I appreciate this opportunity to speak at the NICSA regional meeting. And I am happy to say that this is a continuation of collaborative work between NICSA and the Federal Reserve Bank of Boston which we have had under way for several years. Since the early 1990's we have participated in the meetings and the work of your Custody Fund Accounting Administration Committee, or CFA Committee. In fact, for a few years now my Bank has hosted an annual planning meeting for the Committee, and some of our experts with Total Quality Management techniques have helped the Committee to develop its priorities for the year ahead. We also have spoken several times at NICSA regional meetings, here and around the country, about electronic payment systems, and depositories for securities. These activities have given our Bank a valuable window on the world of mutual funds and the banks and other organizations which work with them. This kind of information can help us to identify market-oriented improvements for some of our most important services for the banking industry, such as the Fedwire Funds Transfer System and the Bookentry Securities Transfer System. In turn, we hope we are providing information, as well as advocacy, to intensify your interest in using electronic payments in place of paper checks, so that you and your customers can benefit from a better national payments system. We look forward to continuing to collaborate with NICSA, and I hope this discussion will be another helpful contribution.

My subject is preparing for the year 2000, a concern which all of us have in common. I would like to offer you some thoughts on the possible economic effects of the coming of the year 2000, or Y2K. Also, I will give you a brief overview of the outlook for the banking industry as it prepares for the year 2000. I would like to share with you some of the important steps we in the Federal Reserve are taking, nationally as well as here in New England, to prepare operationally for Y2K. And then I would like to mention a few issues which require ongoing attention from all of us. In particular, I believe we all can make important contributions to public confidence and the avoidance of needless panic by becoming more active during 1999 in sharing all of the facts about our preparations for Y2K with our customers and the broader public.

Since most enterprises in America have to do some work to get ready for Y2K, it is impossible to know exactly what it all will cost. During 1998 the Federal Reserve Board developed an estimate, based on corporate reports to the SEC, that the U.S. private sector would spend roughly $50 billion dollars, and quite possibly more, to renovate and test systems for the year 2000. As you know, public companies have been reporting about their Y2K preparations in their 10K reports since the third quarter of 1998. Here again, it is difficult to get a complete and clear picture, but it seems likely that many organizations will wind up spending more than they thought previously to complete their preparations. In addition to these private sector costs, the Congress has budgeted about $6 billion dollars for Year 2000 preparation by the federal government. There is no comprehensive information available about state and local governments, but probably some billions more will be spent in these areas. Worldwide, the Gartner Group has estimated that the costs to get ready for the Year 2000 will run between $300 and $600 billion dollars.

All of this spending will have both positive and negative effects on the U.S. economy. Overall, the net impact is likely to be at least slightly negative. The biggest impact may be the opportunity costs of Y2K. When we commit so many of our scarce IT resources to renovation of systems, we have to sacrifice at least some innovations we would be pursuing to make processes more efficient, or to build better mousetraps which would increase revenues and profits. We must be losing, or at least deferring, initiatives which would boost productivity and help businesses to continue to offset rising labor costs with productivity gains.

As an estimate, the net effect of Y2K spending could be a reduction in the growth of U.S. labor productivity by 1 or 2 tenths of a point in 1999 and in 2000. The overall gross domestic product might grow by about 1 tenth of a point less than it would have otherwise in each of these two years.

It is difficult to sort out exactly how Y2K will affect the economy, because some remediation efforts actually will introduce new, more efficient systems to replace non-compliant older systems. Smaller enterprises seem to be more likely than larger ones to use replacements as their direction to prepare for Y2K. Many larger organizations apparently find their legacy systems too complex to replace in the relatively short time they have set aside to get ready for the Year 2000.

We can anticipate something of an inventory cycle due to Y2K. Manufacturers and others may build inventories in late 1999 to guard against shortages of raw materials, inputs to production, and goods for sale. These higher inventories then would be run down in early 2000.

No doubt you have heard some talk about a recession in 2000, to be brought about by Y2K. Of course nobody can say that that is impossible, and I respect the professional economists who make that forecast. However, we in the Federal Reserve believe that that outcome from Y2K is very unlikely. At the time of the Year 2000 rollover, probably there will be some production and distribution problems, and some problems with public services and utilities. We have had such problems in the past, and we have worked through them and returned to normal business operations. If these outages are short-lived, they should not have any lasting effects on the overall economy. Problems which were more widespread and lasted much longer could have feedback effects which could hurt the overall economy, but while that cannot be ruled out, it is not our expectation; particularly if all of us do what we should do now to prepare for the Y2K event.

One other likely development to bear in mind: I anticipate some considerable pent- up demand in 2000 and 2001 for IT resources to build those better mousetraps that have been put off in 1998 and 1999. Many businesses that are seeing a bulge in their IT costs now because of Y2K preparations may be expecting big cost reductions after January, 2000, but may not get them.

I'd like to tell you a little bit about what the Federal Reserve and other bank regulators have been doing to work with the banking industry on its preparations for Y2K. In a coordinated effort with the other banking regulatory agencies, the Federal Reserve is working closely with the institutions it supervises. Results to date indicate that banks continue to make good progress in meeting their Year 2000 objectives. Like all of us, the banks still have a lot of critically important work to do, and must keep up their very good efforts throughout 1999.

Our supervisory reviews of the banks have been divided into two phases. Phase One, which ended on June 30, emphasized awareness, assessment, and renovation of the banks' mission-critical systems. In this phase the Federal Reserve itself reviewed more than 1,600 institutions nationwide. Of course the other bank supervisors, such as the FDIC and the Comptroller of the Currency, reviewed thousands more. Our reviews showed that the overwhelming majority of institutions had made satisfactory progress in their planning and readiness efforts.

The second phase began on July 1, and will continue through March 31 of this year. This phase will emphasize renovation, testing, and implementation of those mission-critical systems. During these 9 months, the Federal Reserve and the other agencies will conduct another round of reviews.

We do anticipate that in this second phase of reviews we may find somewhat more banks have fallen behind in meeting their Y2K milestones, because the tasks they must undertake in this phase are more complex. Overall, though, most banks, large and small, across the country have been making good progress, and if they continue to work as effectively in 1999 as they did during the past couple of years, we as customers can expect to have our banking services available as usual come January, 2000.

As a banking regulator, we are devoting many people and a great deal of time to monitoring the banking industry's preparations for the Year 2000. As a bank, and as a provider of vitally important services to depository institutions, we also are devoting many people and a great deal of time to ensuring that our own systems are renovated and tested extensively in advance of the Year 2000. We really have worked hard on this for a long time, so that now nearly all of our mission-critical systems are compliant, and our internal testing is nearly complete. Specifically, we have 105 mission-critical systems nationally. Of these, 99 now are complaint and the remaining 6 will be replaced by March. Furthermore, we expect to have all of our non-critical systems taken care of before the middle of this year. Our mission-critical systems include some that your organizations rely upon every day, such as Fedwire Funds Transfer, Bookentry, the Automated Clearing House, or ACH, and the Reserve Accounting System used by your banks.

At the heart of our preparations for Y2K is testing our electronic interfaces with depository institutions using those important systems. We set a target to have all of these applications ready for testing by July 1, 1998, to give our customers lots of time and many opportunities to test with us. We hit that target. Since July 1 all of these payment and information systems have been available for testing with all twelve Reserve Banks.

Nationally, over 10,000 institutions of all sizes maintain nearly 12,000 electronic connections with the Federal Reserve. One institution may use its electronic connections for as many as 15 applications. Testing so many applications with so many institutions nationwide is no easy task, but we have made substantial progress already. Here in New England, the Boston Reserve Bank has electronic connections with about 480 institutions. Nearly 400 of them already have done some testing with us. Others are scheduled for testing soon. Nationally, we have had about 6,000 institutions conduct more than 120 thousand tests with us.

Both nationally and locally this Y2K testing has been going quite well. Our Federal Reserve applications with their renovations for Y2K are working, and our customers appear to be interfacing with them well. We still have a lot of testing to do, but so far, so good. And this testing with the Federal Reserve is another indicator that the banking industry is preparing well for the Year 2000.

A lot of our work on Y2K during 1999 will focus on our contingency planning. I would like to describe for you how we are approaching contingency planning, not with any idea that our way is the best way, but with the thought that you might pick up something from our approach that would help your own organizations.

There are six major stages in our contingency planning. First, the best kind of contingency planning is to do everything possible to make sure you will not have to fall back upon contingency plans. For the resources under our own control, including not just our own software applications and computers, but also our building systems and so forth, we have undertaken a very thorough effort, as I have suggested, to renovate, test, and certify that these systems are expected to work reliably in January 2000. The better the job we do at this, the more likely it is that we will not have to fall back upon contingency plans to keep our critical systems going. We might say in this regard that the best defense is a good offense, for you and for us.

Second, extensive testing with those who are connected electronically with us is an essential measure. And as I have reported to you, we have put a lot of emphasis on testing with our customers, to good effect. Again, the more extensively you and we have tested the systems which connect us with other parties, the more confidence we can have that they will continue to serve us well in 2000.

Recognizing that things can go wrong, either with those resources under our control or with those external resources we do not control, such as utilities, our third phase of preparation is the development of what we call business resumption plans, which describe what we will do if a disruption occurs. We start with the lessons we have learned from the past: that is, the contingency plans that Reserve Banks have developed and updated over the years as we experienced other kinds of operational disruptions. We have learned how to keep our critical systems going in the face of disruptions from blizzards, earthquakes, and floods, and we have developed backup arrangements when our buildings lose electricity or other utilities.

We are augmenting these plans to reflect the unique risks of Y2K, which makes it at least a little more likely that some disruptions might occur, and also makes it more likely that any such disruptions will be more widespread than they might have been at other times.

As a fourth phase of contingency preparation, we are using a set of Y2K scenarios to test our contingency plans, identify any gaps, and then improve the plans. In this regard, we intend to focus on a fairly small number of critical scenarios in great depth, and perhaps use some additional scenarios to make sure our plans have not missed anything crucial. Some of you already may have found, to your frustration, that the list of possible problems you can worry about seems endless. However, the use of a limited number of potentially critical scenarios, that would have severe effects on our major business areas, will help us to develop the most effective contingency plans possible.

A key consideration, I think, in deciding what scenarios to use to test contingency plans is to make sure that the scenarios will test every major business area in the organization. For instance, a scenario about disruptions in utility services to a Reserve Bank affects all business areas, but our building operations and automation people would see themselves as our first line of defense, to respond to such problems, and would be able to test their contingency plans in considerable detail against such a scenario. Meanwhile, another scenario, about possible liquidity problems in the banking system, also would affect all of our business areas, but in this case our discount window and monetary policy business areas would see themselves as our first line of defense and would test their plans in great depth against such a scenario. Your institution will have its own best sense of the possible disruptions that would have the greatest impact on you, and you can develop scenarios and test contingency plans accordingly.

Sixth, we will need well-thought-out event management plans for the actual transition, that is, in late December 1999 and early January 2000. Rather than try to have an advance plan for every possible development, we must have plans and people and decision-making criteria in place to enable us to respond rapidly and effectively to whatever develops. To help with our event management, and identify problems as early as possible, we will have people in the Bank at 12 midnight, as the new Waterford crystal ball is dropping in Times Square, to see how our telecommunications and our incoming utilities and our internal building systems hold up at the moment when Year 2000 arrives. Then, during the day on January 1, people in all of our departments will come in to test our automated systems, well ahead of the first business day on January 3. In these ways and many others we will focus on managing the Y2K event.

The final area I want to touch upon with you this evening involves a few issues which require the attention of all of us.

First, utilities, such as electrical power and telecommunications. Some of you know that obtaining information about the preparations of utility companies for Y2K was difficult during much of 1998. More recently, though, I have seen some evidence that utilities have a greater appreciation for the importance of sharing with their customers more information about Y2K. Actually, many utilities may be further along than you realize, and at the national level some of the major players have plans for integrated testing of their systems during 1999. Nevertheless, every utility company has its own story, just as every bank or every mutual fund has its own story. As customers of these companies, we need to know where they are in their preparations. The only way to find out is to ask the companies with whom each of us does business. We should be willing to share with them any information about our preparations which could be useful to them, and then we need to ask for as much information from them as we need to gain confidence that they are on track for continuing to serve our needs reliably in 2000. This could be an activity which a number of us using a common service provider could enter into together.

One of the most difficult sectors on which to obtain good Y2k information is local government around the country. Here also we need to go out and ask them what they are doing to prepare for Y2K. Think, for instance, of how water gets into your building. It is delivered by some combination of state and local governmental units. Think how quickly you could be put out of business if no water were coming into your building. In a good number of cities and towns your electricity is delivered into your buildings by local government. It would make sense for a group of businesses in the same city or town to get together with their local government officials and share information about Y2K readiness.

The amount of information available about international preparations for Y2K varies widely by country. Here also people in the United States feel considerable uncertainty. For the banking systems of the European countries we can take some comfort from the rather smooth introduction of the Euro on January 1. More broadly, though, it still is hard to get an overall sense of Y2K readiness. And in fact, there probably cannot be any one overall sense, because conditions will vary by country.

The Federal Reserve is leading a group called The Joint Year 2000 Council, which brings together many financial regulators from around the world. This Council is working to improve communications and the sharing of information about Year 2000 issues. We also are working with a private sector group known as the Global 2000 Coordinating Group, or G-2000. This group includes more than 40 large financial institutions from over 20 countries. G-2000 has developed a standard framework for assessing a country's preparations for Y2K, and these assessments are going on now.

Those of you with investment activity, and clearing and settlement arrangements, in other countries may know more about the state of readiness of those countries than anyone else knows. If you have mechanisms you can use to share information with others in your industry, I hope you will do so for the common good. You also may be thinking about ideas to minimize risk during the critical last days of 1999 and first days of 2000. For instance, you may be able to set contractual terms that would reduce the number of transactions to be settled during those critical days.

One issue that has already received a great deal of attention is the potential demand for cash. Probably you have heard or read that people will want to hold more cash as they anticipate the coming of January 1 and the possibility that they will not be able to get at their bank accounts or use their ATM cards. In fact, this is not an issue just for banks. As you know well, many people now think of their mutual funds, and in particular their money market accounts, as their bank accounts. I wonder whether you are giving attention to the prospect that some of your customers could be requesting unusual withdrawals during December, just as other consumers will be withdrawing cash from their banks. Even insurance companies have some reason for concern here. One of the largest companies told me recently that it is preparing for the possibility that a larger than normal number of customers may seek loans against their insurance policies to increase their cash liquidity.

Well, first let me assure you that there will be plenty of cash available. Then, let's think about what we can do to give consumers enough assurance about banking services and mutual fund services that they will not feel the need to hold large amounts of cash.

As a precautionary measure, the Federal Reserve plans to increase the amount of currency either in circulation or in our vaults to meet the public's demand. The value of the currency in circulation in July of 1998 was 460 billion dollars. In late 1999 we plan to have about 700 billion dollars either in circulation or in the vaults of the Federal Reserve and the Treasury. This will provide a good-sized cushion to meet increased demand. Also, we will take steps to ensure that depository institutions will be able to obtain currency from us on a timely basis to meet the needs of their customers. The depository institutions should be ordering their cash from us before the last part of December, and we will work with them to get that done. We also will be prepared to work extra hours in our cash departments at all Reserve Banks to meet demand.

The real issue here, though, is why many consumers might want to hold extra cash. It could very well make sense to have a little extra cash on hand over the New Year's holiday weekend, just to be sure we can buy groceries, and gas, and other daily necessities. In my own opinion, it would not make any sense to hold large amounts of cash at home rather than in insured bank deposits or in interest-earning mutual funds. The only reason large numbers of people would consider doing so is that they do not have confidence that their banking and investment services will continue to be reliable and accessible in January 2000.

All of us have an interest and an obligation to maintain public confidence in our nation's financial system. People should not be exposing their savings to the risks of loss or theft because they have heard scary stories about Y2K, and have not heard the other side of the story from their banks, their mutual funds, their insurance companies, and the other organizations on which they have relied for many years.

You know all the steps you are taking to make your systems reliable and to remain in business come January, 2000. You may not yet have shared all of this information with your customers. The more facts you can provide to them, the more you will be helping them to make rational decisions about their money.

As we go through 1999 all of us must pay more attention to the importance of providing more factual reassurance to everyone with whom we do business, and to everyone who relies on us. The better prepared all of us are, and the more information all of us share, the more likely it will be that we will make it safely through the century date change and keep making progress in the Year 2000.

Thank you.