Roger W Ferguson, Jr: Expectations
Commencement address by Mr Roger W Ferguson, Jr, Vice-Chairman of the Board of Governors of
the US Federal Reserve System, at the Olin School of Business, Washington University in St. Louis,
St. Louis, Missouri, 16 May 2003.
* * *
Dean Greenbaum, distinguished trustees and faculty, and honored guests, I am pleased to be at the
Olin School today to congratulate this accomplished group of graduates. I hope today represents but
one among many successful milestones to come. And my advice to the graduates is that they look
back, not just forward, and thank the family and friends who supported them in school and helped to
make today's achievement possible.
I intend to do more than just wish the graduates success this afternoon. In fact, I will take a few
minutes on this happy occasion for a discussion of economic conditions and policy. I will first explain
what the Federal Reserve will be doing to ensure the best possible performance of the economic
system that you are about to enter. Then, I will discuss some steps that you can take to navigate
better in that wider world. Before I proceed, I should note that the views I will be expressing are my
own and do not necessarily represent the views of other members of the Federal Open Market
Committee or the Federal Reserve Board.
What to Expect from the Central Bank
Let me first explain what you, and others graduating during this season, can expect from the central
bank. To my mind, the most important potential contribution of monetary policymakers is to anchor
inflation expectations so that private-sector decisions can be made as efficiently as possible. We can
do this because, as with any central bank, our control over the size of our balance sheet determines
the value of our country's money and the general price level in the long run. We must do it because
our enabling legislation directs the Federal Reserve to seek monetary conditions fostering "maximum
employment, stable prices, and moderate long-term interest rates." The economics profession has
learned, in part from the bitter experience of the 1970s, that those three objectives collapse into one in
the long run. That is, only in an environment of stable prices will households and firms be able to direct
their complete attention to producing, investing, and saving so that employment will be at its maximum
over the long run. And at the same time, when investors are not concerned about a generally rising
level of prices for goods and services, inflation premiums will be compressed and long-term interest
rates will be moderate.
However, an environment of price stability is not one in which measured price indexes do not change.
In fact, price indexes of consumer goods and services suffer from a variety of statistical biases that
imply that the indexes overstate actual inflation. That is why, following Federal Reserve tradition, I
speak of an environment of price stability, or a situation in which concerns about variations in the
general price level do not materially influence the decisions of households and firms. In my view, we
are in such an environment. The four-quarter growth in the core personal consumption deflator is
currently running at a 1-1/2 percent rate, the slowest sustained pace in thirty years and 8 percentage
points below its peak recorded in 1980. Think of it: Inflation has declined over the years - that is, we
have experienced disinflation - to the point that increases in prices are now at a rate not seen on a
sustained basis in the lifetimes of most of today's graduates.
This disinflation represents an impressive victory for the disciplined monetary policy of the Federal
Reserve under the guidance first of Paul Volcker and then Alan Greenspan. But having won the war,
we at the Federal Reserve also have to win the peace. We will do that by always remembering that
our mandate to foster price stability imposes a symmetric responsibility. Because resources are
misused whenever the economy operates outside the zone of price stability, measured inflation can be
too low at times as well as too high.
In the quarters ahead and as noted at the conclusion of our policy meeting earlier this month, the
Federal Reserve has to guard against further declines from the already low prevailing level of inflation.
And we shall be on guard against such a development. Nonetheless, the possibility that the process of
disinflation will cumulate to the point that price levels actually decline for a sustained stretch of time -
that is, we enter into deflation - remains quite remote. Quite simply, the United States has too many
good things going for it to make a forecast of deflation credible, including the stimulus imparted by
prior monetary policy easings, the marked decline in oil prices associated with decisive victory in the
war against Iraq, the progress many households and firms have made in repairing their balance
sheets, and the fact that inflation expectations remain well anchored.
In discussing the fundamentals supporting economic expansion, I particularly want to single out the
impressive growth of labor productivity. These increases in output per hour worked have been made
possible by the harnessing of advances in technology in every aspect of business life. The lessons
learned at institutions such as the Olin School are being applied everywhere to trim inventories,
shorten supply chains, and enhance firms' responsiveness to their customers' needs. Faster
productivity growth implies that workers can look forward to more rapidly rising real wages over time.
Because the economic pie will be getting larger, those wage gains will not come at the expense of
profits.
But we must also remember the unpleasant arithmetic attached to those gains in productivity of late.
Thus far in the economic recovery and expansion, firms have been able to meet increased demand for
their products without adding workers. I would not be credible before this audience if I did not
recognize that some may have had trouble finding employment and a few may still be uncertain of
their next job opportunity. Indeed, over the past year, about one-half million private payroll jobs in the
nonfarm sector have been lost. Because aggregate supply can increase rapidly, aggregate demand
also has to grow faster than its recent pace to ensure that economic slack does not build up. Indeed,
given the existing level of slack in labor and product markets, the economy should be able to enjoy
above-trend growth for some time without putting undue pressure on resources. Recognizing that the
economy is experiencing price stability, I also accept that the central bank should work to create
conditions conducive to closing the gap between output and the ability of our economy to produce,
thereby fostering utilization of resources, including labor.
With the sound fundamentals that are now in place, I believe that such an outcome will be achieved.
That said, an economic system such as ours that relies on the separate decisions of millions of people
working to further their self-interest will be sensitive to expectations and sentiment. As a result,
economic outcomes can change quickly and are thus difficult to predict. The difficulties of prediction
pose a challenge to monetary policymakers: We prefer to act in advance of, rather than in reaction to,
economic developments so as to minimize disruptions to economic activity. We cope with the
challenge of prediction as best we can by devoting substantial resources to economic forecasting, by
monitoring developments in financial markets, by speaking regularly with an extensive network of
business contacts, and by being flexible with our policy actions. But the reality is that the private sector
cannot look to the central bank to eliminate all risk. Real decisions have uncertain outcomes, and
sometimes the result is adverse. But businesses and households must be prepared to take the
reasonable risks associated with modern economies. And I am certain that businesses will return to a
more normal pace of investment, although I am less certain of the timing.
What to Expect of Yourselves
Let me now offer a few thoughts about the world you are entering and the key professional challenges
you face. Frankly, you will join the business world at a time when many have lost confidence in the
integrity and ethics of our institutional leadership. Questions have been raised in the corporate and
nonprofit sectors about the quality and reliability of information that is made available and about the
personal ethics of those who had responsibility for managing the business risks that all organizations
face.
A disregard for ethics, vague accountability, and weak systems of internal control have resulted in
unexpected levels of risk in credit or market exposures, in legal liability, and in tarnished reputations
and careers. But the damage is not necessarily limited to those situations in which wrongdoing was
discovered. The threat is more fundamental: Capital cannot be allocated efficiently if market
participants do not have reliable information with which to make reasoned judgments.
Many investors, businesspeople, policymakers and regulators understand this and have successfully
promoted a needed emphasis on independence, oversight, and accountability. Corporate governance
is now properly understood to be the keystone in risk management. Reputation is a critical competitive
necessity, as you know, because reputation certainly weighed heavily in your educational selection
process. Reputation risk should not be underestimated; I believe, for example, that Enron ceased to
be a viable business because the value of its name was severely reduced well before any liability had
been found in any court of law.
How can the organizations you will soon join manage legal risks and protect their reputations? It is
here that I believe a well-crafted ethics policy and the means to monitor compliance can serve as a
foundation. A solid program in support of ethical behavior, along with sound corporate governance,
can act as an early warning system that raises concerns to senior managers and directors before they
ripen into legal liability. A rigorous compliance program can also identify behavior that, while within the
law, could tarnish the company's reputation with very tangible consequences on equity value.
It would please me thoroughly to say that with your entry into the profession of management the need
for these kinds of programs will be reduced. And your educational experience has no doubt included
some thoughtful and perhaps heartfelt discussions of business ethics. But one of the constants of
human commerce is that a certain proportion of those involved will succumb to the urge to subordinate
ethics to the desire for personal gain, however fleeting. I believe that most of you will live up to the
highest ethical standards. Some of you will be able to profoundly influence your communities and
businesses for the good. I will celebrate that kind of outcome, but my more modest hope is that as a
group you will enter the business world as energetic advocates for the careful management of
reputation risk and that throughout your careers you will use the lessons of our current experience.
My final thought on managing the challenges ahead is one that will be familiar to you. As a person
who was privileged, as you are, to attend some of the world's finest educational institutions, and as
someone who currently serves in an institution that is heavily dependent on analysis, I know that
knowledge matters. Knowing a business plan or an issue or an analytical technique is an absolute
requirement. Recognizing that knowledge is fleeting is the beginning of deeper understanding.
Thus, my hope for you is a continuing commitment to working through difficult problems, a
professional life characterized by the highest commitment to ethical behavior, a lifelong love of
learning, and a few moments - days like today - for celebration of your success. Congratulations and
good luck. We are rooting for you.