Mr Kelley remarks on the challenges of the Year 2000 computer problem  (Central Bank Articles and Speeches, 25 Mar 1999)
Central bank: fed | Type: speech | Date: 1999-03-25

## Mr Kelley remarks on the challenges of the Year 2000 computer problemRemarks by Mr Edward W Kelley, Jr, member of the Board of Governors of the US Federal Rese System, Owens Distinguished Lecture Series, Owens Graduate School of Management, Vanderbi University on 25 March 1999

## Thinking about Y2KI am delighted to be back on this campus again at the invitation of my old friend, Dr Dew who served before me as a governor of the Federal Reserve.

These are challenging times for e policymakers, and there are many issues currently facing our nation's central bank.

But at the list as a first priority is the Year 2000 computer problem, and that is our subject forRecently this topic has been receiving a great deal of attention and I'm sure that every familiar with the basic issue - specifically, that information generated by computers inaccurate, or that computers and electronic systems may malfunction because they cannot c process Year 2000 dates.

With that stipulation, I will dwell no further on the nature of itself, but rather attempt to focus on its likely economic impact.

The economic stakes potentially very large and the spectrum of possible outcomes potentially very broad, ran minimal to very serious.

For the truth of the matter is that this episode is unique: We re no previous experience with a challenge of this sort to give us reliable guideposts.Although the lack of a precedent may be unnerving, that certainly does not free us from the to attempt to analyze how the millennium bug is affecting and will affect the economy.

This puzzle has many complex pieces - some of them I fear quite inscrutable before the event task today is to assemble for you as coherent as possible a picture of where the Y2K proble likely to take us.

Please be forewarned that an assessment of this situation has a very shor conditions are evolving rapidly.

The good news is that they are evolving favorably, the b that the time remaining before the rollover date is passing by rapidly.Let me first turn to the reasons why Y2K has been so challenging.

Then I shall discuss the a are being taken by both the public and private sectors to deal with the millennium bug and these measures are having on economic activity at the present time.

Finally, I shall turn some trepidation, I might add - to an assessment of the spectrum of plausible outcomes millennium rollover as I see them.

As you will shortly hear, I believe the Y2K alarmists hav recognized the attention that is being given to this challenge and to the significant pr being made towards meeting it.

Given what we know today, I am cautiously but increas optimistic that the millennium bug will not cause major economic disruptions when it bites. quite confident that the financial system will be well prepared.Why was it so difficult for so long for people to come to terms with the Year 2000 proble most basic level of any organization - be it public or private, large or small - the Y2K p all too easy to ignore.

It is a hidden threat, cloaked in the arcane language of computer in embedded microchips.

As such, it was difficult at first for senior management in both and public sectors to recognize the serious nature of the problem.

This was compounded by that the costs and benefits of the solution for an individual operation were neither quantified nor very attractive.

But after an initial period of denial, organization leader States have now recognized the problem and are taking aggressive action to correct it.

No given the pervasiveness of the problems involved, I suspect that even the most thoroughly organizations are concerned that something significant might be missed.

Consequently, res and careful organizations are developing extensive contingency plans to work around any e problems as insurance against Y2K disruptions.

Thus, insecurity about the comprehensiven Y2K remediation efforts is affecting corporate investment and production plans now and wil into next year.The second feature of the millennium bug that makes it so difficult to analyze is the inter character of many computer systems.

An individual company may be satisfied that it has done al can to fix its own systems, but it may still feel vulnerable to the actions taken by its supp customers.

For example, what good would it do you to be perfectly ready if your electricity is o if the train bringing in tomorrow's production materials is delayed?

In an environment where 'ju time' inventory systems and electronic data interchanges have linked economic activities very cl together, one firm's failure has the potential to ripple through significant segments of the production, services, and distribution.

Thus, coordination of Y2K remediation activities would benefits for everyone.Of course, it is clearly impossible to coordinate the Y2K activities of millions of indi establishments.

To help fill this void, numerous organizations have emerged as clearinghouses information, and other institutions and consortiums are functioning as vehicles for system testi Federal Reserve, for instance, has established an extensive, separate and dedicated compu environment for the purpose of testing with its depository institution customers, and as we spe securities industry is undergoing a five-week long series of tests to assess its ability to business through its network of institutions.

Bank supervisors, including the Federal Reserve holding their banks accountable for the effectiveness of their Y2K efforts, and I can assure y there will be regulatory consequences for banks that do not fulfill their obligations.

But man organizations are on their own to test their critical systems with their key suppliers and customBecause this situation is ubiquitous, complex, and fragmented, it is a very difficult task to qua aggregate costs of Y2K remediation.

Similarly and perhaps more importantly, we also have n national scorecard on how effective our economy is being in our remediation efforts, and until recently very little national preparedness information at all.

Under these circumstances, it is to understand why the millennium bug is viewed as such as unpredictable phenomenon, and why it has attracted so much gloom and doom commentary.So, what is being done?

The short answer is a great deal is being done.

In January the Presid Commission on the Year 2000 issued the first of its promised quarterly assessments of the stat preparation in our country and internationally.

More recently we have had helpful assessments f the Congress and various security analysts.

From these and other sources, let me review for you understanding of the status of efforts by the private sector, government entities, and the community to deal with the Year 2000 problem.

As far as the private sector is concerned, effor deal with the millennium bug have been steadily intensifying and are now proceeding very rapidl think it is a good sign that in the last few days articles have been appearing in the business the numerous Y2K remediation boutiques which sprang up over the past two years are beginning to experience a slowdown in activity and are starting to look for other things to do.

In Congres testimony last spring, I suggested that the private sector might spend approximately $50 bi between 1998 and 2000 to tackle the Y2K problem.

This figure was based on research done by Fed economists and while our estimate of a '$50 billion bug' still seems to be reasonable, I do expe figure to move upward as we learn more throughout the year.I also perceive that the tools available to companies to address Y2K issues have increa substantially.

Over the past months, most major computer hardware and software companies have released documentation of the Y2K readiness of their products on their websites.

Similarly, mos the major computer publications now have elaborate 'how-to' guides on their web pages that will consumers and small businesses in their efforts to make their systems compliant.

Commercia software producers have also been busy, and new software products are available to aid programme in repairing code.

I hope and believe people are availing themselves of these new resources.As far as depository institutions are concerned, I am encouraged by the progress that has been over the past year, and there is every reason to be confident that our banking system will be Based on ongoing reviews of all depository institutions as completed by federal banking regulaagencies, the vast majority is making satisfactory progress in their Y2K planning and efforts.

Only a small percentage has been rated 'needs improvement' and well under 1% hav rated 'unsatisfactory'.

In these cases, the agencies have initiated intensive supervisor including restrictions on expansionary activities by deficient organizations.

For the rest the agencies will be continually revisiting any institutions identified as having problems, those identified as being key to systemic health.

While we can be confident institutions ar the problem, it is important to recognize that regulators cannot be responsible for e guaranteeing the Y2K readiness and viability of the banking organizations they supervise.

R board of directors and senior management of banks and other financial institutions responsible for ensuring the institutions they manage are able to provide high quality and service in January 2000.

They have every motivation to do so - their survival is at stake.The Federal Reserve System has itself made great progress on Y2K issues, meeting the goals for ourselves.

In addition to completing two rounds of reviews of the Y2K readiness of subject to our supervisory authority, we have renovated and tested virtually all our own a As mentioned, we have opened our mission-critical systems to customers for testing with us progressed significantly in our contingency planning efforts.

For the balance of this year focusing intensely on contingency planning, as we believe that is the best way to be ready t any possible surprises.As in the private sector, activity to fix computer systems maintained by the federal gove been intensifying.

Substantial progress has been made in many areas, but the President's Co agrees that much more work still needs to be done.

Its reviews of federal Y2K program highlighted needed areas of improvement, as well as many other areas getting their preparat good control.

The Commission's evaluation of every agency and department is publicly avail its quarterly summary, so I will not attempt to go through it chapter and verse.

The current federal spending for all preparation is $6.8 billion.

Last fall, legislation was enacted tha sharing of Y2K information among businesses and clarifies the legal liability of reportin these are positive developments.Far less is known about the effectiveness of the Y2K preparations by state and local govern the state level, a survey of web pages indicates that most states have extensive and programs under way, but by recent count several states had no reference to Y2K preparednes and others were quite vague about what was going on under their control.

We can identify $3. earmarked by states, but I am confident that number is low.

While attention is often focuse profile systems such as the nation's air traffic control systems and its electric power g many smaller, yet quite critical, electronically driven systems maintained by coun municipalities that are also vulnerable.

This would include such services as water, pol control, and health and welfare activities.

And as any Washington or Nashville commuter kno or two malfunctioning traffic signals can cause serious congestion, confusion, and delay breakdown of traffic management systems could cause near total gridlock.

I hope that local every area will increasingly focus attention on Y2K preparation and hold local leaders accou preparations to the infrastructure in their areas of responsibility.On the international level, there is both good news and bad.

The governments of industrialized nations have stepped up their own internal Y2K programs over recent month international cooperation is intensifying through efforts such as the Joint Year 2000 Counc by my colleague Federal Reserve Governor Roger Ferguson.

Most large multinational corpora report that they are well along in their own preparations worldwide and many of them are their numerous local suppliers to be prepared to maintain the flow of materials and service significant positive step.

The recent conversion to the euro was very smooth, thus proving similar to the one we have at hand can be successfully accomplished.

But that intense Europe, along with other world financial troubles, has obviously been deflecting all attention away from Y2K issues.

I worry that time will simply run out for some activitiecountries, particularly in the developing economies, and as a result risks exist for some l disruption in various locales around the world.All of this has been affecting our economy in a variety of ways.

On the positive side an impo element in some Y2K programs is the accelerated replacement of aging computer systems with modern, state-of-the-art hardware and software.

Such capital expenditures should raise the lev productivity in those enterprises, and addressing Y2K has increased the awareness of many sen executives of the complexity and importance of carefully managing their corporate informati technology resources.

The increased replacement demand also has contributed to the spectacul recent growth in this country's computer hardware and software industries.

A reverse effect, wh believe will shortly become visible, is that many institutions will 'freeze' their remediated an systems for the remainder of this year, effectively foregoing the installation of major new ha and software systems.

This moves some spending on technology forward from 1999 into 2000.

So, ultimately, we are largely shifting the timing of these investment expenditures, rather than ch their total amounts very much.Another area in which uncertainty about Y2K readiness is likely to have noticeable effects in 19 in the management of inventories.

As the millennium approaches, I expect businesses will want hold larger inventories of goods as insurance against Y2K-related supply disruptions.

Such a from 'just-in-time' inventory management to a 'just-in-case' posture is likely to prompt an incr orders and production during late 1999, with these stocks subsequently being run off in the fir of 2000.

We at the Fed, for example, will do precisely that in our management of the productio new currency.While Year 2000 preparation efforts may give a temporary boost to economic activity in some secto the probable net effect on the aggregate economy is slightly negative.

Other than the obviously valuable ability to maintain operations across the millennium, few quantifiable benefits accr most firms for their extensive remedial work.

It is fair to think of Y2K as a huge onemaintenance project, which is costly on balance and produces no additional product.

Our estimate the net effect of Y2K remediation efforts, on both our nation's overall labor productivity and gross domestic product, are that it will likely shave one or two tenths of a percentage point growth rate, but a more substantial effect is possible if some of the larger estimates of Y2K co out to be accurate.Let's move on to the bottom line.

Will every organization and everybody everywhere be full prepared, so that everything will go off without a hitch?

I seriously doubt it.

As we have discu great deal of work is already completed or planned to deal with the problem, but what if somet does slip through the cracks, and we experience the failure of 'mission-critical' systems?

How w a computer failure in one area of the economy affect the ability of others to continue to o smoothly?

How severe could be the consequences of Y2K problems emanating from abroad?

The number of possible scenarios of this type is endless, and today no one can say with abso confidence how severe any Y2K disruptions could be, or how a failure in one sector would influen operations in others.

That said, let me now turn to a discussion of the spectrum of plausible ou for economic activity in 2000.What will happen as the millennium rolls over?

A few economists are suggesting that Y2K-relate disruptions will induce a deep recession.

That probably is a stretch, but it is unlikely we wil unaffected.

I anticipate that there will be isolated production problems and disruptions to com and perhaps some public services, that could reduce the pace of economic activity early in 2000 mentioned above, at least a mild inventory cycle seems very likely to develop.

But, just lik shocks to our nation's physical infrastructure that occur periodically, I would expect the Y2K i to our information and electronic control infrastructure is most likely to be short-lived an reversed.Most of us have experienced examples of how economic activity has been affected by disrupt the physical infrastructure of some part of our country.

Although the Y2K problem is clear and therefore the usefulness of any analogy is limited, analyzing some of these disrupti physical infrastructure may be useful in organizing our thinking about the consequences of s interruptions in our information infrastructure.

Many of us have experienced major bad episodes: a severe snow or ice storm, a flood, a tornado, or perhaps a hurricane.

Commerce to a halt for up to a week or so in an area, but activity bounces back rapidly once thing up.

Although individual firms and households can be adversely affected by these disruption aggregate, the economy quickly recovers most of the output lost due to such storms. instances, the shock to our economic infrastructure is transitory in nature, and, criticall process is under way before any adverse 'feedback' effects are produced.

Another similar might be the strike not long ago by workers at United Parcel Service.

UPS is a major play package delivery industry in this country, and the strike disrupted the shipping patter businesses.

Some sales were indeed lost but - and this is critical here - in most instanc shipping services were found for high priority packages.

Some businesses were hurt by the s its effect on economic activity was small in the aggregate.

In fairness it must be s disruptions that occur are not isolated events as I have assumed, but rather spread across of the economy by interacting with each other, then there could indeed be a more significan aggregate activity in the first quarter of 2000.The more dire of the Y2K scenarios would involve, among other things, a perpetuatio intensification of these interactive effects and their subsequent feedback.

Should t production disruptions could turn out to be a national or international phenomenon and cou from one industry to another.

Under these circumstances, the decline in economic activi prove to be longer lasting, and a recession could conceivably ensue.

But let me quickly stre not think that this recession scenario has a very high probability.

It is possible, but a l to go wrong for it to occur, and much is being done to prevent its occurrence.Now you might appropriately ask a Fed representative what monetary policy can do to offset a disruption.

The truthful short answer is 'not much'.

We can't plow the streets or deliver p we would be unable to reprogram the nation's computers for 2000.

The Y2K problem is primari issue affecting the aggregate supply side of the economy, whereas the Federal Reserve's policy works mainly on aggregate demand.

We all understand how creating more money, a lowering the level of short-term interest rates, gives a boost to interest-sensitive se homebuilding, but these tools are unlikely to be very effective in generating more Y2K rem efforts or accelerating the recovery process if someone experiences some type of disruption of course, be ready if people want to hold more cash on New Year's Eve 1999, and we w prepared to lend whatever sums may be needed to financial institutions through the discount or to provide needed reserves to the banking system's open market operation.

And, in the event a serious Y2K disruption should have significant feedback effects on aggregate demand, I outlined earlier, there obviously would be a role for the Federal Reserve to play in downturn.

But there is nothing monetary policy can do to offset the direct effects of a Y2KIn summary, as I stated at the outset of my remarks, I am cautiously but increasingly opti the United States will weather this storm without major disruptions to economic activity.

S more frightening scenarios are not without a certain plausibility, if this challenge were b But it is not being ignored, as indeed this meeting today clearly illustrates.

An enormous work is being done in anticipation of the rollover of the millennium.

As the world's larges the heaviest burden of preparation falls on the US.

But it is truly a worldwide issue, and some are not adequately prepared and experience breakdowns of unforeseeable dimension, we all be affected accordingly.

We at the Federal Reserve intend to do our utmost, and we hope others will do likewise.