systems we all depend on will work as well at the dawn of the new millennium as they do today. Indeed, independent Y2K experts have consistently rated the financial services industry as the best prepared for the year 2000.

Banking System Readiness

Reserve banks provide the critical backbone of payments and settlement in the United States, settling far better than $2 trillion every day. Thus, a critical aspect of banking system readiness is Reserve bank readiness. This is nearly complete. All mission critical systems—including those that carry all those payments—have been Y2K compatible and are in current production today. Over 12,000 depository institutions maintain electronic connections with Reserve banks; testing of these linkages began in June 1998 and so far has included most connected institutions.

As a banking regulator, the Federal Reserve System—along with the other members of the Federal Financial Institutions Examination Council (FFIEC)—has approached the Y2K problem in three phases. Phase I, completed in June 1998, emphasized awareness, assessment and renovation of banks' mission-critical systems. During Phase I, the Fed reviewed all institutions subject to its supervision. Phase II, to be completed in March of this year, emphasized renovation, testing and implementation of those mission-critical systems in Y2K ready versions, and included another round of reviews by Fed examiners. Preliminary reviews of internal testing systems suggest that banks supervised by the Fed are giving appropriately high levels of attention to Y2K issues.

In Phase III, which runs from April 1 through the early part of January 2000, the Fed and other FFIEC agencies will concentrate on evaluating the completion of the overall Y2K project, including the adequacy of each institution's contingency plans. Contingency plans will be in place to ensure that a given bank will be able to continue operations even in situations when significant problems occur.

Currency Demand

The Fed has announced that about $50 billion over current inventory levels will be available for excess demand. Also, the Fed has issued guidelines to financial institutions to help them plan for additional cash demand.

The central bank has been clear that having the extra cash on hand does not imply it believes such cash is required. The currency order does not reflect a recommendation by the Fed. The $50 billion figure was developed after reviewing a variety of data, including previous holiday demand, household spending patterns and possible international demand. Additional currency inventories could be increased if needed, but the real risk is not that consumers will lack access to cash. The real risk is that consumers may have access to more than is either necessary or wise and expose themselves unnecessarily to accidental loss or theft.

Macroeconomic Perspectives

The Fed has made numerous public pronouncements on the possible economic effects of the date changeover—many by Board Governor Edward W. Kelley, who oversees the System Y2K effort. While the Fed recognizes the broad range of possible outcomes, from minimal to serious, the central bank is again confident that there will be no major disruptions in economic activity. It is possible that if consumers and businesses store up supplies and inventory in the last part of 1999, that they will spend less on these items in the first part of 2000. This could result in an inventory cycle of mild proportions, but, a recession caused by the date changeover seems highly unlikely. This optimistic outlook is based on the continued diligent preparation of businesses and government offices.

The following are macroeconomic issues of note:

  • Congress has budgeted about $6 billion for Y2K readiness.
  • State governments continue to make progress.
  • About $50 billion may be expended in private sector remediation. Additionally, while productivity may suffer in the short run because of the effort and cost focused on the Y2K problem, the replacement of aging systems will not only benefit businesses in the long run, but also the software and computer companies that provide the products and services.
  • The net effect of remediation spending could reduce gross domestic product by one-tenth of a point over 1999 and 2000.
  • While no recession is expected, the Fed does offer the following caveat: Should problems be more widespread than expected, production disruptions could be great enough to set the economy back further than just one-tenth of a point.

Monetary Policy and the Fed

Finally, it's important to realize that monetary policy cannot do anything to head-off Y2K disruptions. As noted earlier, though, the Fed will be ready with extra currency and will be prepared to lend to financial institutions. Also, in the very unlikely event that Y2K disruptions result in longer-term effects on aggregate demand, the Fed would have an important role in reacting to such a downturn.

As the days pass this year, and scare stories appear in the media, it's important to remember how much preparation has gone into making sure that next New Year's Day is like any other. It is the Fed's expectation that the only "bugs" around that day will be from the party the night before and not from the millennium changeover.