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99th Annual Report
2012

BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM

99th Annual Report
2012

BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM

This and other Federal Reserve Board reports and publications are available online at
www.federalreserve.gov/publications/default.htm.
To order copies of Federal Reserve Board publications offered in print,
see the Board’s Publication Order Form (www.federalreserve.gov/pubs/orderform.pdf)
or contact:
Publications Fulfillment
Mail Stop N-127
Board of Governors of the Federal Reserve System
Washington, DC 20551
(ph) 202-452-3245
(fax) 202-728-5886
(e-mail) Publications-BOG@frb.gov

Letter of Transmittal

Board of Governors of the Federal Reserve System
Washington, D.C.
May 2013
The Speaker of the House of Representatives:
Pursuant to the requirements of section 10 of the Federal Reserve Act, I am pleased to submit the ninety-ninth
annual report of the Board of Governors of the Federal Reserve System.
This report covers operations of the Board during calendar year 2012.
Sincerely,

Ben Bernanke
Chairman

i

Contents

Overview

..................................................................................................................................... 1

About this Report ....................................................................................................................... 1
About the Federal Reserve System .............................................................................................. 1

Monetary Policy and Economic Developments

............................................................ 5

Monetary Policy Report of February 2013 .................................................................................... 5
Monetary Policy Report of July 2012 .......................................................................................... 27

Supervision and Regulation ................................................................................................ 49
2012 Developments .................................................................................................................. 49
Supervision .............................................................................................................................. 51
Regulation ................................................................................................................................ 71

Consumer and Community Affairs

................................................................................. 75
Supervision and Examinations ................................................................................................... 75
Consumer Research and Emerging-Issues and Policy Analysis ................................................... 85
Community Economic Development .......................................................................................... 86
Consumer Laws and Regulations ............................................................................................... 88

Federal Reserve Banks .......................................................................................................... 91
Federal Reserve Priced Services ................................................................................................ 91
Currency and Coin .................................................................................................................... 94
Fiscal Agency and Government Depository Services ................................................................... 95
Use of Federal Reserve Intraday Credit ...................................................................................... 97
FedLine Access to Reserve Bank Services ................................................................................. 98
Information Technology ............................................................................................................. 98
Examinations of the Federal Reserve Banks ............................................................................... 99
Income and Expenses ............................................................................................................. 100
SOMA Holdings and Loans ...................................................................................................... 100
Federal Reserve Bank Premises ............................................................................................... 102
Pro Forma Financial Statements for Federal Reserve Priced Services ...................................... 105

Other Federal Reserve Operations .................................................................................. 111
Regulatory Developments: Dodd-Frank Act Implementation ...................................................... 111
The Board of Governors and the Government Performance and Results Act .............................. 115

ii

Record of Policy Actions of the Board of Governors ............................................. 117
Rules and Regulations ............................................................................................................. 117
Policy Statements and Other Actions ....................................................................................... 120
Discount Rates for Depository Institutions in 2012 .................................................................... 121

Minutes of Federal Open Market Committee Meetings ......................................... 123
Meeting Held on January 24–25, 2012 ...................................................................................... 124
Meeting Held on March 13, 2012 ............................................................................................. 156
Meeting Held on April 24–25, 2012 ........................................................................................... 166
Meeting Held on June 19–20, 2012 .......................................................................................... 191
Meeting Held on July 31–August 1, 2012 .................................................................................. 216
Meeting Held on September 12–13, 2012 ................................................................................. 227
Meeting Held on October 23–24, 2012 ..................................................................................... 251
Meeting Held on December 11–12, 2012 .................................................................................. 261

Litigation ................................................................................................................................. 287
Statistical Tables .................................................................................................................... 289
Federal Reserve System Audits ........................................................................................ 319
Board of Governors Financial Statements ................................................................................. 320
Federal Reserve Banks Combined Financial Statements ........................................................... 342
Office of Inspector General Activities ........................................................................................ 344
Government Accountability Office Reviews ............................................................................... 409

Federal Reserve System Organization

........................................................................... 411

Board of Governors ................................................................................................................. 411
Federal Open Market Committee ............................................................................................. 416
Board of Governors Advisory Councils ..................................................................................... 417
Federal Reserve Bank Branches .............................................................................................. 420

Index ......................................................................................................................................... 437

1

Overview

The Federal Reserve, the central bank of the United
States, is a federal system composed of a central governmental agency—the Board of Governors—and
12 regional Federal Reserve Banks.
The Board of Governors, located in Washington,
D.C., consists of seven members appointed by the
President of the United States and supported by a
2,540-person staff. Besides conducting research,
analysis, and policymaking related to domestic and
international financial and economic matters, the
Board plays a major role in the supervision and regulation of U.S. financial institutions and activities, has
broad oversight responsibility for the nation’s payments system and the operations and activities of the
Federal Reserve Banks, and plays an important role
in promoting consumer protection, fair lending, and
community development.

About this Report
This report covers Board and System operations and
activities during calendar-year 2012. The report
includes 11 sections:
• Monetary Policy and Economic Developments.
Section 1 provides adapted versions of the Board’s
semiannual monetary policy reports to Congress.

For More Background on Board
Operations
For more information about the Federal Reserve
Board and the Federal Reserve System, visit the
Board’s website at www.federalreserve.gov/
aboutthefed/default.htm. An online version of this
Annual Report is available at www.federalreserve
.gov/pubs/alpha.htm.

by the Board in 2012, including new or amended
rules and regulations and other actions as well as
the deliberations and decisions of the Federal Open
Market Committee (FOMC); Section 8 summarizes litigation involving the Board.1
• Statistical Tables. Section 9 includes 14 statistical
tables that provide updated historical data concerning Board and System operations and activities.
• Federal Reserve System Audits. Section 10 provides
detailed information on the several levels of audit
and review conducted in regards to System operations and activities, including those provided by
outside auditors and the Board’s Office of Inspector General.
• Federal Reserve System Organization. Section 11
provides listings of key officials at the Board and in
the Federal Reserve System, including the Board of
Governors, its officers, FOMC members, several
System councils, and Federal Reserve Bank and
Branch officers and directors.

• Federal Reserve Operations. Section 2 provides a
summary of Board and System activities in the
areas of supervision and regulation; Section 3, in
consumer and community affairs; and Section 4, in
Reserve Bank operations.

About the Federal Reserve System

• Dodd-Frank Act Implementation and Other
Requirements. Section 5 summarizes the Board’s
efforts in 2012 to implement provisions of the
Dodd-Frank Wall Street Reform and Consumer
Protection Act as well as the Board’s compliance
with the Government Performance and Results Act
of 1993.

The Federal Reserve System, which serves as the
nation’s central bank, was created by an act of Congress on December 23, 1913. The System consists of
a seven-member Board of Governors with headquarters in Washington, D.C., and the 12 Reserve Banks
located in major cities throughout the United States.

• Policy Actions and Litigation. Section 6 and
Section 7 provide accounts of policy actions taken

1

For more information on the FOMC, see the Board’s website at
www.federalreserve.gov/monetarypolicy/fomc.htm.

2

99th Annual Report | 2012

The Federal Reserve Banks are the operating arms of
the central banking system, carrying out a variety of
System functions, including operating a nationwide
payment system; distributing the nation’s currency
and coin; under authority delegated by the Board of
Governors, supervising and regulating a variety of
financial institutions and activities; serving as fiscal
agents of the U.S. Treasury; and providing a variety
of financial services for the Treasury, other government agencies, and other fiscal principals.
The maps below and opposite identify Federal
Reserve Districts by their official number, city, and
letter designation.

■ Federal Reserve Bank city
■ Board of Governors of the Federal Reserve System, Washington, D.C.
N

Overview

■ Federal Reserve Bank city
● Federal Reserve Branch city
■ Board of Governors of the Federal Reserve System, Washington, D.C.
N
— Branch boundary

3

5

Monetary Policy and Economic
Developments

As required by section 2B of the Federal Reserve Act,
the Federal Reserve Board submits written reports to
the Congress that contain discussions of “the conduct of monetary policy and economic developments
and prospects for the future.” The Monetary Policy
Report, submitted semiannually to the Senate Committee on Banking, Housing, and Urban Affairs and
to the House Committee on Banking and Financial
Services, is delivered concurrently with testimony
from the Federal Reserve Board Chairman.
The following discussion is a review of U.S. monetary
policy and economic developments in 2012, based on
the Monetary Policy Reports published in February 2013 and July 2012. Those complete reports
are available on the Board’s website at www
.federalreserve.gov/monetarypolicy/files/20130226_
mprfullreport.pdf (February 2013) and www
.federalreserve.gov/monetarypolicy/files/20120717_
mprfullreport.pdf (July 2012).
Other materials in this annual report related to the
conduct of monetary policy include the minutes of
the 2012 meetings of the Federal Open Market Committee (see the “Minutes” section on page 123) and
statistical tables 1–4 (see the “Statistical Tables”
section on page 289).

Monetary Policy Report
of February 2013
Summary
The U.S. economy continued to expand at a moderate rate, on average, over the second half of 2012.
The housing recovery appeared to gain additional
traction, consumer spending rose moderately, and
business investment advanced further. Financial conditions eased over the period but credit remained
tight for many households and businesses, and concerns about the course of federal fiscal policy and the
ongoing European situation likely restrained privatesector demand. In addition, total government pur-

chases continued to move lower in an environment of
budget restraint, while export growth was held back
by slow foreign economic growth. All told, real gross
domestic product (GDP) is estimated to have
increased at an average annual rate of 1½ percent in
the second half of the year, similar to the pace in the
first half.
Conditions in the labor market gradually improved.
Employment increased at an average monthly pace of
175,000 in the second half of the year, about the
same as in the first half. The unemployment rate
moved down from 8¼ percent last summer to a little
below 8 percent in January. Even so, the unemployment rate was still well above levels observed prior to
the recent recession. Moreover, it remained the case
that a large share of the unemployed had been out of
work for more than six months, and that a significant
portion of the employed had part-time jobs because
they were unable to find full-time employment.
Meanwhile, consumer price inflation remained subdued amid stable long-term inflation expectations
and persistent slack in labor markets. Over the second half of the year, the price index for personal consumption expenditures increased at an annual rate of
1½ percent.
During the summer and fall, the Federal Open Market Committee (FOMC) judged that the economic
recovery would strengthen only gradually over time,
as some of the factors restraining activity—including
restrictive credit for some borrowers, continuing concerns about the domestic and international economic
environments, and the ongoing shift toward tighter
federal fiscal policy—were thought likely to recede
only slowly. Moreover, the Committee judged that
the possibility of an escalation of the financial crisis
in Europe and uncertainty about the course of fiscal
policy in the United States posed significant downside risks to the outlook for economic activity. However, the Committee expected that, with appropriate
monetary accommodation, economic growth would
proceed at a moderate pace, with the unemployment
rate gradually declining toward levels consistent with

6

99th Annual Report | 2012

the FOMC’s dual mandate of maximum employment
and price stability. Against this backdrop, and with
long-run inflation expectations well anchored, the
FOMC projected that inflation would remain at or
below the rate consistent with the Committee’s dual
mandate.
Accordingly, to promote its objectives, the FOMC
provided additional monetary accommodation during the second half of 2012 by both strengthening its
forward guidance regarding the federal funds rate
and initiating additional asset purchases. In September, the Committee announced that it would continue
its program to extend the average maturity of its
Treasury holdings and would begin purchasing additional agency-guaranteed mortgage-backed securities
(MBS) at a pace of $40 billion per month. The Committee also stated its intention to continue its purchases of agency MBS, undertake additional asset
purchases, and employ its other policy tools as
appropriate until the outlook for the labor market
improves substantially in a context of price stability.
The Committee agreed that in determining the size,
pace, and composition of its asset purchases, it
would, as always, take account of the likely efficacy
and costs of such purchases. The Committee also
modified its forward guidance regarding the federal
funds rate at the September meeting, noting that
exceptionally low levels for the federal funds rate were
likely to be warranted at least through mid-2015,
longer than had been indicated in previous FOMC
statements. Moreover, the Committee stated its
expectation that a highly accommodative stance of
monetary policy would remain appropriate for a considerable time after the economic recovery
strengthens.
In December, the Committee announced that in
addition to continuing its purchases of agency MBS,
it would purchase longer-term Treasury securities,
initially at a pace of $45 billion per month, starting
after the completion at the end of the year of its program to extend the maturity of its Treasury holdings.
It also further modified its forward rate guidance,
replacing the earlier date-based guidance with
numerical thresholds for the unemployment rate and
projected inflation. In particular, the Committee indicated that it expected the exceptionally low range for

the federal funds rate would remain appropriate at
least as long as the unemployment rate remains
above 6½ percent, inflation between one and two
years ahead is projected to be no more than ½ percentage point above the Committee’s 2 percent
longer-run goal, and longer-term inflation expectations continue to be well anchored.
Partly in response to this additional monetary
accommodation, as well as to improved sentiment
regarding the situation in Europe, broad financial
conditions eased over the second half of 2012.
Although yields on nominal Treasury securities rose,
on net, yields on inflation-protected Treasury securities declined, and longer-term interest rates paid by
households and firms generally fell. Yields on agency
MBS and investment- and speculative-grade corporate bonds touched record lows, and broad equity
price indexes rose. Conditions in short-term dollar
funding markets eased over the summer and
remained stable thereafter, and market sentiment
toward the banking industry improved. Nonetheless,
credit remained tight for borrowers with lower credit
scores, and borrowing conditions for small businesses
continued to improve more gradually than for large
firms.
At the time of the most recent FOMC meeting in
January, Committee participants saw the economic
outlook as little changed or modestly improved from
the time of their December meeting, when the most
recent Summary of Economic Projections (SEP) was
compiled. (The December SEP is included as Part 3
of the February 2013 Monetary Policy Report on
pages 43–57; it is also included in the “Minutes” section of this annual report on page 272.) Participants
generally judged that strains in global financial markets had eased somewhat, and that the downside
risks to the economic outlook had lessened. Under
the assumption of appropriate monetary policy—
that is, policy consistent with the Committee’s Statement on Longer-Run Goals and Monetary Policy
Strategy (see box 1)—FOMC participants expected
the economy to expand at a moderate pace, with the
unemployment rate gradually declining and inflation
remaining at or below the Committee’s 2 percent
longer-run goal.

Monetary Policy and Economic Developments

7

Box 1. Statement on Longer-Run Goals and Monetary Policy Strategy
As amended effective on January 29, 2013
The Federal Open Market Committee (FOMC) is
firmly committed to fulfilling its statutory mandate
from the Congress of promoting maximum employment, stable prices, and moderate long-term interest
rates. The Committee seeks to explain its monetary
policy decisions to the public as clearly as possible.
Such clarity facilitates well-informed decisionmaking
by households and businesses, reduces economic
and financial uncertainty, increases the effectiveness
of monetary policy, and enhances transparency and
accountability, which are essential in a democratic
society.
Inflation, employment, and long-term interest rates
fluctuate over time in response to economic and
financial disturbances. Moreover, monetary policy
actions tend to influence economic activity and
prices with a lag. Therefore, the Committee’s policy
decisions reflect its longer-run goals, its mediumterm outlook, and its assessments of the balance of
risks, including risks to the financial system that
could impede the attainment of the Committee’s
goals.
The inflation rate over the longer run is primarily
determined by monetary policy, and hence the Committee has the ability to specify a longer-run goal for
inflation. The Committee judges that inflation at the
rate of 2 percent, as measured by the annual change
in the price index for personal consumption expenditures, is most consistent over the longer run with the
Federal Reserve’s statutory mandate. Communicating this inflation goal clearly to the public helps keep
longer-term inflation expectations firmly anchored,
thereby fostering price stability and moderate longterm interest rates and enhancing the Committee’s
ability to promote maximum employment in the face
of significant economic disturbances.

Part 1
Recent Economic
and Financial Developments
Real gross domestic product (GDP) increased at a
moderate annual rate of 1½ percent, on average, in
the second half of 2012—similar to the rate of
increase in the first half—as various headwinds continued to restrain growth. Financial conditions eased
over the second half in response to the additional
monetary accommodation provided by the Federal
Open Market Committee (FOMC) and to improved
sentiment regarding the crisis in Europe. However,
credit availability remained tight for many households and businesses. In addition, declines in real
government purchases continued to weigh on economic activity, as did household and business concerns about the economic outlook, while weak for-

The maximum level of employment is largely determined by nonmonetary factors that affect the structure and dynamics of the labor market. These factors
may change over time and may not be directly measurable. Consequently, it would not be appropriate to
specify a fixed goal for employment; rather, the Committee’s policy decisions must be informed by
assessments of the maximum level of employment,
recognizing that such assessments are necessarily
uncertain and subject to revision. The Committee
considers a wide range of indicators in making these
assessments. Information about Committee participants’ estimates of the longer-run normal rates of
output growth and unemployment is published four
times per year in the FOMC’s Summary of Economic
Projections. For example, in the most recent projections, FOMC participants’ estimates of the longer-run
normal rate of unemployment had a central tendency
of 5.2 percent to 6.0 percent, unchanged from one
year ago but substantially higher than the corresponding interval several years earlier.
In setting monetary policy, the Committee seeks to
mitigate deviations of inflation from its longer-run
goal and deviations of employment from the Committee’s assessments of its maximum level. These
objectives are generally complementary. However,
under circumstances in which the Committee judges
that the objectives are not complementary, it follows
a balanced approach in promoting them, taking into
account the magnitude of the deviations and the
potentially different time horizons over which employment and inflation are projected to return to levels
judged consistent with its mandate.
The Committee intends to reaffirm these principles
and to make adjustments as appropriate at its annual
organizational meeting each January.

eign demand restrained exports. In this environment,
conditions in the labor market continued to improve
gradually but remained weak. At a little under 8 percent in January, the unemployment rate was still well
above levels prevailing prior to the recent recession.
Inflation remained subdued at the end of last year,
with consumer prices rising at about a 1½ percent
annual rate in the second half, and measures of
longer-run inflation expectations remained in the
narrow ranges seen over the past several years.
Domestic Developments
GDP increased moderately but continued to be
restrained by various headwinds

Real GDP is estimated to have increased at an annual
rate of 3 percent in the third quarter but to have been
essentially flat in the fourth, as economic activity was

8

99th Annual Report | 2012

Figure 1. Change in real gross domestic product, 2006–12

Figure 2. Net change in payroll employment, 2006–13
Thousands of jobs

Percent, annual rate

400
4

Private

200
+
0
_

H2
H1

H1 H2

2

200

+
0
_

400
Total nonfarm

600

2
800
2006

2007

2008

2009

2010

2011

2012

2006

2007

2008

2009

2010

2011

2012

2013

Note: Here and in subsequent figures, except as noted, change for a given period
is measured to its final quarter from the final quarter of the preceding period.

Note: The data are three-month moving averages and extend through January 2013.

Source: Department of Commerce, Bureau of Economic Analysis.

Source: Department of Labor, Bureau of Labor Statistics.

temporarily restrained by weather-related disruptions
and declines in some erratic categories of spending,
including inventory investment and federal defense
spending.1 On average, real GDP expanded at an
annual rate of 1½ percent in the second half of 2012,
similar to the pace of increase in the first half of the
year (figure 1). The housing recovery gained additional traction, consumer spending continued to
increase moderately, and business investment rose
further. However, a severe drought in much of the
country held down farm production, and disruptions
from Hurricane Sandy also likely held back economic
activity somewhat in the fourth quarter. More fundamentally, some of the same factors that restrained
growth in the first half of last year likely continued
to weigh on activity. Although financial conditions
continued to improve overall, the financial system
has not fully recovered from the financial crisis, and
banks remained cautious in their lending to many
households and businesses. In particular, restricted
financing for home mortgages and new-home construction projects, along with the depressing effects
on housing demand of an uncertain outlook for
house prices and jobs, kept the level of activity in the
housing sector well below longer-run norms. Budgetary pressures at all levels of government also continued to weigh on GDP growth. Moreover, businesses
and households remained concerned about many
aspects of the economic environment, including the
uncertain course of U.S. fiscal policy at the turn of
1

Data for the fourth quarter of 2012 from the national income
and product accounts reflect the advance estimate released on
January 30, 2013.

Figure 3. Civilian unemployment rate, 1979–2013
Percent

12
10
8
6
4

1981

1989

1997

2005

2013

Note: The data are monthly and extend through January 2013.
Source: Department of Labor, Bureau of Labor Statistics.

the year as well as the still-worrisome European situation and the slow recovery more generally.
The labor market improved somewhat, but the
unemployment rate remained high

In this economic environment, firms increased their
workforces moderately. Over the second half of last
year, nonfarm payroll employment rose an average of
about 175,000 per month, similar to the average
increase in the first half (figure 2). These job gains
helped lower the unemployment rate from 8.2 percent
in the second quarter of last year to 7.9 percent in
January (figure 3). Nevertheless, the unemployment
rate remained much higher than it was prior to the
recent recession, and long-term unemployment con-

Monetary Policy and Economic Developments

tinued to be widespread. In the fourth quarter, about
40 percent of the unemployed had been out of work
for more than six months. Moreover, the proportion
of workers employed part time because they were
unable to find full-time work remained elevated.
Some of the increase in the unemployment rate since
the beginning of the recent recession could reflect
structural changes in the labor market—such as a
greater mismatch between the types of jobs that are
open and the skills of workers available to fill them—
that would reduce the maximum sustainable level of
employment. However, most of the economic analysis on this subject suggests that the bulk of the
increase in unemployment probably reflects a deficiency in labor demand.2 As a result, the unemployment rate likely remains well above levels consistent
with maximum sustainable employment.
As described in the box “Assessing Conditions in the
Labor Market” (see pages 8–9 of the February 2013
Monetary Policy Report), the unemployment rate
appears to be a very good indicator of labor market
conditions. That said, other indicators also provide
important perspectives on the health of the labor
market, and the most accurate assessment of labor
market conditions can be obtained by combining the
signals from many such indicators. Aside from the
decline in the unemployment rate, probably the most
important other pieces of evidence corroborating the
gradual improvement in labor market conditions over
the second half of last year were the gains in nonfarm payrolls noted earlier and the slight net reduction in initial claims for unemployment insurance.
Restrained by the ongoing weak conditions in the
labor market, labor compensation has increased
slowly. The employment cost index for private industry workers, which encompasses both wages and the
cost to employers of providing benefits, increased
only 2 percent over the 12 months of 2012, similar to
the rate of gain since 2010. Similarly, nominal compensation per hour in the nonfarm business sector—a measure derived from the labor compensation
data in the national income and product accounts
2

See, for example, Mary C. Daly, Bart Hobijn, Ayşegül Şahin,
and Robert G. Valletta (2012), “A Search and Matching
Approach to Labor Markets: Did the Natural Rate of Unemployment Rise?” Journal of Economic Perspectives, vol. 26
(Summer), pp. 3–26; Michael W. L. Elsby, Bart Hobijn, Ayşegül
Şahin, and Robert G. Valletta (2011), “The Labor Market in the
Great Recession—An Update to September 2011,” Brookings
Papers on Economic Activity, Fall, pp. 353–71; and Jesse Rothstein (2012), “The Labor Market Four Years into the Crisis:
Assessing Structural Explanations,” ILRReview, vol. 65 (July),
pp. 467–500.

9

Figure 4. Change in the chain-type price index for
personal consumption expenditures, 2006–12
Percent

5
4

Total

3
2
Excluding food
and energy

1
+
0
_
1

2006

2007

2008

2009

2010

2011

2012

Note: The data are monthly and extend through December 2012; changes are
from one year earlier.
Source: Department of Commerce, Bureau of Economic Analysis.

(NIPA)—increased 2½ percent over the four quarters
of 2012, well below average increases of close to
4 percent in the years prior to the recent recession. As
a result of these modest gains, nominal compensation
has increased only about as fast as consumer prices
over the recovery.
Inflation remained low . . .

Consumer price inflation was low over the second
half of 2012. With considerable slack in labor markets and limited increases in labor costs, relatively
stable prices for commodities and imports, and wellanchored longer-term inflation expectations, prices
for personal consumption expenditures (PCE)
increased at an annual rate of 1½ percent in the second half of the year, similar to the rate of increase in
the first half (figure 4). Excluding food and energy
prices, consumer prices increased only 1 percent in
the second half of the year, down from 2 percent in
the first half. A deceleration in prices of imported
goods likely contributed to the low rate of inflation
seen in the second half, though price increases for
non-energy services were also low.
As noted, gains in labor compensation have been
subdued given the weak conditions in labor markets,
and unit labor costs—which measure the extent to
which compensation rises in excess of productivity—
have increased very little over the recovery. That said,
compensation per hour rose more rapidly last year,
and productivity growth, which has averaged 1½ percent per year over the recovery, was relatively low. As

10

99th Annual Report | 2012

Figure 6. Median inflation expectations, 2001–13

Figure 5. Prices of oil and nonfuel commodities, 2008–13
Dollars per barrel

December 2006 = 100

6

140

160

5

120

Nonfuel
commodities

140

Michigan survey expectations
for next 5 to 10
years

100

4

120

3
80
Oil

100
80

2

SPF expectations
for next 10 years

60

1
+
0
_

40

2008

2009

2010

2011

2012

2013

Note: The data are monthly. The oil price is the spot price of Brent crude oil, and
the last observation is the average for February 1–21, 2013. The price of nonfuel
commodities is an index of 45 primary-commodity prices and extends through
January 2013.
Source: For oil, the Commodity Research Bureau; for nonfuel commodities,
International Monetary Fund.

a result, unit labor costs rose 2 percent in 2012, well
above average increases earlier in the recovery.
Global oil prices rose in early 2012 but subsequently
gave up those gains and remained about flat through
the later part of the year (figure 5). Developments
related to Iran, including a tightening embargo on
Iranian oil exports, likely put upward pressure on
prices, but these pressures were apparently offset by
continued concerns about weak global demand.
However, in recent weeks, global oil prices have
increased in response to generally positive demand
indicators from China and some reductions in Saudi
production. Partly in response to this rise, retail gasoline prices, which changed little, on net, over 2012,
have moved up appreciably.
Nonfuel commodity prices have remained relatively
flat over the past year despite significant movements
in the prices of a few specific commodities. Of particular interest, prices for corn and soybeans eased
some over the fall after having risen sharply during
the summer as the scale of the drought affecting
much of the United States became apparent. Given
this easing and the small share of grain costs in the
retail price of food, the effect of the drought on U.S.
consumer food prices is likely to be modest: Consumer food prices rose at an annual rate of 2 percent
in the fourth quarter following increases of less than
1 percent in the middle of last year.

2001

2003

2005

2007

2009

2011

2013

Note: The Michigan survey data are monthly and extend from January 2001
through a preliminary estimate for February 2013. The SPF data are quarterly and
extend from 2007:Q1 through 2013:Q1.
Source: Thomson Reuters/University of Michigan Surveys of Consumers and
Survey of Professional Forecasters (SPF).

In line with these flat overall commodity prices, as
well as earlier dollar appreciation, prices for
imported goods excluding oil were about unchanged
on average over the last five months of 2012 and the
early part of 2013.
. . . and longer-term inflation expectations stayed
in their historical range

Survey measures of longer-term inflation expectations have changed little, on net, since last summer.
Median expected inflation over the next 5 to 10 years,
as reported in the Thomson Reuters/University of
Michigan Surveys of Consumers, was 3 percent in
early February, within the narrow range of the past
10 years (figure 6). In the Survey of Professional
Forecasters, conducted by the Federal Reserve Bank
of Philadelphia, the median expectation for the
increase in the price index for PCE over the next
10 years was 2 percent in the first quarter of this
year, similar to its level in recent years. A measure of
5-year inflation compensation derived from nominal
and inflation-protected Treasury securities has
increased 55 basis points since the end of June, while
a similar measure of inflation compensation for the
period 5 to 10 years ahead has increased about
30 basis points; both measures are within their
respective ranges observed in the several years before
the recent financial crisis (figure 7). While the
increases in these measures could reflect changes in
market participants’ expectations of future inflation,
they may also have been affected by improved investor risk sentiment and an associated reduction in

Monetary Policy and Economic Developments

11

Figure 8. Change in real personal consumption
expenditures and disposable personal income, 2006–12

Figure 7. Inflation compensation, 2004–13
Percent

Percent, annual rate

4

Change in real PCE
Change in real DPI

5 to 10 years ahead
3

6

2

H2
H1

5-year (carry adjusted)

1
+
0
_

H1 H2

2
+
0
_

1
2
2005

2007

2009

2011

4

2

2013

Note: The data are weekly averages of daily data and extend through February 15,
2013. Inflation compensation is the difference between yields on nominal Treasury
securities and Treasury inflation-protected securities (TIPS) of comparable maturities, based on yield curves fitted to off-the-run nominal Treasury securities and
on- and off-the-run TIPS. The 5-year measure is adjusted for the effect of indexation lags.
Source: Federal Reserve Bank of New York; Barclays; Federal Reserve Board staff
estimates.

demand for the relatively greater liquidity of nominal
Treasury securities.
Consumer spending continued to
increase moderately

Turning to some important components of final
demand, real PCE increased at a moderate annual
rate of 2 percent over the second half of 2012, similar
to the rate of increase in the first half (figure 8).
Household wealth—buoyed by increases in house
prices and equity values—moved up over the second
half of the year and provided some support for consumer spending. In addition, for those households
with access to credit, low interest rates spurred
spending on motor vehicles and other consumer
durables, which increased at an annual rate of 11 percent over the second half of last year. But increases
in real wages and salaries were modest over the second half of the year, and overall growth in consumer
spending continued to be held back by concerns
about the economic outlook and limited access to
credit for some households. After rising earlier in the
year, consumer sentiment—which reflects household
views on their own financial situations as well as
broader economic conditions—fell back at the end of
the year and stood well below longer-run norms.
Real disposable personal income (DPI) rose at an
annual rate of 3½ percent over the second half of
2012. However, much of this increase was a result of
unusually large increases in dividends and employee

2006

2007

2008

2009

2010

2011

2012

Note: The data are quarterly and extend through 2012:Q4.
Source: Department of Commerce, Bureau of Economic Analysis.

bonuses, as many firms apparently shifted income
disbursements into 2012 in anticipation of an
increase in marginal tax rates for high-income households at the beginning of this year. Excluding these
special payments, real DPI is estimated to have
increased at a modest annual rate of 1¼ percent over
the second half of the year, similar to the average
pace of increase over the recovery. The surge in dividend and bonus payments also led the personal saving rate to jump from 3.8 percent in the second quarter to 4.7 percent in the fourth quarter. In their
absence, the saving rate would have likely been little
changed over the second half of the year.
Households continue to pay down debt
and gain access to credit

Household debt—the sum of mortgage and consumer debt—edged down further in the third quarter
of 2012 as a continued contraction in mortgage debt
more than offset a solid expansion in consumer
credit. With the reduction in household debt, low levels of most interest rates, and modest income growth,
the household debt service ratio—the ratio of
required principal and interest payments on outstanding household debt to DPI—decreased further
and, at the end of the third quarter, stood at a level
last seen in 1983.
Consumer credit expanded at an annual rate of about
5¼ percent in the second half of 2012. Nonrevolving
credit (mostly auto loans and student loans), which
accounts for about two-thirds of total consumer
credit outstanding, drove the increase. Revolving
consumer credit (primarily credit card lending) was

12

99th Annual Report | 2012

Figure 9. Private housing starts, 1999–2013

Figure 10. Mortgage interest rates, 1995–2013

Millions of units, annual rate

Percent

9
1.8

Single-family

8
Fixed rate
7

1.4

6

1.0

5
.6

Multifamily

4
.2

1999

2001

2003

2005

2007

2009

2011

2013

Note: The data are monthly and extend through January 2013.
Source: Department of Commerce, Bureau of the Census.

Adjustable rate
1995

1998

2001

2004

3
2007

2010

2013

Note: The data, which are weekly and extend through February 20, 2013, are contract rates on 30-year mortgages.
Source: Federal Home Loan Mortgage Corporation.

about flat on net. Overall, the increase in nonrevolving consumer credit is consistent with banks’ recent
responses to the Senior Loan Officer Opinion Survey
on Bank Lending Practices (SLOOS), which indicated that demand had strengthened and standards
eased, on net, for auto loans.3
Changes in interest rates on consumer loans were
mixed over the second half of 2012. Interest rates on
auto loans declined a bit, as did most measures of
the spreads of rates on these loans over yields on
Treasury securities of comparable maturity. Interest
rates on credit card debt quoted by banks generally
declined slightly, while rates observed in credit card
offer mailings continued to increase.
The housing market recovery gained traction . . .

The housing market has continued to recover. Housing starts, sales of new and existing homes, and
builder and realtor sentiment all increased over the
second half of last year, and residential investment
rose at an annual rate of nearly 15 percent. Combined, single-family and multifamily housing starts
rose from an average annual rate of 740,000 in the
second quarter of last year to 900,000 in the fourth
quarter (figure 9). Activity increased most noticeably
in the smaller multifamily sector—where starts have
nearly reached pre-recession levels—as demand for
new housing has apparently shifted toward smaller
3

The SLOOS is available on the Federal Reserve Board’s website
at www.federalreserve.gov/boarddocs/SnLoanSurvey.

rental units and away from larger, typically owneroccupied single-family units.
. . . as mortgage interest rates reached record
lows and house prices rose . . .

Mortgage interest rates declined to historically low
levels toward the end of 2012—importantly reflecting
Federal Reserve policy actions—making housing
quite affordable for households with good credit ratings (figure 10). However, the spread between mortgage rates and yields on agency-guaranteed
mortgage-backed securities (MBS) remained elevated
by historical standards. This unusually wide spread
probably reflects still-elevated risk aversion and some
capacity constraints among mortgage originators.
Overall, refinance activity increased briskly over the
second half of 2012—though it was still less than
might have been expected, given the level of interest
rates—while the pace of mortgage applications for
home purchases remained sluggish. Recent responses
to the SLOOS indicate that banks’ lending standards
for residential mortgage loans were little changed
over the second half of 2012.
House prices, as measured by several national
indexes, continued to increase in the second half of
2012. For example, the CoreLogic repeat-sales index
rose 3½ percent (not an annual rate) over the last six
months of the year to reach its highest level since late
2008 (figure 11). This recent improvement notwith-

Monetary Policy and Economic Developments

Figure 11. Prices of existing single-family houses, 2002–12

13

Figure 12. Change in real business fixed investment,
2006–12

Index value
Percent, annual rate

Structures
Equipment and software

100
FHFA
index

30

90

20
H1

80
70

S&P/Case-Shiller
20-city index

10
+
0
_

60

CoreLogic
price index

10

H2

20

50

30
2003

2006

2009

2012

Note: The data are monthly and extend into 2012:Q4. Each index has been normalized so that its peak is 100. Both the CoreLogic price index and the FHFA index
include purchase transactions only. The S&P/Case-Shiller index reflects all arm’slength sales transactions in selected metropolitan areas.
Source: For CoreLogic, CoreLogic; for FHFA, Federal Housing Finance Agency; for
S&P/Case-Shiller, Standard & Poor’s.

standing, this measure of house prices remained
27 percent below its peak in early 2006.
. . . but the level of new construction remained
low, and mortgage delinquencies remained
elevated

Despite the improvements seen over the second half
of 2012, housing starts remained well below the
1960–2000 average of 1.5 million per year, as concerns about the job market and tight mortgage credit
for less-credit-worthy households continued to
restrain demand for housing. In addition, although
the number of vacant homes for sale has declined significantly, the stock of vacant homes held off the
market remained quite elevated. Once put on the
market, this “shadow” inventory, which likely
includes many bank-owned properties, may redirect
some demand away from new homes and toward
attractively priced existing homes. With home values
depressed and unemployment still high, measures of
late-stage mortgage delinquency, such as the inventory of properties in foreclosure, remained elevated,
keeping high the risk of homes transitioning to
vacant bank-owned properties.
Growth of business investment has slowed since
earlier in the recovery

After increasing at double-digit rates in 2010 and
2011, business expenditures on equipment and software (E&S) decelerated in 2012 (figure 12). Pent-up
demand for capital goods, an important contributor
to earlier increases in E&S spending, has likely

2006

2007

2008

2009

2010

2011

2012

Source: Department of Commerce, Bureau of Economic Analysis.

diminished as the recovery has aged. In addition,
concerns about possible threats to economic growth
and stability from U.S. fiscal policy and the situation
in Europe may have contributed to soft investment
spending in the middle of last year. As a result,
despite a pickup in the pace of gains toward the end
of the year, E&S investment increased at an annual
rate of 5 percent in the second half of the year, similar to the first-half pace. As for business investment
in structures, a sustained recovery has yet to take
hold, as high vacancy rates, tight credit for new construction, and low prices for commercial real estate
(CRE) are still hampering investment in new buildings. However, in the drilling and mining sector,
elevated oil prices and new drilling technologies have
kept investment in structures at a relatively high level.
Inventory investment remained at a moderate level in
the second half of last year, as limited growth in final
sales and the uncertain economic environment continued to limit firms’ incentives to accumulate inventories. Census Bureau measures of book-value
inventory-to-sales ratios, as well as surveys of private
inventory satisfaction and plans, generally suggest
that stocks were fairly well aligned with sales at the
end of 2012.
Corporate earnings growth slowed, but firms’
balance sheets remained strong

After having risen 6 percent over the first half of
2012, aggregate operating earnings per share for S&P
500 firms were about flat on a seasonally adjusted
basis in the second half of 2012, held down, in part,
by weak demand from Europe and some emerging
market economies (EMEs). However, the ratio of

14

99th Annual Report | 2012

corporate profits to gross national product in the second half of 2012 hovered around its historical high,
and cash flow remained solid. In addition, the ratio
of liquid assets to total assets for nonfinancial corporations was close to its highest level in more than
20 years, and the aggregate debt-to-asset ratio
remained low by historical standards.
With corporate credit quality remaining robust and
interest rates at historically low levels, nonfinancial
firms continued to raise funds at a strong pace in the
second half of 2012. Bond issuance by both
investment- and speculative-grade nonfinancial firms
was extraordinarily strong, although much of the
proceeds from bond issuance appeared to be earmarked for the refinancing of existing debt. Meanwhile, nonfinancial commercial paper (CP) outstanding was about unchanged. Issuance in the institutional segment of the syndicated leveraged loan
market accelerated in the second half of the year,
boosted by rapid growth of newly established collateralized loan obligations. Commercial and industrial
(C&I) loans outstanding at commercial banking
organizations in the United States continued to
expand at a brisk pace in the second half of 2012.
Moreover, according to the SLOOS, modest net fractions of banks continued to report having eased their
lending standards on C&I loans over the second half
of the year, and large net fractions of banks indicated having reduced the spread of rates on C&I
loans over their cost of funds, largely in response to
increased competition from other banks or nonbank
lenders.
Gross public equity issuance by nonfinancial firms
slowed a bit in the second half of 2012, held down by
a moderate pace of initial public offerings. Meanwhile, data for the third quarter of 2012 indicate that
net equity issuance remained deeply negative, as
share repurchases and cash-financed mergers by nonfinancial firms remained robust.
Borrowing conditions for small businesses
continued to improve, albeit more gradually than
for large firms

Borrowing conditions for small businesses continued
to improve over the second half of 2012, but as has
been the case in recent years, the improvement was
more gradual than for larger firms. Moreover, the
demand for credit from small firms apparently
remained subdued. C&I loans with original amounts
of $1 million or less—a large share of which likely
consist of loans to small businesses—rose slightly in
the second half of 2012, at about the same rate that

prevailed in the first half. Recent readings from the
Survey of Terms of Business Lending indicate that
the spreads charged by commercial banks on newly
originated C&I loans with original amounts less than
$1 million, while still quite elevated, continued to
decline.4
According to surveys conducted by the National
Federation of Independent Business during the second half of 2012, the fraction of small businesses
with borrowing needs stayed low. The net percentage
of respondents that found credit more difficult to
obtain than three months prior edged up, on balance,
over this period, as did the net percentage that
expected tighter credit conditions over the next three
months; both measures remained at relatively high
levels in the January survey.
Financial conditions in the commercial real
estate sector eased but remained relatively tight

Financial conditions in the CRE sector continued to
ease but remained relatively tight amid weak fundamentals. According to the SLOOS, a modest net fraction of banks reported having eased standards on
CRE loans over the second half of last year, and a
significant net fraction of banks reported increased
demand for such loans. Consistent with these readings, the multiyear contraction in banks’ holdings of
CRE loans continued to slow and, indeed, came
roughly to a halt as banks’ holdings of CRE loans
were about flat over the last quarter of 2012. Issuance of commercial mortgage-backed securities
(CMBS) continued to increase over the second half
of 2012 from the low levels observed in 2011. Nonetheless, the delinquency rate on loans in CMBS pools
remained extremely high, as some borrowers with
five-year loans issued in 2007 were unable to refinance upon the maturity of those loans because of
high loan-to-value ratios. While delinquency rates for
CRE loans at commercial banks continued to
decline, they remained somewhat elevated, especially
for construction and land development loans.
Budget strains for state and local governments
eased, but federal purchases continued
to decline

Strains on state and local government budgets appear
to have lessened some since earlier in the recovery.
Although federal grants provided to state governments in the American Recovery and Reinvestment
Act have essentially phased out, state and local tax
4

Data releases for the Survey of Terms of Business Lending are
available on the Federal Reserve Board’s website at www
.federalreserve.gov/releases/e2/default.htm.

Monetary Policy and Economic Developments

Figure 13. Change in real government expenditures on
consumption and investment, 2006–12

Figure 14. Change in real imports and exports of goods
and services, 2007–12
Percent, annual rate

Percent, annual rate

Federal
State and
local

Imports
Exports

9

15

6

10

3
H1 H2

H1

+
0
_

5
H2

3

2007

2008

2009

2010

2011

2012

Source: Department of Commerce, Bureau of Economic Analysis.

receipts, which have been increasing since 2010, rose
moderately further over the second half of last year.
Accordingly, after declining at an annual rate of
1½ percent in the first half of last year, real government purchases at the state and local level changed
little in the second half (figure 13). Similarly, employment levels at states and municipalities, which had
been declining since 2009, changed little, on balance,
over the second half of last year.
Federal purchases continued to decline over the second half of 2012, reflecting ongoing efforts to reduce
the budget deficit and the scaling back of overseas
military activities. As measured in the NIPA, real federal expenditures on consumption and gross investment—the part of federal spending included in the
calculation of GDP—fell at an annual rate of
3½ percent over the second half of 2012. Real
defense spending fell at an annual rate of a little over
6 percent, while nondefense purchases increased at an
annual rate of 2 percent.
The deficit in the federal unified budget remains
high. The budget deficit for fiscal year 2012 was
$1.1 trillion, or 7 percent of nominal GDP, down
from the deficit recorded in 2011 but still sharply
higher than the deficits recorded prior to the onset of
the last recession. The narrowing of the budget deficit relative to fiscal 2011 reflected an increase in tax
revenues that largely stemmed from the gradual
increase in economic activity as well as a decline in
spending. Despite the rise in tax revenues, the ratio of
federal receipts to national income, at 16 percent in
fiscal 2012, remained near the low end of the range
for this ratio over the past 60 years. The ratio of fed-

+
0
_
5

6

2006

15

2007

2008

2009

2010

2011

2012

Source: Department of Commerce, Bureau of Economic Analysis.

eral outlays to GDP declined but was still high by
historical standards, at 23 percent. With deficits still
large, federal debt held by the public rose to 73 percent of nominal GDP in the fourth quarter of 2012,
5 percentage points higher than at the end of 2011.
Net exports added modestly to real GDP growth

Real imports of goods and services contracted at an
annual rate of nearly 2 percent over the second half
of 2012, held back by the sluggish pace of U.S.
demand (figure 14). The decline in imports was fairly
broad based across major trading partners and categories of trade.
Real exports of goods and services also fell at an
annual rate of about 2 percent in the second half
despite continued expansion in demand from EMEs.
Exports were dragged down by a steep falloff in
demand from the euro area and declining export sales
to Japan, consistent with weak economic conditions
in those areas. In contrast, exports to Canada
remained essentially flat. Across the major categories
of exports, industrial supplies, automotive products,
and agricultural goods contributed to the overall
decrease.
Overall, real net exports added an estimated 0.1 percentage point to real GDP growth in the second half
of 2012, according to the advance estimate of GDP
from the Bureau of Economic Analysis, but data
received since then suggest a somewhat larger positive contribution.
The nominal trade deficit shrank, on net, over the
second half of 2012, contributing to the narrowing of

16

99th Annual Report | 2012

the current account deficit to 2¾ percent of GDP in
the third quarter. The trade deficit as a share of GDP
narrowed substantially in late 2008 and early 2009
when U.S. imports dropped sharply, in part reflecting
the steep decline in oil prices. Since then, the trade
deficit as a share of GDP has remained close to its
2009 level: Although imports recovered from their
earlier drop, exports strengthened as well.

Figure 15. Interest rates on Treasury securities at
selected maturities, 2004–13
Percent

5
10-year nominal

2
5-year TIPS

Expectations regarding the future stance
of monetary policy reflected the additional
accommodation provided by the
Federal Open Market Committee . . .

In response to the steps taken by the FOMC to provide additional monetary policy accommodation
over the second half of 2012, market participants
pushed out the date when they expect the federal
funds rate to first rise above its current target range
of 0 to ¼ percent. In particular, interest rates on
overnight index swaps indicate that investors currently anticipate that the effective federal funds rate

1
+
0
_
1

2005

2007

2009

2011

2013

Note: The data are daily and extend through February 21, 2013. Treasury inflationprotected securities (TIPS) are based on yield curves fitted by Federal Reserve
staff to on- and off-the-run TIPS.

National saving is very low

Financial Developments

3

5-year nominal

The current account deficit in the third quarter was
financed by strong inflows from foreign official institutions and by foreign private purchases of Treasury
securities and equities. More-recent data suggest continued strong foreign purchases of Treasury securities
and equities in the fourth quarter of 2012. Consistent
with improved market sentiment over the third quarter, U.S. investors also increased their holdings of
foreign assets.

Total U.S. net national saving—that is, the saving of
U.S. households, businesses, and governments, net of
depreciation charges—remains extremely low by historical standards. In the third quarter of last year, net
national saving as a percent of nominal GDP was
close to zero. The relative flatness of the national saving rate over the past few years reflects the offsetting
effects of a narrowing in the federal budget deficit as
a share of nominal GDP and a downward movement
in the private saving rate. National saving will likely
remain low this year, in light of the still-large federal
budget deficit. A portion of the decline in federal savings relative to pre-recession levels is cyclical and
would be expected to reverse as the economy recovers. If low levels of national saving persist over the
longer run, they will likely be associated with both
low rates of capital formation and heavy borrowing
from abroad, limiting the rise in the standard of living for U.S. residents over time.

4

Source: Department of the Treasury; Barclays; Federal Reserve Board staff
estimates.

will rise above its current target range around the
fourth quarter of 2014, roughly four quarters later
than they expected at the end of June 2012. Meanwhile, the modal target rate path—the most likely values for future federal funds rates derived from interest rate options—suggests that investors think the
rate is most likely to remain in its current range
through the first quarter of 2016. In addition, recent
readings from the Survey of Primary Dealers conducted by the Open Market Desk at the Federal
Reserve Bank of New York suggest that market participants expect the Federal Reserve to hold about
$3.75 trillion of Treasury and agency securities at the
end of 2014, roughly $1 trillion more than was
expected in the middle of 2012.5
. . . and held yields on longer-term Treasury
securities and agency mortgage-backed
securities near historic lows

Yields on nominal and inflation-protected Treasury
securities remained near historic lows over the second
half of 2012 and into 2013. Yields on longer-term
nominal Treasury securities rose, on balance, over
this period, while yields on inflation-protected securities fell (figure 15). These changes likely reflect the
effects of additional monetary accommodation, a
substantial improvement in sentiment regarding the
crisis in Europe that reduced demand for the relative
5

The Survey of Primary Dealers is available on the Federal
Reserve Bank of New York’s website at www.newyorkfed.org/
markets/primarydealer_survey_questions.html.

Monetary Policy and Economic Developments

safety and liquidity of nominal Treasury securities,
and increases in the prices of key commodities since
the end of June 2012. On balance, yields on 5-, 10-,
and 30-year nominal Treasury securities increased
roughly 15 basis points, 30 basis points, and 40 basis
points, respectively, from their levels at the end of
June 2012, while yields on 5- and 10-year inflationprotected securities decreased roughly 55 basis points
and 15 basis points, respectively. Treasury auctions
generally continued to be well received by investors,
and the Desk’s outright purchases and sales of
Treasury securities did not appear to have a material
adverse effect on liquidity or market functioning.

Figure 16. Spreads of corporate bond yields over
comparable off-the-run Treasury yields,
by securities rating, 1997–2013
Percentage points

18
16
14
12
10

High-yield

8
6
4

BBB

Yields on agency MBS were little changed, on net,
over the second half of 2012 and into 2013. They fell
sharply following the FOMC’s announcement of
additional agency MBS purchases in September but
retraced over subsequent months. Spreads of yields
on agency MBS over yields on nominal Treasury
securities narrowed, largely reflecting the effects of
the additional monetary accommodation. The Desk’s
outright purchases of agency MBS did not appear to
have a material adverse effect on liquidity or market
functioning, although implied financing rates for
some securities in the MBS dollar roll market
declined in the second half of 2012, and the Desk
responded by postponing settlement of some purchases using dollar roll transactions.6
Yields on corporate bonds reached record lows,
and equity prices increased

Yields on investment- and speculative-grade bonds
reached record lows in the second half of 2012 and
early 2013, respectively, partly reflecting the effects of
the FOMC’s additional monetary policy accommodation and increased investor appetite for bearing
risk. Spreads to comparable-maturity Treasury securities also narrowed substantially but remained above
the narrowest levels that they reached prior to the
financial crisis (figure 16). Prices in the secondary
market for syndicated leveraged loans have increased,
on balance, since the middle of 2012.
Broad equity price indexes have increased about
10 percent since the end of June 2012, boosted by the
same factors that contributed to the narrowing in
bond spreads. Nevertheless, the spread between the
6

Dollar roll transactions consist of a purchase or sale of agency
MBS with the simultaneous agreement to sell or purchase substantially similar securities on a specified future date. The Committee directs the Desk to engage in these transactions as necessary to facilitate settlement of the Federal Reserve’s agency
MBS purchases.

17

AA

2
+
0
_

1997 1999 2001 2003 2005 2007 2009 2011 2013
Note: The data are daily and extend through February 21, 2013. The spreads
shown are the yields on 10-year bonds less the 10-year Treasury yield.
Source: Derived from smoothed corporate yield curves using Merrill Lynch bond
data.

12-month forward earnings–price ratio for the S&P
500 and a long-run real Treasury yield—a rough
gauge of the equity risk premium—remained at the
high end of its historical range. Implied volatility for
the S&P 500 index, as calculated from option prices,
spiked at times but is currently near the bottom end
of the range it has occupied since the onset of the
financial crisis.
Conditions in short-term dollar funding markets
improved some in the third quarter and remained
stable thereafter

Measures of stress in unsecured dollar funding markets eased somewhat in the third quarter of 2012 and
remained stable at relatively low levels thereafter,
reflecting improved sentiment regarding the crisis in
Europe. For example, the average maturity of unsecured financial CP issued by institutions with European parents increased, on net, to around the same
length as such CP issued by institutions with U.S.
parents.
Signs of stress were largely absent in secured shortterm dollar funding markets. In the market for repurchase agreements (repos), bid–asked spreads and
haircuts for most collateral types have changed little
since the middle of 2012. However, repo rates continued to edge up over the second half of 2012, likely
reflecting in part the financing of the increase in
dealers’ inventories of shorter-term Treasury securities that resulted from the maturity extension program (MEP). Following year-end, repo rates fell back

18

99th Annual Report | 2012

Figure 17. Spreads on credit default swaps for selected
U.S. banking organizations, 2007–13
Basis points

400
350
300
Large bank
holding companies

250
200
150
100

Other banks
50
2007

2008

2009

2010

2011

2012

2013

Note: The data are daily and extend through February 21, 2013. Median spreads
for six large bank holding companies and nine other banks.
Source: Markit.

as the MEP came to an end and the level of reserve
balances began to increase. In asset-backed commercial paper (ABCP) markets, volumes outstanding
declined a bit for programs with European and U.S.
sponsors, while spreads on ABCP with European
bank sponsors remained slightly above those on
ABCP with U.S. bank sponsors.
Year-end pressures in short-term funding markets
were generally modest and roughly in line with the
experiences during other years since the financial
crisis.
Market sentiment toward the banking industry
improved as the profitability of banks increased

Market sentiment toward the banking industry
improved in the second half of 2012, reportedly
driven in large part by perceptions of reduced downside risks stemming from the European crisis. Equity
prices for bank holding companies (BHCs) increased,
outpacing the increases in broad equity price indexes,
and BHC credit default swap (CDS) spreads declined
(figure 17).
The profitability of BHCs increased in the second
half of 2012 but continued to run well below the levels that prevailed before the financial crisis. Measures
of asset quality generally improved further, as delinquency and charge-off rates decreased for almost all
major loan categories, although the recent improvement in delinquency rates for consumer credit in part
reflects a compositional shift of credit supply toward
higher-credit-quality borrowers. Loan loss provisions

were flat at around the slightly elevated levels seen
prior to the crisis, though they continued to be outpaced by charge-offs. Regulatory capital ratios
remained at high levels based on current standards,
but the implementation of generally more stringent
Basel III capital requirements will likely lead to some
decline in reported regulatory capital ratios at the
largest banks. Overall, banks remain well funded with
deposits, and their reliance on short-term wholesale
funding stayed near its low levels seen in recent quarters. The expiration of the Federal Deposit Insurance
Corporation’s Transaction Account Guarantee program on December 31, 2012, does not appear to have
caused any significant change in the availability of
deposit funding for banks.
Credit provided by commercial banking organizations in the United States increased in the second half
of 2012 at about the same moderate pace as in the
first half of the year. Core loans—the sum of C&I
loans, real estate loans, and consumer loans—expanded modestly, with strong growth in C&I loans
offsetting weakness in real estate and credit card
loans. Banks’ holdings of securities continued to rise
moderately overall, as strong growth in holdings of
Treasury and municipal securities more than offset
modest declines in holdings of agency MBS.
Despite continued improvements in market
conditions, risks to the stability of financial
markets remain

While conditions in short-term dollar funding markets have improved, these markets remain vulnerable
to potential stresses. Money market funds (MMFs)
have sharply reduced their overall exposures to
Europe since the middle of 2011, but prime fund
exposures to Europe continue to be substantial.
MMFs also remain susceptible to the risk of investor
runs due to structural vulnerabilities posed by the
rounding of net asset values and the absence of lossabsorbing capital.7
Dealer firms have reduced their wholesale short-term
funding ratios and have increased their liquidity buffers in recent years, but they still heavily rely on
wholesale short-term funding. As a result, they
remain susceptible to swings in market confidence
and a possible resurgence of anxiety regarding counterparty credit risk. Respondents to the Senior Credit
Officer Opinion Survey on Dealer Financing Terms
7

In November 2012, the Financial Stability Oversight Council
proposed recommendations for structural reforms of U.S.
MMFs to reduce their vulnerability to runs and mitigate associated risks to the financial system.

Monetary Policy and Economic Developments

19

indicated that credit terms applicable to important
classes of counterparties were little changed over the
second half of 2012.8 Dealers reported increased
demand for funding of securitized products and indicated that the use of financial leverage among trading real estate investment trusts, or REITs, had
increased somewhat. However, respondents continued to note an increase in the amount of resources
and attention devoted to the management of concentrated exposures to central counterparties and other
financial utilities as well as, to a smaller extent, dealers and other financial intermediaries.

sition of Treasury securities holdings also changed
over the second half of 2012 as a result of the continuation of the MEP, which was announced at the
June 2012 FOMC meeting. Under this program,
between July and December, the Desk purchased
$267 billion in Treasury securities with remaining
maturities of 6 to 30 years and sold or redeemed an
equal par value of Treasury securities with maturities
of 3 years or less. As a result, the average maturity of
the Federal Reserve’s Treasury holdings increased
1.7 years over the second half of 2012 and into 2013
and, as of February 2013, stood at 10.5 years.

With prospective returns on safe assets remaining
low, some financial market participants appeared
willing to take on more duration and credit risk to
boost returns. The pace of speculative-grade corporate bond issuance has been rapid in recent months,
and while most of this issuance appears to have been
earmarked for the refinancing of existing debt, there
has also been an increase in debt to facilitate transactions involving significant risks. In particular, in
bonds issued to finance private equity transactions,
there has been a reemergence of payment-in-kind
options that permit the issuer to increase the face
value of debt in lieu of a cash interest payment, and
anecdotal reports indicate that bond covenants are
becoming less restrictive. Similarly, issuance of bank
loans to finance dividend recapitalization deals as
well as covenant-lite loans was robust over the second
half of the year. (For a discussion of regulatory steps
taken related to financial stability, see the box “The
Federal Reserve’s Actions to Foster Financial Stability” on pages 30–31 of the February 2013 Monetary
Policy Report.)

. . . while exposure to facilities established during
the crisis continued to wind down

Federal Reserve assets increased, and the
average maturity of its Treasury holdings
lengthened . . .

Total assets of the Federal Reserve increased to
$3,097 billion as of February 20, 2013, $231 billion
more than at the end of June 2012 (table 1). The
increase primarily reflects growth in Federal Reserve
holdings of Treasury securities and agency MBS as a
result of the purchase programs initiated at the September 2012 and December 2012 FOMC meetings.
As of February 20, 2013, the par value of Treasury
securities and agency MBS held by the Federal
Reserve had increased $70 billion and $178 billion,
respectively, since the end of June 2012. The compo8

The Senior Credit Officer Opinion Survey on Dealer Financing
Terms is available on the Federal Reserve Board’s website at
www.federalreserve.gov/econresdata/releases/scoos.htm.

In the second half of 2012, the Federal Reserve continued to reduce its exposure to facilities established
during the financial crisis to support specific institutions. The portfolio holdings of Maiden Lane LLC
and Maiden Lane III LLC—entities that were created during the crisis to acquire certain assets from
The Bear Stearns Companies, Inc., and American
International Group, Inc., to avoid the disorderly
failures of those institutions—declined $14 billion to
approximately $1 billion, primarily reflecting the sale
of the remaining securities in Maiden Lane III LLC
that was announced in August 2012. These sales
resulted in a net gain of $6.6 billion for the benefit of
the U.S. public. The Federal Reserve’s loans to
Maiden Lane LLC and Maiden Lane III LLC had
been fully repaid, with interest, as of June 2012.
Loans outstanding under the Term Asset-Backed
Securities Loan Facility (TALF) decreased $4 billion
to under $1 billion because of prepayments and
maturities of TALF loans. With accumulated fees
collected through TALF exceeding the amount of
TALF loans outstanding, the Federal Reserve and
the Treasury agreed in January to end the backstop
for TALF provided by the Troubled Asset Relief
Program.
The improvement in offshore U.S. dollar funding
markets over the second half of 2012 led to a decline
in the outstanding amount of dollars provided
through the temporary U.S. dollar liquidity swap
arrangements with other central banks. As of February 20, 2013, draws on the liquidity swap lines were
$5 billion, down from $27 billion at the end of
June 2012. On December 13, 2012, the Federal
Reserve announced the extension of these arrangements through February 1, 2014.
On the liability side of the Federal Reserve’s balance
sheet, deposits held by depository institutions

20

99th Annual Report | 2012

Table 1. Selected components of the Federal Reserve balance sheet, 2012–13
Millions of dollars
Balance sheet item
Total assets
Selected assets
Credit extended to depository institutions and dealers
Primary credit
Central bank liquidity swaps
Credit extended to other market participants
Term Asset-Backed Securities Loan Facility (TALF)
Net portfolio holdings of TALF LLC
Support of critical institutions
Net portfolio holdings of Maiden Lane LLC, Maiden Lane II LLC, and
Maiden Lane III LLC1
Securities held outright
U.S. Treasury securities
Agency debt securities
Agency mortgage-backed securities (MBS)2
Total liabilities
Selected liabilities
Federal Reserve notes in circulation
Reverse repurchase agreements
Deposits held by depository institutions
Of which: Term deposits
U.S. Treasury, general account
U.S. Treasury, Supplementary Financing Account
Total capital

Feb. 22, 2012

June 27, 2012

Feb. 20, 2013

2,935,149

2,865,698

3,096,802

3
107,959

18
27,059

8
5,192

7,629
825

4,773
845

439
507

30,822

15,031

1,483

1,656,581
100,817
853,045
2,880,556

1,666,530
91,484
854,979
2,811,029

1,736,456
74,613
1,032,712
3,041,820

1,048,004
89,824
1,622,800
0
36,033
0
54,594

1,067,917
83,737
1,491,988
0
117,923
0
54,669

1,127,723
93,121
1,668,383
0
40,703
0
54,982

Note: LLC is a limited liability company.
1
The Federal Reserve has extended credit to several LLCs in conjunction with efforts to support critical institutions. Maiden Lane LLC was formed to acquire certain assets of
The Bear Stearns Companies, Inc. Maiden Lane II LLC was formed to purchase residential mortgage-backed securities from the U.S. securities lending reinvestment portfolio
of subsidiaries of American International Group, Inc. (AIG). Maiden Lane III LLC was formed to purchase multisector collateralized debt obligations on which the Financial
Products group of AIG has written credit default swap contracts.
2
Includes only MBS purchases that have already settled.
Source: Federal Reserve Board, Statistical Release H.4.1, “Factors Affecting Reserve Balances of Depository Institutions and Condition Statement of Federal Reserve Banks.”

increased $176 billion since June 2012, while Federal
Reserve notes in circulation rose $60 billion, reflecting solid demand both at home and abroad. M2 has
increased at an annual rate of about 8 percent since
June 2012. Holdings of M2 assets, including its largest component, liquid deposits, remain elevated relative to what would have been expected based on historical relationships with nominal income and interest rates, likely due to investors’ continued preference
to hold safe and liquid assets.
As part of its ongoing program to ensure the readiness of tools to manage reserves, the Federal Reserve
conducted a series of small-value reverse repurchase
transactions using all eligible collateral types with its
expanded list of counterparties, as well as a few
small-value repurchase agreements with primary
dealers. In the same vein, the Federal Reserve continued to offer small-value term deposits through the
Term Deposit Facility to provide eligible institutions
with an opportunity to become familiar with term
deposit operations.

International Developments
Foreign financial market stresses abated . . .

Since mid-July, global financial market conditions
have improved, on balance, in part reflecting reduced
fears of a significant worsening of the European fiscal and financial crisis. Market sentiment was bolstered by a new European Central Bank (ECB)
framework for purchases of sovereign debt known as
Outright Monetary Transactions (OMT), agreements
on continued official-sector support for Greece, progress by Spain in recapitalizing its troubled banks, and
some steps toward fiscal and financial integration in
Europe. Nevertheless, financial market stresses in
Europe remained elevated, and policymakers still
face significant challenges (see the box “An Update
on the European Fiscal and Banking Crisis” on page
32 of the February 2013 Monetary Policy Report).
Reduced concerns about the European crisis contributed to an easing of funding conditions for European
banks. Euro-area banks have relied somewhat less on

Monetary Policy and Economic Developments

Figure 18. Government debt spreads for peripheral
European economies, 2009–13

21

Figure 19. U.S. dollar exchange rate against broad index
and selected major currencies, 2010–13
Percent

December 31, 2009 = 100

32

120

28

Greece

115
Euro
110

24
20

105

Broad

16

100

12

95

8

Portugal

Ireland

90

Spain

4
+
0
_

Italy
2009

2010

2011

2012

2013

Note: The data are weekly. The last observation for each series is February 15,
2013. The spreads shown are the yields on 10-year bonds less the 10-year German bond yield.
Source: For Greece, Italy, Portugal, and Spain, Bloomberg; for Ireland, staff estimates using traded bond prices from Thomson Reuters and Bloomberg.

ECB funding in recent months, and use of central
bank dollar liquidity swap lines declined significantly.
Reflecting market views of the decreased risk of
default, CDS premiums on the debt of many large
banks in Europe dropped significantly, on net, especially for Italy and Spain, and euro-area bank stocks
increased about 30 percent since mid-2012.
As risk sentiment improved, foreign equity indexes
rose significantly: Over the second half of 2012 and
into early 2013, equity indexes increased about
10 percent for the United Kingdom and Canada,
about 15 percent in the euro area, and about 25 percent in Japan; equity indexes in EMEs also moved up
across the board. Likewise, yields on 10-year government bonds in many countries increased moderately,
though Japanese yields remained below 1 percent.
Spreads of peripheral European sovereign yields over
German bond yields of comparable maturity
declined significantly as overall euro-area financial
strains abated (figure 18). Corporate credit spreads
also declined, and bond issuance picked up.
The U.S. dollar depreciated nearly 1 percent against a
broad set of currencies over the second half of 2012
and into early 2013 (figure 19). Some of this depreciation reflected a reversal of flight-to-safety flows, in
part stemming from the reduction in European financial stress. Indeed, the dollar depreciated 4 percent
against the euro. In contrast, the dollar appreciated
17 percent against the Japanese yen. Most of this rise
came in recent months, as Shinzo Abe, the newly

Japanese yen

85
80

2010

2011

2012

2013

Note: The data, which are in foreign currency units per dollar, are daily. The last
observation for each series is February 21, 2013.
Source: Federal Reserve Board, Statistical Release H.10, “Foreign Exchange
Rates.”

elected prime minister of Japan, called for the Bank
of Japan to employ “unlimited easing” of monetary
policy to overcome deflation.
. . . but economic activity in the advanced foreign
economies continued to weaken . . .

Despite the easing of financial stresses in the euro
area and some improvement in global financial markets, activity in the advanced foreign economies
(AFEs) continued to lose steam in the second half of
2012. The euro area fell further into recession, as fiscal austerity, rising unemployment, and depressed
confidence restrained spending, especially in the
countries at the center of the crisis. Real GDP also
contracted in Japan, reflecting plummeting exports.
In the United Kingdom, real GDP growth resumed
in the third quarter, partly thanks to a temporary
boost to demand from the London Olympics, but
contracted again in the fourth quarter. Canadian real
GDP growth remained positive but also weakened,
largely owing to lower external demand. Survey indicators suggest that conditions in the AFEs improved
only marginally around the turn of the year. Amid
this weakness in economic activity and limited pressures from commodity prices, inflation readings for
most AFEs remained contained.
Several foreign central banks expanded their balance
sheets further and took other actions to support their
economies. In addition to its introduction of the
OMT, the ECB lowered its main policy rate. The
Bank of England completed its latest round of asset

22

99th Annual Report | 2012

purchases, bringing its holdings to £375 billion, and
began the implementation of its Funding for Lending Scheme, designed to boost lending to households
and firms. The Bank of Japan took a number of
steps. It introduced a new Stimulating Bank Lending
Facility in October and raised its inflation target
from 1 percent to 2 percent in January. In addition, it
increased the size of its Asset Purchase Program by
¥30 trillion, to ¥101 trillion, by the end of 2013 and
announced that purchases would be open ended
beginning in 2014.
. . . even as economic growth stabilized in
emerging market economies

After slowing earlier in the year, in part because of
headwinds associated with Europe’s troubles, economic growth in EMEs stabilized in the third quarter
and appeared to pick up in the fourth. This modest
pickup in economic activity in the face of continued
weakness in exports to advanced economies was supported by monetary and fiscal policy stimulus.
In China, following slower growth in the first half of
2012, stimulus measures helped boost the pace of real
GDP growth in the second half of the year.
Improved economic conditions in China also provided a lift to other emerging Asian economies. GDP
accelerated in Hong Kong and Taiwan in the third
quarter; in the fourth quarter, exports and purchasing managers indexes moved higher in most of the
region, and GDP growth rebounded in a number of
economies.
After stagnating for about a year, economic activity
in Brazil picked up in the third quarter to a stilllackluster pace of 2½ percent. Indicators for the
fourth quarter suggest a further modest pickup, supported by accommodative policies. In contrast, GDP
growth in Mexico continued to fall in the third quarter as the growth of U.S. manufacturing production
slowed; however, Mexican growth picked up to 3 percent in the fourth quarter, boosted by services and
the volatile agricultural sector.
Despite occasional spikes in food prices, inflation in
most emerging Asian economies remained well contained as moderate output growth limited broader
price pressures. India was a notable exception, with
12-month inflation around 10 percent in recent
months. In some Latin American economies,
increases in food prices had a greater effect on inflation than in Asia, leading to 12-month price increases
of around 5½ percent in Brazil and around 4¼ percent in Mexico over the second half of last year.

Part 2
Monetary Policy
To promote the objectives given to it by the Congress,
the Federal Open Market Committee (FOMC) provided additional monetary accommodation at its
September 2012 and December 2012 meetings, by
both strengthening its forward guidance regarding
the federal funds rate and initiating additional asset
purchases.
As discussed in Part 1, incoming economic data
throughout the second half of 2012 and into 2013
indicated that economic activity was expanding at a
moderate pace. Employment gains were modest, and
although the unemployment rate declined somewhat
over the period, it remained elevated relative to levels
that almost all members of the FOMC viewed as
consistent with the Committee’s dual mandate. Inflation remained subdued, apart from some temporary
variations that largely reflected fluctuations in commodities prices. Members generally attached an
unusually high level of uncertainty to their assessments of the economic outlook. Moreover, they continued to judge that the risks to economic growth
were tilted to the downside because of strains in
financial markets stemming from the sovereign debt
and banking situation in Europe, as well as the
potential for a significant slowdown in global economic growth and for a sharper-than-anticipated fiscal contraction in the United States. With longerterm inflation expectations stable and stillconsiderable slack in resource markets, most
members anticipated that inflation over the medium
term would run at or below the Committee’s longerrun goal of 2 percent.
Accordingly, to promote the FOMC’s objectives of
maximum employment and price stability, the Committee maintained a target range for the federal funds
rate of 0 to ¼ percent throughout the second half of
2012 and provided additional monetary accommodation at its September and December meetings, by
both strengthening its forward guidance regarding
the federal funds rate and initiating additional purchases of longer-term securities. The Committee also
completed at year-end the continuation of the program to extend the average maturity of its holdings
of Treasury securities that was announced in
June 2012 and continued its policy of reinvesting
principal payments from its holdings of agency debt
and agency-guaranteed mortgage-backed securities
(MBS) into agency MBS.

Monetary Policy and Economic Developments

23

Box 2. Efficacy and Costs of Large-Scale Asset Purchases
In order to provide additional monetary stimulus
when short-term interest rates are near zero, the
Federal Reserve has undertaken a series of largescale asset purchase (LSAP) programs. Between
late 2008 and early 2010, the Federal Reserve purchased approximately $1.7 trillion in longer-term
Treasury securities, agency debt, and agency
mortgage-backed securities (MBS). From late
2010 to mid-2011, a second round of LSAPs was
implemented, consisting of purchases of $600 billion
in longer-term Treasury securities. Between September 2011 and the end of 2012, the Federal Reserve
implemented the maturity extension program and its
continuation, under which it purchased approximately $700 billion in longer-term Treasury securities and sold or allowed to run off an equal amount
of shorter-term Treasury securities. And in September and December 2012, the Federal Reserve
announced flow-based purchases of agency MBS
and longer-term Treasury securities at initial paces
of $40 billion and $45 billion per month, respectively.
These purchases were undertaken in order to put
downward pressure on longer-term interest rates,
support mortgage markets, and help to make
broader financial conditions more accommodative,
thereby supporting the economic recovery. One
mechanism through which asset purchases can
affect financial conditions is the “portfolio balance
channel,” which is based on the premise that different financial assets may be reasonably close but
imperfect substitutes in investors’ portfolios. This
assumption implies that changes in the supplies of
various assets available to private investors may
affect the prices or yields of those assets and the
prices of assets that may be reasonably close substitutes. As a result, the Federal Reserve’s asset
purchases can push up the prices and lower the
yields on the securities purchased and influence
other asset prices as well. As investors further rebal-

ance their portfolios, overall financial conditions
should ease more generally, stimulating economic
activity through channels similar to those for conventional monetary policy. In addition, asset purchases
could also signal that the central bank intends to
pursue a more accommodative policy stance than
previously thought, thereby lowering investor expectations about the future path of the federal funds
rate and putting additional downward pressure on
longer-term yields.
A substantial body of empirical research finds that
the Federal Reserve’s asset purchase programs
have significantly lowered longer-term Treasury
yields.1 More important, the effects of LSAPs do not
1

For a selective list of references regarding the effect of the first
LSAP, see the box “The Effects of Federal Reserve Asset Purchases” in Board of Governors of the Federal Reserve System
(2011), Monetary Policy Report to the Congress (Washington:
Board of Governors, March), www.federalreserve.gov/
monetarypolicy/mpr_20110301_part2.htm. For additional references, including those that analyze the effect of the second
LSAP as well as the maturity extension program, see, for
example, Stefania D’Amico, William English, David LópezSalido, and Edward Nelson (2012), “The Federal Reserve’s
Large-Scale Asset Purchase Programmes: Rationale and
Effects,” Economic Journal, vol. 122 (November), pp. F415–45;
Arvind Krishnamurthy and Annette Vissing-Jorgensen (2011),
“The Effects of Quantitative Easing on Interest Rates: Channels
and Implications for Policy,” Brookings Papers on Economic
Activity, Fall, pp. 215–65; Canlin Li and Min Wei (2012), “Term
Structure Modelling with Supply Factors and the Federal
Reserve’s Large Scale Asset Purchase Programs,” Finance and
Economics Discussion Series 2012-37 (Washington: Board of
Governors of the Federal Reserve System, May), www
.federalreserve.gov/pubs/feds/2012/201237/201237pap.pdf, and
references in those studies. For work that specifically emphasizes the signaling channel of LSAPs, see, for example, Michael
D. Bauer and Glenn D. Rudebusch (2012), “The Signaling Channel for Federal Reserve Bond Purchases,” Working Paper Series
2011-21 (San Francisco: Federal Reserve Bank of San Francisco, August), www.frbsf.org/publications/economics/papers/
2011/wp11-21bk.pdf. For work that focuses on the effects on
credit default risk, see, for example, Simon Gilchrist and Egon
Zakrajšek (2012), “The Impact of the Federal Reserve’s Large-

(continued on next page)

At the September 12–13 meeting, the Committee
agreed that the outlook called for additional monetary accommodation, and that such accommodation
should be provided by both strengthening its forward
guidance regarding the federal funds rate and initiating additional purchases of agency MBS at a pace of
$40 billion per month. Along with the ongoing purchases of $45 billion per month of longer-term
Treasury securities under the maturity extension program announced in June, these purchases increased
the Committee’s holdings of longer-term securities
by about $85 billion each month through the end of
the year. These actions were taken to put downward
pressure on longer-term interest rates, support mort-

gage markets, and help make broader financial conditions more accommodative (see box 2, “Efficacy and
Costs of Large-Scale Asset Purchases”). The Committee agreed that it would closely monitor incoming
information on economic and financial developments
in coming months, and that if the outlook for the
labor market did not improve substantially, it would
continue its purchases of agency MBS, undertake
additional asset purchases, and employ its other
policy tools as appropriate until such improvement is
achieved in a context of price stability. The Committee also agreed that in determining the size, pace, and
composition of its asset purchases, it would, as
always, take appropriate account of the likely efficacy

24

99th Annual Report | 2012

Box 2. Efficacy and Costs of Large-Scale Asset Purchases—continued
seem to be restricted to Treasury yields. In particular, LSAPs have been found to be associated with
significant declines in MBS yields and corporate
bond yields as well as with increases in equity
prices.
While there seems to be substantial evidence that
LSAPs have lowered longer-term yields and eased
broader financial conditions, obtaining accurate estimates of the effects of LSAPs on the macroeconomy is inherently difficult, as the counterfactual
case—how the economy would have performed
without LSAPs—cannot be directly observed. However, econometric models can be used to estimate
the effects of LSAPs on the economy under the
assumption that the economic effects of the easier
financial conditions that are induced by LSAPs are
similar to those that are induced by conventional
monetary policy easing. Model simulations conducted at the Federal Reserve have generally found
that asset purchases provide a significant boost to
the economy. For example, a study based on the
Federal Reserve Board’s FRB/US model estimated
that, as of 2012, the first two rounds of LSAPs had
raised real gross domestic product almost 3 percent
and increased private payroll employment by about
3 million jobs, while lowering the unemployment rate
Scale Asset Purchase Programs on Default Risk,” paper presented at “Macroeconomics and Financial Intermediation: Directions since the Crisis,” a conference held at the National Bank of
Belgium, Brussels, December 9–10, 2011. Although the majority
of research on the effects of LSAPs appears to support a significant influence on asset prices, the overall result of such programs is generally difficult to estimate precisely: Event studies
can make only sharp predictions on the effects within a relatively
short time horizon, whereas approaches based on time-series
models tend to face challenges in isolating the effects of the programs from other economic developments. For a more skeptical
view on the effect of LSAPs, see, for example, Daniel L. Thornton (2012), “Evidence on the Portfolio Balance Channel of Quantitative Easing,” Working Paper Series 2012-015A (St. Louis:
Federal Reserve Bank of St. Louis, October), http://research
.stlouisfed.org/wp/2012/2012-015.pdf.

and costs of such purchases. This flexible approach
was seen as allowing the Committee to tailor its
policy over time in response to incoming information
while clarifying its intention to improve labor market
conditions, thereby enhancing the effectiveness of the
action by helping to bolster business and consumer
confidence.
The Committee also modified its forward guidance
regarding the federal funds rate at the September
meeting, noting that exceptionally low levels for the
federal funds rate were likely to be warranted at least
through mid-2015, longer than had been indicated in
previous FOMC statements. Moreover, the Commit-

about 1.5 percentage points, relative to what would
have been expected otherwise. These simulations
also suggest that the program materially reduced
the risk of deflation.2
Of course, all model-based estimates of the macroeconomic effects of LSAPs are subject to considerable statistical and modeling uncertainty and thus
should be treated with caution. Indeed, while some
other studies also report significant macroeconomic
effects from asset purchases, other research finds
smaller effects.3 Nonetheless, a balanced reading of
the evidence supports the conclusion that LSAPs
have provided meaningful support to the economic
recovery while mitigating deflationary risks.
2

3

These results are discussed further in Hess Chung, JeanPhilippe Laforte, David Reifschneider, and John C. Williams
(2012), “Have We Underestimated the Likelihood and Severity of
Zero Lower Bound Events?” Journal of Money, Credit and Banking, vol. 44 (February supplement), pp. 47–82.
For studies reporting significant macroeconomic effects from
asset purchases, see, for example, Jeffrey C. Fuhrer and Giovanni P. Olivei (2011), “The Estimated Macroeconomic Effects of
the Federal Reserve’s Large-Scale Treasury Purchase Program,” Public Policy Briefs 11-02 (Boston: Federal Reserve
Bank of Boston, April), www.bos.frb.org/economic/ppb/2011/
ppb112.pdf; and Christiane Baumeister and Luca Benati (2012),
“Unconventional Monetary Policy and the Great Recession: Estimating the Macroeconomic Effects of a Spread Compression at
the Zero Lower Bound,” Working Papers 2012-21 (Ottawa: Bank
of Canada, July), www.bankofcanada.ca/wp-content/uploads/
2012/07/wp2012-21.pdf. Also, the Bank of England has implemented LSAPs similar to those undertaken by the Federal
Reserve, and its staff research finds that the effects appear to
be quantitatively similar to those in the United States.
For studies reporting smaller effects from asset purchases, see,
for example, Michael T. Kiley (2012), “The Aggregate Demand
Effects of Short- and Long-Term Interest Rates,” Finance and
Economics Discussion Series 2012-54 (Washington: Board of
Governors of the Federal Reserve System, August), www
.federalreserve.gov/pubs/feds/2012/201254/201254pap.pdf; and
Han Chen, Vasco Curdia, and Andrea Ferrero (2012), “The Macroeconomic Effects of Large-Scale Asset Purchase Programmes,” Economic Journal, vol. 122 (November),
pp. F289–315.

tee stated its expectation that a highly accommodative stance of monetary policy would remain appropriate for a considerable time after the economic
recovery strengthens. The new language was meant to
clarify that the Committee’s anticipation that exceptionally low levels for the federal funds rate were
likely to be warranted at least through mid-2015 did
not reflect an expectation that the economy would
remain weak, but rather reflected the Committee’s
determination to support a stronger economic
recovery.
At the December 11–12 meeting, members judged
that continued provision of monetary accommoda-

Monetary Policy and Economic Developments

25

Box 2. Efficacy and Costs of Large-Scale Asset Purchases—continued
The potential benefits of LSAPs must be considered
alongside their possible costs. One potential cost of
conducting additional LSAPs is that the operations
could lead to a deterioration in market functioning or
liquidity in markets where the Federal Reserve is
engaged in purchasing. More specifically, if the Federal Reserve becomes too dominant a buyer in a
certain market, trading among private participants
could decrease enough that market liquidity and
price discovery become impaired. As the global
financial system relies on deep and liquid markets
for U.S. Treasury securities, significant impairment
of this market would be especially costly; impairment
of this market could also impede the transmission of
monetary policy. Although the large volume of the
Federal Reserve’s purchases relative to the size of
the markets for Treasury or agency securities could
ultimately become an issue, few if any problems
have been observed in those markets thus far.
A second potential cost of LSAPs is that they may
undermine public confidence in the Federal
Reserve’s ability to exit smoothly from its accommodative policies at the appropriate time. Such a
reduction in confidence might increase the risk that
long-term inflation expectations become unanchored. The Federal Reserve is certainly aware of
these concerns and accordingly has placed great
emphasis on developing the necessary tools to
ensure that policy accommodation can be removed
when appropriate. For example, the Federal
Reserve will be able to put upward pressure on
short-term interest rates at the appropriate time by
raising the interest rate it pays on reserves, using
draining tools like reverse repurchase agreements or
term deposits with depository institutions, or selling
securities from the Federal Reserve’s portfolio. To
date, the expansion of the balance sheet does not
appear to have materially affected long-term inflation
expectations.
A third cost to be weighed is that of risks to financial
stability. For example, some observers have raised
concerns that, by driving longer-term yields lower,
nontraditional policies could induce imprudent risktaking by some investors. Of course, some risk-

tion was warranted in order to support further progress toward the Committee’s goals of maximum
employment and price stability. The Committee
judged that, following the completion of the maturity
extension program at the end of the year, such
accommodation should be provided in part by continuing to purchase agency MBS at a pace of $40 billion per month and by purchasing longer-term Treasury securities at a pace initially set at $45 billion per
month. The Committee also decided that, starting in

39

444

taking is a necessary element of a healthy economic
recovery, and accommodative monetary policiescould even serve to reduce the risk in the system
by strengthening the overall economy. Nonetheless,
the Federal Reserve has substantially expanded its
monitoring of the financial system and modified its
supervisory approach to take a more systemic
perspective.
There has been limited evidence so far of excessive
buildups of duration, credit risk, or leverage, but the
Federal Reserve will continue both its careful oversight and its implementation of financial regulatory
reforms designed to reduce systemic risk.4
The Federal Reserve has remitted substantial
income to the Treasury from its earnings on securities, totaling some $290 billion since 2009. However,
if the economy continues to strengthen and policy
accommodation is withdrawn, remittances will likely
decline in coming years. Indeed, in some scenarios,
particularly if interest rates were to rise quickly,
remittances to the Treasury could be quite low for a
time.5 Even in such scenarios, however, average
annual remittances over the period affected by the
Federal Reserve’s purchases are highly likely to be
greater than the pre-crisis norm, perhaps substantially so. Moreover, if monetary policy promotes a
stronger recovery, the associated reduction in the
federal deficit would far exceed any variation in the
Federal Reserve’s remittances to the Treasury. That
said, the Federal Reserve conducts monetary policy
to meet its congressionally mandated objectives of
maximum employment and price stability and not
primarily for the purpose of turning a profit for the
U.S. Department of the Treasury.
4

5

For additional details, see the box “The Federal Reserve’s
Actions to Foster Financial Stability” on page 30 of the February 2013 Monetary Policy Report.
For additional details, see Seth B. Carpenter, Jane E. Ihrig,
Elizabeth C. Klee, Daniel W. Quinn, and Alexander H. Boote
(2013), “The Federal Reserve’s Balance Sheet and Earnings: A
primer and projections,” Finance and Economics Discussion
Series 2013-01 (Washington: Board of Governors of the Federal
Reserve System, January), www.federalreserve.gov/pubs/feds/
2013/201301/201301abs.html.

January, it would resume rolling over maturing Treasury securities at auction.
With regard to its forward rate guidance, the Committee decided to indicate in the statement that it
expects the highly accommodative stance of monetary policy to remain appropriate for a considerable
time after the asset purchase program ends and the
economic recovery strengthens. In addition, it
replaced the date-based guidance for the federal

26

99th Annual Report | 2012

funds rate with numerical thresholds linked to the
unemployment rate and projected inflation. In particular, the Committee indicated that it expected that
the exceptionally low range for the federal funds rate
would be appropriate at least as long as the unemployment rate remains above 6½ percent, inflation
between one and two years ahead is projected to be
no more than ½ percentage point above the Committee’s 2 percent longer-run goal, and longer-term
inflation expectations continue to be well anchored.
These thresholds were seen as helping the public to
more readily understand how the likely timing of an
eventual increase in the federal funds rate would shift
in response to unanticipated changes in economic
conditions and the outlook. Accordingly, thresholds
could increase the probability that market reactions
to economic developments would move longer-term
interest rates in a manner consistent with the Committee’s assessment of the likely future path of shortterm interest rates. The Committee indicated in its
December statement that it viewed the economic
thresholds, at least initially, as consistent with its earlier, date-based guidance. The new language noted

that the Committee would also consider other information when determining how long to maintain the
highly accommodative stance of monetary policy,
including additional measures of labor market conditions, indicators of inflation pressures and inflation
expectations, and readings on financial
developments.
At the conclusion of its January 29–30 meeting, the
Committee made no changes to its target range for
the federal funds rate, its asset purchase program, or
its forward guidance for the federal funds rate. The
Committee stated that, with appropriate policy
accommodation, it expected that economic growth
would proceed at a moderate pace and the unemployment rate would gradually decline toward levels the
Committee judges consistent with its dual mandate.
It noted that strains in global financial markets had
eased somewhat, but that it continued to see downside risks to the economic outlook. The Committee
continued to anticipate that inflation over the
medium term likely would run at or below its 2 percent objective.

Monetary Policy and Economic Developments

Monetary Policy Report of July 2012
Part 1
Overview: Monetary Policy
and the Economic Outlook
The pace of economic recovery appears to have
slowed during the first half of this year, with real
gross domestic product (GDP) likely having risen at
only a modest pace. In the labor market, the rate of
job gains has diminished recently, and, following a
period of improvement, the unemployment rate has
been little changed at an elevated level since January.
Meanwhile, consumer price inflation over the first
five months of 2012 was lower, on net, than in 2011,
and longer-term inflation expectations have remained
stable. A number of factors will likely restrain economic growth in the period ahead, including weak
economic growth abroad and a fiscal environment
that looks set to become less accommodative. Uncertainty about these factors may also restrain household and business spending. In addition, credit conditions are likely to improve only gradually, as are
still-elevated inventories of vacant and foreclosed
homes. Moreover, the possibility of a further material
deterioration of conditions in Europe, or of a particularly severe change in U.S. fiscal conditions, poses
significant downside risks to the outlook.
Against this backdrop, the Federal Open Market
Committee (FOMC) took steps to provide additional
monetary policy accommodation during the first half
of 2012. In particular, the Committee changed its
forward guidance regarding the period over which it
anticipates the federal funds rate to remain at exceptionally low levels and announced a continuation of
its maturity extension program (MEP) through the
end of the year. These policies put downward pressure on longer-term interest rates and made broad
financial conditions more accommodative than they
would otherwise be, thereby supporting the economic
recovery.
The European fiscal and banking crisis has remained
a major source of strain on global financial markets.
Early in the year, financial stresses within the euro
area moderated somewhat in light of a number of
policy actions: The European Central Bank (ECB)
provided ample liquidity to the region’s banks, euroarea leaders agreed to increase the lending capacity
of their rescue facilities, and a new assistance package for Greece was approved following a restructuring of Greek sovereign debt. However, tensions

27

within the euro area increased again in the spring as
political uncertainties rekindled fears of a disorderly
Greek exit from the euro area and mounting losses at
Spanish banks renewed questions about the sustainability of Spain’s sovereign debt and the resiliency of
the euro-area banking system. As yields on the government debt of Spain and other vulnerable European countries rose toward new highs, euro-area
leaders responded with additional policy measures in
late June, including increasing the flexibility of the
region’s financial backstops and making progress
toward greater cooperation in the supervision and, as
necessary, recapitalization of Europe’s banks. Many
critical details, however, remain to be worked out
against a backdrop of continued economic weakness
and political strain.
Financial markets were somewhat volatile over the
first half of 2012 mostly due to fluctuating views
regarding the crisis in the euro area and the likely
pace of economic growth at home and abroad. As
investors’ concerns about the situation in Europe
eased early in the year and with data releases generally coming in to the upside of market expectations,
broad equity price indexes rose and risk spreads in
several markets narrowed. Subsequently, however,
market participants pulled back from riskier assets
amid renewed concerns about the euro area and evidence of slowing global economic growth. Reflecting
these developments but also owing to the lengthening
of the forward rate guidance, continuation of the
MEP, and increased expectations by market participants of additional balance sheet actions by the Federal Reserve, yields on longer-term Treasury securities and corporate debt as well as rates on residential
mortgages declined, on net, and reached historically
low levels at times during the first half of the year.
On balance since the beginning of the year, broad
equity prices rose as corporate earnings remained
fairly resilient through the first quarter.
After rising at an annual rate of 2½ percent in the
second half of 2011, real GDP increased at a 2 percent pace in the first quarter of 2012, and available
indicators point to a still smaller gain in the second
quarter. Private spending continues to be weighed
down by a range of factors, including uncertainty
about developments in Europe and the path for U.S.
fiscal policy, concerns about the strength and sustainability of the recovery, the still-anemic state of the
housing market, and the difficulties that many
would-be borrowers continue to have in obtaining
credit. Such considerations have made some businesses more cautious about increasing investment or

28

99th Annual Report | 2012

materially expanding their payrolls and have led
households to remain quite pessimistic about their
income and employment prospects. Smoothing
through the effects of unseasonably warm weather
this past winter, activity in the housing sector appears
to have been a little stronger so far this year. However, the level of housing activity remains low and
continues to be held down by tight mortgage credit.
Meanwhile, the drag on real GDP growth from government purchases is likely to persist, as budgets for
state and local governments remain strained and federal fiscal policy is likely to become more restrictive
in 2013.
In the labor market, gains in private payroll employment averaged 225,000 jobs per month in the first
quarter, up from 165,000 jobs per month in the second half of last year, but fell back in the second
quarter to just 90,000 jobs per month. Although the
slowing in the pace of net job creation may have been
exaggerated by issues related to swings in the weather
and to seasonal adjustment difficulties associated
with the timing of the sharpest job losses during the
recession, those factors do not appear to fully
account for the slowdown. The unemployment rate
declined from about 9 percent last summer to a stillelevated 8¼ percent in January, and it has remained
close to that level since then. Likewise, long-term joblessness has shown little net improvement this year,
with the share of those unemployed persons who
have been jobless for six months or longer remaining
around 40 percent. Further meaningful reductions in
unemployment are likely to require some pickup in
the pace of economic activity.
Consumer price inflation moved down, on net, during the first half of the year. The price index for overall personal consumption expenditures (PCE) rose
rapidly in the first three months of the year, reflecting large increases in oil prices, but inflation turned
down in the spring when oil prices more than
reversed their earlier run-ups. In all, the PCE price
index increased at an annual rate of about 1½ percent over the first five months of the year, compared
with a rise of 2½ percent during 2011. Excluding
food and energy, consumer prices rose at about a
2 percent rate over the first five months of the year,
close to the pace recorded over 2011. In addition to
the net decline in crude oil prices over the first half of
the year, factors contributing to low consumer price
inflation this year include the deceleration of non-oil
import prices in the latter part of 2011, subdued
labor costs associated with the weak labor market,
and stable inflation expectations.

In the household sector, credit conditions have generally remained tight for all but highly rated borrowers;
among other factors, this tightness reflects the uncertain economic outlook and the high unemployment
rate. Total mortgage debt decreased further as the
pace of mortgage applications to purchase a new
home was sluggish. Refinancing activity increased
over the course of the second quarter but remained
below levels reached in previous refinancing booms
despite historically low mortgage interest rates. The
increase in refinancing was partially attributable to
recent enhancements made to the Home Affordable
Refinance Program that appeared to boost refinancing activity somewhat for borrowers with underwater
mortgages—that is, for those who owed more on
their mortgages than their homes were worth. Consumer credit expanded moderately mainly because of
growth in federal student loans.
Firms in the nonfinancial corporate sector continued
to raise funds at a generally moderate pace in the first
half of the year. Those with access to capital markets
took advantage of low interest rates to refinance
existing debt. As a result, corporate debt issuance
was solid over the first part of the year, although
issuance of speculative-grade corporate bonds weakened notably in June as investors pulled back from
riskier assets. Commercial and industrial loans on the
books of banks expanded briskly, but borrowing
conditions for small businesses have improved more
slowly than have those for larger firms. Financing
conditions for commercial real estate stayed relatively
restrictive, and fundamentals in that sector showed
few signs of improvement.
Market sentiment toward major global banks fluctuated in the first half of 2012. In March, the release of
the results from the Comprehensive Capital Analysis
and Review, which investors interpreted as indicating
continued improvements in the health of domestic
banks, provided a significant boost to the equity
prices of U.S. financial institutions. Those gains partially reversed when market sentiment worsened in
May, driven in large part by concerns about Europe
and potential spillovers to the United States and its
financial institutions. On balance, however, equity
prices of banks rose significantly from relatively low
levels at the start of the year. An index of credit
default swap spreads for the large bank holding companies declined about 60 basis points, but those
spreads remained at a high level. Despite the swings
in market sentiment about global banking organizations, conditions in unsecured short-term dollar
funding markets were fairly stable in the first half of

Monetary Policy and Economic Developments

2012. European financial institutions have reduced
their demand for dollar funding over recent quarters,
and general funding pressures apparently were alleviated by the ECB’s longer-term refinancing
operations.
With the Committee anticipating only slow progress
in bringing unemployment down toward levels that it
judges to be consistent with its dual mandate and
strains in global financial markets continuing to pose
significant downside risks to the economic outlook,
the FOMC took additional steps to augment the
already highly accommodative stance for monetary
policy during the first half of 2012. In January, the
Committee modified its forward rate guidance, noting that economic conditions were likely to warrant
exceptionally low levels for the federal funds rate at
least through late 2014. And in June, the FOMC
decided to continue the MEP until the end of the
year rather than completing the program at the end
of June as previously scheduled.
The June Summary of Economic Projections is presented in Part 4 of the July 2012 Monetary Policy
Report on pages 43–55 (it is also included in the
“Minutes” section of this annual report on page 203).
At the time of the Committee’s June meeting,
FOMC participants (the 7 members of the Board of
Governors and the presidents of the 12 Federal
Reserve Banks) saw the economy expanding at a
moderate pace over coming quarters and then picking up gradually under the assumption of appropriate monetary policy. Most participants marked down
their projections for economic growth in 2012 and
2013 relative to what they anticipated in January and
April largely as a result of the adverse developments
in Europe and the associated effects on financial markets. Moreover, headwinds from the fiscal and financial situation in Europe, from the still-depressed
housing market, and from tight credit for some borrowers were cited as likely to hold back the pace of
economic expansion over the forecast period.
FOMC participants also projected slower progress in
reducing unemployment than they had anticipated in
January and April. Committee participants’ projections for the unemployment rate had a central tendency of 8.0 to 8.2 percent in the fourth quarter of
this year and then declined to 7.0 to 7.7 percent at
the end of 2014; those levels are still generally well
above participants’ estimates of the longer-run normal rate of unemployment. Meanwhile, participants’
projections for inflation had a central tendency of
1.2 to 1.7 percent for 2012 and 1.5 to 2.0 percent for

29

both 2013 and 2014; these projections are lower, particularly in 2012, than participants reported in January and April, in part reflecting the effects of the
recent drop in crude oil prices.
With the unemployment rate expected to remain
elevated over the projection period and inflation generally expected to be at or under the Committee’s
2 percent objective, most participants expected that,
under their individual assessments of appropriate
monetary policy, the federal funds rate would remain
extraordinarily low for some time. In particular, 11 of
the 19 participants placed the target federal funds
rate at 0.75 percent or lower at the end of 2014; only
4 of them saw the appropriate rate at 2 percent or
higher. All participants reported levels for the appropriate target federal funds rate at the end of 2014 that
were well below their estimates of the level expected
to prevail in the longer run. In addition to projecting
only slow progress in bringing down unemployment,
most participants saw the risks to the outlook as
weighted mainly toward slower growth and higher
unemployment. In particular, participants noted that
strains in global financial markets, the prospect of
reduced fiscal accommodation in the United States,
and a general slowdown in global economic growth
posed significant risks to the recovery and to a further improvement in labor market conditions.

Part 2
Recent Economic
and Financial Developments
Economic activity appears to have expanded at a
somewhat slower pace over the first half of 2012 than
in the second half of 2011. After rising at an annual
rate of 2½ percent in the second half of 2011, real
gross domestic product (GDP) increased at a 2 percent pace in the first quarter of 2012, and available
indicators point to a still smaller gain in the second
quarter. An important factor influencing economic
and financial developments this year is the unfolding
fiscal and banking crisis in Europe. Indeed, the economic outlook for the second half of 2012 depends
crucially on the extent to which current and potential
disruptions in Europe directly reduce U.S. net
exports and indirectly curtail private domestic spending through adverse spillover effects on U.S. financial
markets and institutions and on household and business confidence. At the same time, the economy continues to face other headwinds, including restricted
access to some types of household and small business
credit, a still sizable inventory of vacant homes, and
less-accommodative fiscal policy.

30

99th Annual Report | 2012

The labor market remains weak. Private payroll
employment stepped up early in the year but then
slowed in the second quarter (though those moves
may have been exaggerated by issues related to swings
in the weather and to seasonal adjustment), and the
unemployment rate hovered around 8¼ percent after
a significant decrease over the latter months of 2011
and in January. Meanwhile, consumer price inflation,
in part buffeted by sharp swings in the price of gasoline, stepped up early in the year but subsequently
turned down, and longer-term inflation expectations
remained stable.
Financial markets were somewhat volatile over the
first half of 2012 mostly due to fluctuating views
regarding the crisis in the euro area and the likely
pace of economic growth at home and abroad. Yields
on longer-term Treasury securities have declined significantly, reflecting greater monetary policy accommodation, the weaker outlook, and safe-haven flows.
Broad indexes of U.S. equity prices rose, on net, risk
spreads on corporate bonds were generally
unchanged or slightly lower, and unsecured shortterm dollar funding markets were fairly stable. Debt
issuance by U.S. corporations was solid, and bank
lending to larger firms was brisk. In the household
sector, consumer credit expanded and mortgage refinancing activity increased modestly, reflecting the
decline in mortgage rates to historically low levels as
well as recent changes to the Home Affordable Refinance Program (HARP).
Domestic Developments
The Household Sector

Consumer Spending and Household Finance
After rising at an annual rate of about 2 percent in
the second half of 2011, real personal consumption
expenditures (PCE) increased 2½ percent in the first
quarter, but available information suggests that real
PCE decelerated some in the second quarter. The
first-quarter increase in spending occurred across a
broad array of goods and services with the notable
exception of outlays for energy services, which were
held down by reduced demand for heating because of
the unseasonably warm winter. Spending on energy
services appears to have rebounded in the second
quarter as the temperate winter gave way to a relatively more typical spring. In contrast, the pace of
motor vehicle sales edged down in the second quarter, and reports on retail sales suggest that consumer
outlays on a wide range of items rose less rapidly
than they did in the first quarter. The moderate rise

in consumer spending over the first half of the year
occurred against the backdrop of the considerable
economic challenges still facing many households,
including high unemployment, sluggish gains in
employment, tepid growth in income, still-stressed
balanced sheets, tight access to some types of credit,
and lingering pessimism about job and income prospects. With increases in spending outpacing growth
in income so far this year, the personal saving rate
continued to decline, on net, though it remained well
above levels that prevailed before the recession.
Aggregate real disposable personal income (DPI)—
personal income less personal taxes, adjusted for
changes in prices—rose more rapidly over the first
five months of the year than it did in 2011, in part
because of declining energy prices. The wage and salary component of real DPI, which reflects both the
number of hours worked and average hourly wages
adjusted for inflation, rose at an annual rate of nearly
1¼ percent through May of this year after having
increased at a similar pace in 2011. The increase in
real wage and salary income so far in 2012 is largely
attributable to the modest improvement in employment and hours worked; real average hourly earnings
are little changed thus far this year.
The ratio of household net worth to income, in the
aggregate, moved up slightly further in the first quarter, reflecting increases in both house prices and
equity prices. Taking a longer view, this ratio has
been on a slow upward trend since 2009, and while it
remains far below levels seen in the years leading up
to the recession, it is about equal to its average over
the past 20 years. Household-level data through 2010
indicate that wealth losses were proportionately
larger for the middle portion of the wealth distribution—not a surprising result, given the relative
importance of housing among the assets of those
households. Meanwhile, indicators of consumer sentiment are above their lows from last summer but
have yet to return to pre-recession levels.
Household debt—the sum of mortgage and consumer debt—edged down again in the first quarter of
2012 as the continued contraction in mortgage debt
was almost offset by solid expansion in consumer
credit. With the reduction in household debt, low
level of most interest rates, and modest growth of
income, the debt-service ratio—the aggregate
required principal and interest payments on existing
household debt relative to income—decreased further, and, at the end of the first quarter, it stood at a
level last seen in 1994.

Monetary Policy and Economic Developments

Consumer credit expanded at an annual rate of about
6¼ percent in the first five months of 2012, driven by
an increase in nonrevolving credit. This component
accounts for about two-thirds of total consumer
credit and primarily consists of auto and student
loans. The rise in nonrevolving credit so far this year
was primarily due to the strength in student loans,
which were almost entirely originated and funded by
the federal government. Meanwhile, auto loans maintained a steady pace of increase. Revolving consumer
credit (primarily credit card lending) remained much
more subdued in the first five months of the year in
part because nonprime borrowers continued to face
tight underwriting standards. Overall, the increase in
consumer credit is consistent with recent responses to
the Senior Loan Officer Opinion Survey on Bank
Lending Practices (SLOOS) indicating that demand
had strengthened and standards had eased, on net,
for all consumer loan categories.1
Interest rates on consumer loans generally edged
down in the first half of 2012, and spreads on these
loans relative to Treasury securities of comparable
maturity held fairly steady. In particular, interest
rates on new auto loans continued to be quite low.
However, the spread of rates on credit card loans
relative to the two-year Treasury yield has remained
wide since the end of 2008 in part because of pricing
adjustments made in response to provisions included
in the Credit Card Accountability Responsibility and
Disclosure Act of 2009.2
Aggregate indicators of consumer credit quality
improved further in the first quarter of 2012. The
delinquency rate on credit card loans registered its
lowest level since the series began in 1991. The recent
improvement importantly reflects an ongoing compositional shift in total credit card balances toward
borrowers with higher credit scores, due in part to
tighter lending standards. Charge-offs on credit card
loans also declined, reaching levels last seen at the
end of 2007. Delinquencies and charge-offs on nonrevolving consumer loans at commercial banks also
edged lower, to levels slightly below their historical
averages. In addition, the delinquency rate on auto
loans at finance companies decreased slightly to a
level that is near the middle of its historical range.

1

2

The SLOOS is available on the Federal Reserve Board’s website
at www.federalreserve.gov/boarddocs/SnLoanSurvey.
The act includes some provisions that place restrictions on issuers’ ability to impose certain fees and to engage in risk-based
pricing.

31

Issuance of consumer asset-backed securities (ABS)
in the first half of 2012 exceeded issuance for the
same period in 2011 but was still below pre-crisis levels. Issuances of securities backed by auto loans
dominated the market for most of the first half, while
student loan ABS issuance was about the same as in
the past two years. In contrast, issuance of credit
card ABS remained weak for most of the first half of
2012 as growth of credit card loans continued to be
somewhat subdued and most major banks have chosen to fund such loans on their balance sheets. Yields
on ABS and their spreads over comparable-maturity
swap rates were little changed, on net, over the first
half of 2012 and held steady in the low ranges that
have prevailed since early 2010.
Housing Activity and Housing Finance
Activity in the housing sector appears to be on a
gradual uptrend, albeit from a very depressed level.
Sales of new and existing homes have risen so far this
year, likely supported by the low level of house prices
and by low interest rates for conventional mortgages.
Nonetheless, the factors that have restrained demand
for owner-occupied housing in recent years have yet
to dissipate. Many potential buyers are reluctant to
purchase homes because of ongoing concerns about
future income, employment, and the direction of
house prices. In addition, tight mortgage finance
conditions preclude many borrowers from obtaining
mortgage credit. Much of the home purchase
demand that does exist has been channeled to the
abundant stock of vacant houses, thereby limiting
the response of new construction activity to such
expansion of demand as has occurred. Given the
large numbers of properties still in, or at risk of
being in, foreclosure, this overhang seems likely to
continue to weigh on new construction activity for
some time.
Despite these factors, housing starts have risen
gradually so far this year. From January to May,
single-family houses were started at an annual rate of
about 495,000 units, up from 450,000 in the second
half of 2011 but less than half of the average pace of
the past 50 years. Although the unseasonably warm
winter may have contributed to the increase, the
underlying pace of activity likely rose some as well.
Indeed, data on single-family permit issuance, which
is less likely to be affected by weather, also moved up
a little from its level late last year. In the multifamily
sector, demand has remained robust, as many individuals and families that are unable or unwilling to
purchase homes have sought out rental units. As a
result, the vacancy rate for rental housing has fallen

32

99th Annual Report | 2012

to its lowest level since 2002, putting upward pressure
on rents and spurring new construction. Over the
first five months of the year, new multifamily projects were started at an average annual rate of about
225,000 units, up from about 200,000 in the second
half of 2011 but still below the 300,000-unit rate that
prevailed for much of the previous decade.
House prices, as measured by several national
indexes, turned up in recent months after edging
down further, on balance, in 2011. For example, the
CoreLogic repeat-sales index rose 4 percent (not an
annual rate) over the first five months of the year.
This recent improvement notwithstanding, this measure of house prices remains 30 percent below its peak
in 2006. The same factors that are restraining singlefamily housing construction also continue to weigh
on house prices, including the large inventory of
vacant homes, tight mortgage credit conditions, and
lackluster demand.
Mortgage rates declined to historically low levels during the first half of 2012. While significant, the drop
in mortgage rates generally did not keep pace with
the declines in the yields on Treasury and mortgagebacked securities (MBS), probably reflecting stillelevated risk aversion and some capacity constraints
among mortgage originators. Despite the drop in
mortgage rates, many potentially creditworthy borrowers have had difficulty obtaining mortgages or
refinancing because of tight standards and terms (see
the box “The Supply of Mortgage Credit” on
pages 10–11 of the July 2012 Monetary Policy
Report). Another factor impeding the ability of many
borrowers to refinance, or to sell their home and purchase a new one, has been the prevalence of underwater mortgages. Overall, refinancing activity
increased in the second quarter but was still less than
might be expected, given the level of interest rates,
and the pace of mortgage applications for home purchases remained sluggish. However, refinancing
activity attributed to recent changes to the HARP—
one of which eliminated caps on loan-to-value ratios
for those who were refinancing mortgages already
owned by government-sponsored enterprises
(GSEs)—has picked up over the first half of the year.
Indicators of credit quality in the residential mortgage sector continued to reflect strains on homeowners confronting depressed home values and high
unemployment. The fraction of current prime mortgages becoming delinquent remained at a high level
but inched lower, on net, over the first five months of
the year, likely reflecting in part stricter underwriting

of more-recent originations. Additionally, measures
of late-stage mortgage delinquency, such as the
inventory of properties in foreclosure, continued to
linger near the peak in the first quarter of 2012.
Gross issuance of MBS guaranteed by GSEs
remained moderate in the first half of 2012, consistent with the slow pace of mortgage originations. In
contrast, the securitization market for mortgage
loans not guaranteed by a housing-related GSE or
the Federal Housing Administration—an important
source of funding before the crisis for prime-grade
mortgages that exceeded the conforming loan size
limit—continued to be essentially closed.
The Business Sector

Fixed Investment
Real business spending for equipment and software
(E&S) rose at an annual rate of 3½ percent in the
first quarter of 2012 after having risen at a doubledigit pace, on average, in the second half of 2011.
The slowdown in E&S investment growth in the first
quarter was fairly widespread across categories of
equipment and software. This deceleration in E&S
spending along with the recent softening in indicators
of investment demand, such as surveys of business
sentiment and capital spending plans, may signal
some renewed caution on the part of businesses, perhaps related to the situation in Europe.
After posting robust gains throughout much of 2011,
investment in nonresidential structures edged up in
the first quarter of this year. A drop in outlays for
drilling and mining structures was probably related to
the low level of natural gas prices. Outside of the
drilling and mining segments, investment increased at
an annual rate of 7 percent in the first quarter,
broadly similar to its gain in the fourth quarter of
2011. Although financing conditions for existing
properties have eased some, they remain tight; moreover, high vacancy rates, low commercial real estate
prices, and difficult financing conditions for new construction will likely weigh on building activity for the
foreseeable future.
Inventory Investment
Firms accumulated inventories in the first quarter at
about the same pace as in the fourth quarter of last
year. Motor vehicle inventories surged in the first
quarter, as automakers rebuilt dealers’ inventories to
comfortable levels after natural disasters disrupted
global supply chains in 2011. Stockbuilding outside
of motor vehicles moderated somewhat from the

Monetary Policy and Economic Developments

fourth-quarter pace of accumulation. Inventory-tosales ratios for most industries covered by the Census
Bureau’s book-value data, as well as surveys of private inventory satisfaction and plans, generally suggest that stocks are fairly well aligned with the pace
of sales.
Corporate Profits and Business Finance
Aggregate operating earnings per share for S&P 500
firms rose about 7 percent at a seasonally adjusted
quarterly rate in the first quarter of 2012. Financial
firms accounted for most of the gain, while profits
for firms in the nonfinancial sector were about
unchanged from the high level seen in the fourth
quarter of last year. As of the end of June, privatesector analysts projected moderate earnings growth
through the end of the year.
The ratio of corporate profits to gross national product in the first quarter of 2012 hovered around its
historical high, and cash flow remained solid. In
addition, the ratio of liquid assets to total assets continued to be near its highest level in more than
20 years, and the share of corporate cash flow needed
to cover interest expenses remained low. Against this
backdrop of generally strong corporate earnings and
balance sheets, credit rating upgrades continued to
outpace downgrades for nonfinancial corporations,
and the bond default rate for nonfinancial firms
remained low in the first half of the year. The delinquency rate on commercial and industrial (C&I)
loans decreased further in the first quarter and
approached the lower end of its historical range.
With corporate credit quality remaining robust, nonfinancial firms were able to continue to raise funds at
a generally strong pace in the first half of the year. So
far this year, nonfinancial commercial paper (CP)
outstanding was about unchanged. Bond issuance by
both investment- and speculative-grade nonfinancial
firms was strong over the first four months of the
year, but speculative-grade issuance weakened some
in May and notably further in June. The institutional
segment of the syndicated leveraged loan market
remained solid in the first half of the year, reportedly
supported by continued demand for loans from nonbank investors, such as pension plans and insurance
companies. In addition, the volume of newly established collateralized loan obligations so far this year
has already surpassed 2011 levels. Much of the bond
and loan issuance was reportedly used to refinance,
and likely also to extend the maturity of, existing
debt, given the low level of long-term interest rates.

33

C&I loans outstanding at commercial banking organizations in the United States expanded at a brisk
pace in the first half of 2012 despite declines in the
holdings of such loans by U.S. branches and agencies
of European institutions. The strength is consistent
with a relatively large number of banks, on balance,
that have reported stronger demand for C&I loans in
the recent SLOOS. Moreover, in the April SLOOS,
banks continued to report having eased both price
and nonprice terms for C&I loans, largely in response
to strong competition from other banks and nonbank lenders. The extent of easing generally has been
greater for large and middle-market firms. That said,
according to the Survey of Terms of Business Lending (STBL), spreads on C&I loans over banks’ cost
of funds, while continuing to trend down gradually in
the February and May surveys, are still quite high in
historical terms. Spreads on newly issued syndicated
loans have also remained somewhat wide.
Borrowing conditions for small businesses generally
have improved over the past few years but have done
so much more gradually than have conditions for
larger firms; moreover, the demand for credit from
small firms apparently remains subdued. C&I loans
with original amounts of $1 million or less—a large
share of which likely consists of loans to small businesses—were about unchanged in the first quarter.3
According to results from surveys conducted by the
National Federation of Independent Business during
the first half of this year, the fraction of firms with
borrowing needs stayed low. The net percentage of
respondents that found credit more difficult to obtain
than three months earlier and that expected tighter
credit conditions over the next three months have
both declined, but they remained at relatively high
levels in the June survey. In addition, recent readings
from the STBL indicate that the spreads charged by
commercial banks on newly originated C&I loans
with original amounts less than $1 million remained
quite high, even on loans with the strongest credit
ratings.
Financial conditions in the commercial real estate
(CRE) sector have eased some but stayed relatively
tight amid weak fundamentals. According to the
April SLOOS, some domestic banks reported having
eased standards on CRE loans and, on balance, a significant number of domestic banks reported
increased demand for such loans. While banks’ hold3

The original amount for a C&I loan is defined in the Call
Report as the maximum of the amount of the loan or the
amount of the total commitment.

34

99th Annual Report | 2012

ings of CRE loans continued to contract in the first
half of this year, they did so at a slower pace than in
the second half of last year. The weakest segment of
CRE lending has been the portion supporting construction and land development; some other segments have recently expanded modestly. Issuance of
commercial mortgage-backed securities (CMBS) has
also increased recently from the low levels observed
last year. Nonetheless, the delinquency rate on loans
in CMBS pools continued to set new highs in June, as
some five-year loans issued in 2007 at the height of
the market were unable to refinance at maturity
because of their high loan-to-value ratios. While
delinquency rates for CRE loans at commercial
banks improved slightly in the first quarter, they
remained elevated, especially for construction and
land development loans.
In the corporate equity market, gross public equity
issuance by nonfinancial firms was strong in the first
five months of 2012, boosted by a solid pace of initial public offerings (IPOs).4 Data for the first quarter of 2012 indicate that share repurchases and cashfinanced mergers by nonfinancial firms remained
robust, and net equity issuance remained deeply
negative. However, fewer mergers and new share
repurchase programs were announced in the second
quarter.
The Government Sector

Federal Government
The deficit in the federal unified budget remains
elevated. The Congressional Budget Office projects
that the deficit for fiscal year 2012 will be close to
$1.2 trillion, or about 7½ percent of nominal GDP.
Such a deficit would be a narrower share of GDP
than those recorded over the past several years
though still sharply higher than those recorded in the
few years prior to the onset of the financial crisis and
recession. The narrowing of the budget deficit
expected to occur in the current fiscal year mostly
reflects increases in tax revenues as the economy continues to recover, although the growth in outlays is
being held back by the winding down of expansionary fiscal policies enacted in response to the recession, as well as some budgetary restraint in defense
and other discretionary spending programs.

Federal receipts increased 5 percent in the first nine
months of fiscal 2012 compared with the same
period in fiscal 2011. Receipts were bolstered thus far
this fiscal year by a robust rise in corporate tax revenues that is largely attributable to a scaling back in
the favorable tax treatment of some business investment. In addition, individual income and payroll tax
receipts have moved higher, reflecting increases in
nominal wage and salary income. Nonetheless, at
only about 15½ percent, the ratio of federal receipts
to national income is near the lowest reading for this
ratio over the past 60 years.
Total federal outlays moved sideways in the first nine
months of fiscal 2012 relative to the comparable
year-earlier period. Outlays were reduced by the
winding down of stimulus-related programs (including the American Recovery and Reinvestment Act of
2009), lower payments for unemployment insurance,
and falling defense expenditures. In addition, outlays
for Medicaid so far this fiscal year were unusually
weak, apparently reflecting in part the implementation of cost-containment measures by many state
governments to reduce spending growth for that program. In contrast, Social Security outlays rose in part
because of the first cost-of-living adjustments since
2009, and outlays for financial transactions were
boosted by the revaluation of the expected cost of
previous Troubled Asset Relief Program transactions
and an increase in net outlays for deposit insurance.5
Net interest payments increased moderately, reflecting the rising level of the federal debt.
As measured in the national income and product
accounts (NIPA), real federal expenditures on consumption and gross investment—the part of federal
spending included in the calculation of GDP—fell at
an annual rate of close to 6 percent in the first quarter. Defense spending, which tends to be erratic from
quarter to quarter, contracted more than 8 percent,
and nondefense purchases edged down.
Federal debt held by the public rose to about 72 percent of nominal GDP in the second quarter of 2012,
3½ percentage points higher than at the end of last
year. Treasury auctions generally continued to be well
received by investors. Indicators of demand at Treas-

5

4

Indeed, the second largest IPO on record began trading in midMay. However, the price performance of those shares in the
days following that offering was sharply negative on net, and
IPO activity subsequently weakened significantly.

The subsidy costs of outstanding Troubled Asset Relief Program assistance are reestimated annually by updating cash flows
for actual experience and new assumptions about the future performance of the programs; any changes in these estimated subsidy costs are recorded in the federal budget in the current fiscal
year.

Monetary Policy and Economic Developments

ury auctions, such as bid-to-cover ratios and indirect
bidding ratios, were within their historical ranges.
State and Local Government
State and local government budgets remain strained,
but overall fiscal conditions for these governments
may be slowly improving. In particular, state and
local tax receipts appeared to increase moderately
over the first half of this year. Census Bureau data
indicate that state revenue collections rose 4 percent
in the first quarter relative to a year earlier, and anecdotal evidence suggests that collections during April
and May were well maintained. Moreover, only a few
states reported budget shortfalls during fiscal 2012
(which ended on June 30 in most states). The
improvement is less evident at the local level, where
property tax receipts—the largest source of tax revenue for these governments—were roughly flat in
2011 and early 2012, reflecting the crosscutting
effects of the earlier declines in home prices and
increases in property tax rates. Moreover, federal aid
to both state and local governments has declined as
stimulus-related grants have been almost completely
phased out.
One of the ways that state and local governments
have addressed their tight budget situations has been
through cuts in their employment and construction
spending. After shedding jobs at an average pace of
19,000 per month in 2011, these governments
reduced their employment over the first half of the
year at a slower pace by trimming 3,000 jobs per
month on average. However, real construction expenditures fell sharply in the first quarter after having
edged down in the latter half of 2011, and available
information on nominal construction spending
through May points to continued declines in recent
months. The decreases in employment and construction are evident in the Bureau of Economic Analysis
(BEA) estimate for real state and local purchases,
which fell at an annual rate of 2¾ percent in the first
quarter, about the same pace as in 2011.
Gross issuance of bonds by states and municipalities
picked up in the second quarter of 2012. Credit quality in the sector continued to deteriorate over the first
half of the year. For instance, credit rating downgrades by Moody’s Investors Service substantially
outpaced upgrades, and credit default swap (CDS)
indexes for municipal bonds rose on net. Yields on
long-term general obligation municipal bonds were
about unchanged over the first half of the year.

35

The External Sector

Exports and Imports
Both real exports and imports grew moderately in the
first quarter of 2012. Real exports of goods and services rose at an annual rate of 4¼ percent, supported
by relatively strong foreign economic growth.
Exports of services, automobiles, computers, and aircraft expanded rapidly, while those of consumer
goods declined. The rise in exports was particularly
strong to Canada and Mexico. Data for April and
May suggest that exports continued to rise at a moderate pace in the second quarter.
Real imports of goods and services rose a relatively
modest 2¾ percent in the first quarter, reflecting
slower growth in U.S. economic activity. Imports of
services, automobiles, and computers rose significantly, while those of petroleum, aircraft, and consumer goods fell. The rise in imports was broadly
based across major trading partners, with imports
from Japan and Mexico showing particularly strong
growth. April and May data suggest that import
growth picked up in the second quarter.
Altogether, net exports made a small positive contribution of one-tenth of 1 percentage point to real
GDP growth in the first quarter.
Commodity and Trade Prices
After increasing earlier in the year, oil prices have
subsequently fallen back. Over much of the first
quarter, an improved outlook for the global economy
and increased geopolitical tensions—most notably
with Iran—helped spur a run-up in the spot price of
oil, with the Brent benchmark averaging $125 per
barrel in March, about $15 above its January average.
Since mid-March, however, oil prices have more than
retraced their earlier gains amid an intensification of
the crisis in Europe and increased concerns over the
strength of economic growth in China. An easing of
geopolitical tensions and increased crude oil supply—production by Saudi Arabia has been running
at near-record high levels—have also likely contributed to the decline in oil prices. All told, the price of
Brent has plunged $25 a barrel from March to about
$100 per barrel in mid-July.
Prices of many nonfuel commodities followed a path
similar to that shown by oil prices, albeit with less
volatility. Early in 2012, commodity prices rallied, as
global economic prospects and financial conditions

36

99th Annual Report | 2012

improved along with a temporary abatement of
stresses in Europe. However, as with oil prices,
broader commodity prices fell in the second quarter,
reflecting growing pessimism regarding prospects for
the global economy.
Prices for non-oil imported goods increased less than
¼ percent in the first quarter, with the modest pace
of increase likely reflecting the lagged effects of both
the appreciation of the dollar and the decline in commodity prices that occurred late last year. Moving
into the second quarter, import price inflation
appears to have remained subdued, consistent with a
further appreciation of the dollar.
The Current and Financial Accounts
Largely reflecting the run-up in oil prices early in the
year, the nominal trade deficit widened slightly in the
first quarter. In addition, as the net investment
income balance continued to decline, the current
account deficit deteriorated from an annual average
of $470 billion in 2011 to $550 billion in the first
quarter, or 3½ percent of GDP.6
The financial flows that provide the financing of the
current account deficit reflected the general trends in
financial market sentiment and in reserve accumulation by emerging market economies (EMEs). Consistent with a temporary improvement in the tone of
financial markets in the first quarter, foreign private
investors slowed their net purchases of U.S. Treasury
securities and resumed net purchases of U.S. equities,
although they continued to sell other U.S. bonds.
However, the tentative increase in foreign risk appetite abated early in the second quarter and foreign
private investors showed renewed demand for U.S.
Treasury securities and less demand for other U.S.
securities.
U.S. investors’ demand for foreign securities was flat,
on net, in the first quarter and the early part of the
second quarter, but this outcome nonetheless represents an increase relative to net sales of foreign securities in the fourth quarter of 2011.
Inflows from foreign official institutions strengthened
in the first quarter as emerging market governments
bought dollars to counter upward pressure on their
6

In 1999, the BEA—while revisiting its methodology for the balance of payments accounts—redefined the current account to
exclude capital transfers. In the process, the capital account was
renamed the financial account, and a newly defined capital
account was created to include capital transfers as well as the
acquisition and disposal of nonproduced nonfinancial assets.

currencies, resulting in increased accumulation of
dollar-denominated reserves, which were then
invested in U.S. securities. Partial data for the second
quarter suggest that foreign official inflows remained
strong despite renewed dollar appreciation against
emerging market currencies. U.S. official assets registered a $51 billion inflow during the first quarter as
drawings on the Federal Reserve’s dollar swap lines
with the European Central Bank (ECB) and the
Bank of Japan (BOJ) were partially repaid.
National Saving

Total U.S. net national saving—that is, the saving of
U.S. households, businesses, and governments, net of
depreciation charges—remains extremely low by historical standards. Net national saving fell from 4 percent of nominal GDP in 2006 to negative 2 percent in
2009, as the federal budget deficit widened. The
national saving rate subsequently increased to near
zero, where it remained as of the first quarter of 2012
(the latest quarter for which data are available). The
relative flatness of the saving rate over the past
couple of years reflects the offsetting effects of a narrowing in the federal budget deficit as a share of
nominal GDP and a downward movement in the private saving rate. National saving will likely remain
low this year in light of the continuing large federal
budget deficit. A portion of the decline in federal savings relative to pre-crisis levels is cyclical and would
be expected to reverse as the economy recovers. However, if low levels of national saving persist over the
longer run, they will likely be associated with both
low rates of capital formation and heavy borrowing
from abroad, limiting the rise in the standard of living for U.S. residents over time.
The Labor Market

Employment and Unemployment
Labor market conditions remain weak. After averaging 165,000 jobs per month in the second half of
2011, private payroll employment gains increased to
225,000 jobs per month over the first three months of
the year and then fell back to 90,000 jobs per month
over the past three months. The apparent slowing in
the pace of net job creation may have been exaggerated by issues related to swings in the weather and to
seasonal adjustment difficulties associated with the
timing of the sharpest job losses during the recession.
Moreover, employment gains during the second half
of last year and into the early part of this year may
have reflected some catch-up in hiring on the part of
employers that aggressively pared their workforces
during and just after the recession. The recent decel-

Monetary Policy and Economic Developments

eration in employment may suggest that much of this
catch-up has now taken place and that, consequently,
more-rapid gains in economic activity will be
required to achieve significant further increases in
employment and declines in the unemployment rate.
The unemployment rate, though down from around
9 percent last summer, has held about flat at 8¼ percent since early this year and remains elevated relative
to levels observed prior to the recent recession. Moreover, long-term unemployment also remains elevated.
In June, around 40 percent of those unemployed had
been out of work for more than six months. Meanwhile, the labor force participation rate has fluctuated
around a low level so far this year after having moved
down 2 percentage points since 2007.
Other labor market indicators were consistent with
little change in overall labor market conditions during the first half of the year. Initial claims for unemployment insurance were not much changed, on net,
although their average level over the first half of the
year was lower than in the second half of 2011.
Measures of job vacancies edged up, on balance, and
households’ labor market expectations largely
reversed the steep deterioration from last summer.
However, indicators of hiring activity remained
subdued.
Productivity and Labor Compensation
Gains in labor productivity have continued to slow
recently following an outsized increase in 2009 and a
solid gain in 2010. According to the latest published
data, output per hour in the nonfarm business sector
rose just ½ percent in 2011 and declined in the first
quarter of 2012. Although these data can be volatile
from quarter to quarter, the moderation in productivity growth over the past two years suggests that firms
have been adding workers not only to meet rising
production needs but also to relieve pressures on
their existing workforces, which were cut back
sharply during the recession.
Increases in hourly compensation continue to be
restrained by the very weak condition of the labor
market. The 12-month change in the employment
cost index for private industry workers, which measures both wages and the cost to employers of providing benefits, has been about 2 percent or less since
the start of 2009 after several years of increases in
the neighborhood of 3 percent. Nominal compensation per hour in the nonfarm business sector—a
measure derived from the labor compensation data in
the NIPA—also decelerated significantly over the

37

past few years; this measure rose just 1¼ percent over
the year ending in the first quarter of 2012, well
below the average increase of about 4 percent in the
years before the recession. Similarly, average hourly
earnings for all employees—the timeliest measure of
wage developments—rose about 2 percent in nominal
terms over the 12 months ending in June. According
to each of these measures, gains in hourly compensation failed to keep up with increases in consumer
prices in 2011 and again in the first quarter of this
year.
The change in unit labor costs faced by firms—which
measures the extent to which nominal hourly compensation rises in excess of labor productivity—remained subdued. Unit labor costs in the nonfarm
business sector rose 1 percent over the year ending in
the first quarter of 2012. Over the preceding
year, unit labor costs increased 1½ percent.
Prices

Consumer price inflation moved down, on net, during the first part of 2012. Overall PCE prices rose
rapidly in the first three months of the year, reflecting large increases in oil prices, but inflation turned
down in the spring as oil prices more than reversed
their earlier run-ups. The overall chain-type PCE
price index increased at an annual rate of about
1½ percent between December 2011 and May 2012,
compared with a rise of 2½ percent over 2011.
Excluding food and energy, consumer prices rose at a
rate of about 2 percent over the first five months of
the year, essentially the same pace as in 2011. In addition to the net decline in crude oil prices over the first
half of the year, factors contributing to low consumer price inflation this year include the deceleration of non-oil import prices in the latter part of
2011, subdued labor costs associated with the weak
labor market, and stable inflation expectations.
Consumer energy prices surged at an annual rate of
over 20 percent in the first three months of 2012, as
higher costs for crude oil were passed through to
gasoline prices. In April, the national-average price
for gasoline at the pump approached $4 per gallon.
Since then, crude oil prices have tumbled, and gasoline prices have declined roughly in line with crude
costs, more than reversing the earlier run-up. Consumer prices for natural gas plunged over the first
five months of the year after falling late last year; this
drop is attributable, at least in part, to the unseasonably warm winter, which reduced demand for natural
gas. More recently, spot prices for natural gas have
turned up as production has been cut back, but they

38

99th Annual Report | 2012

still remain substantially lower than they were last
summer.
Consumer food price inflation has slowed noticeably
so far this year, as the effect on retail food prices
from last year’s jump in farm commodity prices
appears to have largely dissipated. Indeed, PCE
prices for food and beverages only edged up slightly,
rising at an annual rate of about ½ percent from
December to May after increasing more than 5 percent in 2011. Although farm commodity prices were
tempered earlier this year by expectations of a substantial increase in crop output this growing season,
grain prices rose rapidly in late June and early July as
a wide swath of the Midwest experienced a bout of
hot, dry weather that farm analysts believe cut yield
prospects considerably.

improved. Those gains partially reversed when market participants became more pessimistic about the
European situation and global growth prospects in
May and June. Yields on longer-term Treasury securities declined, on balance, over the first half of the
year. Conditions in unsecured short-term dollar
funding markets generally remained stable as European financial institutions reduced their demand for
dollar funding and general funding pressures were
alleviated by the longer-term refinancing operations
of the ECB. In the domestic banking sector, the
release of the results from the Comprehensive Capital
Analysis and Review (CCAR) in March provided a
significant boost to the equity prices of U.S. financial
institutions (see the box “The Capital and Liquidity
Position of Large U.S. Banks” on pages 24–25 of the
July 2012 Monetary Policy Report).

Survey-based measures of near-term inflation expectations have changed little, on net, so far this year.
Median year-ahead inflation expectations, as
reported in the Thomson Reuters/University of
Michigan Surveys of Consumers (Michigan survey),
rose in March when gasoline prices were high but
then fell back as those prices reversed course.
Longer-term expectations remained more stable. In
the Michigan survey, median expected inflation over
the next 5 to 10 years was 2.8 percent in early July,
within the narrow range of the past 10 years. In the
Survey of Professional Forecasters, conducted by the
Federal Reserve Bank of Philadelphia, expectations
for the increase in the price index for PCE over the
next 10 years remained at 2¼ percent, in the middle
of its recent range.

Monetary Policy Expectations and
Treasury Rates

Measures of medium- and longer-term inflation
compensation derived from nominal and inflationprotected Treasury securities—which not only reflect
inflation expectations, but also can be affected by
changes in investor risk aversion and by the different
liquidity properties of the two types of securities—
were little changed, on net, so far this year. These
measures increased early in the period amid rising
prices for oil and other commodities, but they subsequently declined as commodity prices fell back and
as worries about domestic and global economic
growth increased.

Yields on longer-term nominal Treasury securities
declined, on balance, over the first half of 2012.
Early in the year, longer-term Treasury yields rose,
reflecting generally positive U.S. economic data,
improved market sentiment regarding the crisis in
Europe, and higher energy prices. More recently,
however, longer-term yields have more than reversed
their earlier increases. Investors sought the relative
safety and liquidity of Treasury securities as the crisis
in Europe intensified again and as weaker-thanexpected economic data releases raised concerns
about the pace of economic recovery both in the
United States and abroad. In addition, those developments fostered expectations that the Federal
Reserve would provide additional accommodation.
And the Treasury yield curve flattened further following the FOMC’s decision at its June meeting to continue the maturity extension program (MEP) through
the end of 2012. On balance, yields on 5-, 10-, and

Financial Developments
Financial markets were somewhat volatile over the
first half of 2012. Early in the year, broad equity
price indexes rose and risk spreads in several markets
narrowed as investor sentiment regarding short-term
European prospects and the economic outlook

In response to the steps taken by the Federal Open
Market Committee (FOMC) to provide additional
monetary policy accommodation, and amid growing
anxiety about the European crisis and a worsening of
the economic outlook, investors pushed out further
the date when they expect the federal funds rate to
first rise above its current target range of 0 to ¼ percent. In addition, they apparently scaled back the
pace at which they expect the federal funds rate subsequently to be increased. Market participants currently anticipate that the effective federal funds rate
will be about 50 basis points by the middle of 2015,
roughly 55 basis points lower than they expected at
the beginning of 2012.

Monetary Policy and Economic Developments

30-year nominal Treasury securities declined roughly
20, 40, and 35 basis points, respectively, from their
levels at the start of this year. The Open Market
Desk’s outright purchases and sales of Treasury securities under the MEP did not appear to have any
material adverse effect on Treasury market
functioning.
Short-Term Funding Markets

Despite the reemergence of strains in Europe, conditions in unsecured short-term dollar funding markets
have remained fairly stable in the first half of 2012.
Measures of stress in short-term funding markets
have eased somewhat, on balance, since the beginning
of the year. A few factors seem to have contributed
to the relative stability of those markets. European
institutions apparently reduced their demand for
funds in recent quarters by selling dollardenominated assets and exiting from business lines
requiring heavy dollar funding. In addition, European banks reportedly switched to secured funding
supported by various types of collateral. Further, the
availability of funds from the ECB through its
longer-term refinancing operations likely helped
reduce funding strains and the need to access interbank markets more generally. Reflecting these developments, the amount of dollar swaps outstanding
between the Federal Reserve and the ECB has
declined substantially from its peak earlier this year.
Conditions in the CP market were also fairly stable.
On net, 30-day spreads of rates on unsecured A2/P2
CP over comparable-maturity AA-rated nonfinancial
CP declined a bit. The volume outstanding of unsecured financial CP issued in the United States by
institutions with European parents decreased slightly
in the first half of the year. The average maturity of
unsecured financial CP issued by institutions with
both U.S. and European parents is about 50 days, a
level that is near the middle of its historical range.
Signs of stress were also largely absent in secured
short-term dollar funding markets. In the market for
repurchase agreements, bid-asked spreads for most
collateral types were little changed. However, shortterm interest rates continued to edge up from the
level observed around the turn of the year, likely
reflecting in part the financing of the increase in
dealers’ inventories of shorter-term Treasury securities that resulted from the ongoing MEP and higherthan-expected bill issuance by the Treasury Department earlier in the year. In asset-backed commercial
paper (ABCP) markets, volumes outstanding
declined for programs with European sponsors, and

39

spreads on ABCP with European bank sponsors
remained a bit above those on ABCP with U.S. bank
sponsors.
Respondents to the Senior Credit Officer Opinion
Survey on Dealer Financing Terms (SCOOS) in both
March and June indicated that credit terms applicable to important classes of counterparties have
been relatively stable since the beginning of the year.7
In addition, dealers reported that the use of financial
leverage among hedge funds had decreased somewhat since the beginning of 2012. Moreover, respondents to the June SCOOS noted an increase in the
amount of resources and attention devoted to the
management of concentrated exposures to dealers
and other financial intermediaries as well as central
counterparties and other financial utilities. In
response to a special question in the June SCOOS,
dealers reported that despite the persistently low level
of interest rates, only moderate fractions of their
unlevered institutional clients had shown an
increased appetite for credit risk or duration risk over
the past year.
Financial Institutions

Market sentiment toward the banking industry fluctuated in the first half of 2012. Early in the year,
after the actions of the European authorities to ease
the euro-area crisis and the release of the results from
the CCAR, equity prices for bank holding companies
(BHCs) increased and their CDS spreads declined. In
late spring—as investors reacted to concerns about
Europe—equity prices reversed some of those gains,
and CDS spreads rose for large BHCs, especially
those with substantial investment-banking operations. More recently, Moody’s downgraded the longand short-term credit ratings of five of the six largest
U.S. banks, but none of the banks lost their
investment-grade status on long-term debt. The
short-term debt ratings of some banks were downgraded to Prime-2, which may affect the ability of
some to place significant amounts of CP with money
market funds, but the market effect appears to have
been muted so far, as those banks currently have limited demand for such funding. On balance, equity
prices of banks rose significantly from relatively low
levels at the start of the year; an index of CDS
spreads for large BHCs declined about 60 basis
points but remained at a high level.

7

The SCOOS is available on the Federal Reserve Board’s website
at www.federalreserve.gov/econresdata/releases/scoos.htm.

40

99th Annual Report | 2012

The profitability of BHCs decreased slightly in the
first quarter of 2012 and remained well below the
levels that prevailed before the financial crisis. Litigation provisions taken by some large banks in connection with the mortgage settlement reached earlier this
year accounted for some of the downward pressure
on bank profitability. The variability in earnings due
to accounting gains and losses related to changes in
the market value of banks’ own debt amplified recent
swings of bank profits.8 Smoothing through these
special factors, profitability has been about flat in
recent quarters. Net income continued to be supported by the release of loan loss reserves, albeit to a
lesser extent than in the previous year, as charge-off
rates decreased a bit further across most major asset
classes. Still-subdued dividend payouts and share
repurchases as well as reductions in risk-weighted
assets pushed regulatory capital ratios higher in the
first quarter of 2012 (see the box “Implementing the
New Financial Regulatory Regime” on pages 28–29
of the July 2012 Monetary Policy Report).
Credit provided by commercial banking organizations in the United States increased in the first half of
2012 at about the same moderate pace as in the second half of 2011. Core loans—the sum of C&I loans,
real estate loans, and consumer loans—expanded
modestly; as noted earlier, the upturn in lending was
particularly noticeable for C&I loans. The expansion
in C&I lending has been broad based outside of U.S.
branches and agencies of European banks and has
been particularly evident at large domestic banks.
This pattern is consistent with SLOOS results suggesting that a portion of the increase in C&I lending
observed at large domestic banks reflected decreased
competition from European banks and their affiliates
and subsidiaries for either foreign or domestic customers. Banks’ holdings of securities rose moderately, with purchases concentrated in Treasury securities and agency-guaranteed MBS. Given the stilldepressed housing market, banks continued to be
attracted by the government guarantee on agency
securities, and some large banks may also have been
accumulating government-backed securities to
improve their liquidity positions.
8

Under fair value accounting rules, changes in the creditworthiness of a BHC generate changes in the value of some of its
liabilities. Those changes are then reflected as gains or losses on
the income statement.

Corporate Debt and Equity Markets

Yields on investment-grade bonds reached record
lows in June, partly reflecting the search by investors
for relatively safe assets in light of rising concerns
about Europe as well as the weakness in the domestic
and global economic data releases. However, yields
on speculative-grade corporate debt, which had
reached record-low levels in February, rose somewhat
in the second quarter reflecting those same concerns.
The spread on investment-grade corporate bonds was
about unchanged, on net, relative to the start of the
year. Despite the backup in yields over the second
quarter, spreads on speculative-grade corporate
bonds decreased some, on balance, over the same
period. Prices in the secondary market for syndicated
leveraged loans have changed little, on balance, since
the beginning of the year; demand from institutional
investors for these mostly floating-rate loans has
remained strong despite the reemergence of anxiety
about developments in Europe.
Broad equity price indexes were boosted early in the
year by improved sentiment stemming in part from
relatively strong job gains as well as actions taken by
major central banks to mitigate the financial strains
emanating from Europe. However, equity price
indexes subsequently reversed a portion of their earlier gains as concerns about the European banking
and fiscal crisis intensified again and economic
reports suggested slower growth, on balance, at home
and abroad. The spread between the 12-month forward earnings-price ratio for the S&P 500 and a real
long-run Treasury yield—a rough gauge of the equity
risk premium—widened a bit more in the first half of
2012, and is now closer to the very high levels it
reached in 2008 and again last fall. Implied volatility
for the S&P 500 index, as calculated from option
prices, spiked at times this year but is currently
toward the bottom end of the range that this indicator has occupied since the onset of the financial
crisis.
In the current environment of very low interest rates,
mutual funds that invest in higher-yielding debt
instruments (including speculative-grade corporate
bonds and leveraged loans) continued to have significant inflows for most of the first half of 2012, while
money market funds experienced outflows. Equity
mutual funds also recorded modest outflows early in
the year and, as market sentiment deteriorated, both

Monetary Policy and Economic Developments

equity and high-yield mutual funds registered outflows in May.
Monetary Aggregates and
the Federal Reserve’s Balance Sheet

The growth rate of M2 slowed in the first half of
2012 to an annual rate of about 7 percent.9 However,
the levels of M2 and its largest component, liquid
deposits, remain elevated relative to what would have
been expected based on historical relationships with
nominal income and interest rates, likely reflecting
investors’ continued preference to hold safe and
liquid assets. Currency in circulation increased
robustly, reflecting solid demand both at home and
abroad. Retail money market funds and small time
deposits continued to contract. At the same time as
currency in circulation was increasing, reserve balances held at the Federal Reserve were decreasing; as
a result, the monetary base—which is equal to the
sum of these two items—changed little, on average,
over the first half of the year.
Total assets of the Federal Reserve decreased to
$2,868 billion as of July 11, 2012, about $60 billion
less than at the end of 2011 (table 1). The small
decrease since December largely reflects lower usage
of foreign central bank liquidity swaps and declines
in the net portfolio holdings of the Maiden Lane
LLCs. The composition of Treasury security holdings changed over the course of the first half of this
year as a result of the implementation of the MEP.
As of July 13, 2012, the Open Market Desk at the
Federal Reserve Bank of New York (FRBNY) had
purchased $283 billion in Treasury securities with
remaining maturities of 6 to 30 years and sold or
redeemed $293 billion in Treasury securities with
maturities of 3 years or less under the MEP.10 Total
9

10

M2 consists of (1) currency outside the U.S. Treasury, Federal
Reserve Banks, and the vaults of depository institutions;
(2) traveler’s checks of nonbank issuers; (3) demand deposits at
commercial banks (excluding those amounts held by depository
institutions, the U.S. government, and foreign banks and official
institutions) less cash items in the process of collection and Federal Reserve float; (4) other checkable deposits (negotiable order
of withdrawal, or NOW, accounts and automatic transfer service accounts at depository institutions; credit union share draft
accounts; and demand deposits at thrift institutions); (5) savings
deposits (including money market deposit accounts); (6) smalldenomination time deposits (time deposits issued in amounts of
less than $100,000) less individual retirement account (IRA)
and Keogh balances at depository institutions; and (7) balances
in retail money market mutual funds less IRA and Keogh balances at money market mutual funds.
Between the MEP’s announcement in September 2011 and the
end of that year, the Desk had purchased $133 billion in longerterm Treasury securities and had sold $134 billion in shorterterm Treasury securities.

41

Table 1. Selected components of the Federal Reserve
balance sheet, 2011–12
Millions of dollars
Balance sheet item

Dec. 28, 2011 Feb. 22, 2012 July 11, 2012

Total assets
2,928,485
2,935,149
Selected assets
Credit extended to depository institutions and dealers
Primary credit
42
3
Central bank liquidity swaps
99,823
107,959
Credit extended to other market
participants
Term Asset-Backed Securities Loan
Facility (TALF)
9,013
7,629
Net portfolio holdings of TALF LLC
811
825
Support of critical institutions
Net portfolio holdings of Maiden Lane
LLC, Maiden Lane II LLC, and Maiden
Lane III LLC 1
34,248
30,822
Credit extended to American
International Group, Inc.
…
…
Preferred interests in AIA Aurora LLC and
ALICO Holdings LLC
…
…
Securities held outright
U.S. Treasury securities
1,672,092
1,656,581
Agency debt securities
103,994
100,817
Agency mortgage-backed securities
(MBS)2
837,295
853,045
Total liabilities
2,874,686
2,880,556
Selected liabilities
Federal Reserve notes in circulation
1,034,520
1,048,004
Reverse repurchase agreements
88,674
89,824
Deposits held by depository institutions
1,569,267
1,622,800
Of which: term deposits
0
0
U.S. Treasury, general account
91,418
36,033
U.S. Treasury, Supplementary Financing
Account
0
0
Total capital
53,799
54,594

2,868,387

8
29,708

4,504
845

15,388
…
…
1,663,949
91,484
855,044
2,813,713
1,073,732
89,689
1,527,556
0
75,287
0
54,674

Note: LLC is a limited liability company.
1
The Federal Reserve has extended credit to several LLCs in conjunction with
efforts to support critical institutions. Maiden Lane LLC was formed to acquire
certain assets of The Bear Stearns Companies, Inc. Maiden Lane II LLC was
formed to purchase residential mortgage-backed securities from the U.S.
securities lending reinvestment portfolio of subsidiaries of American
International Group, Inc. (AIG). Maiden Lane III LLC was formed to purchase
multisector collateralized debt obligations on which the Financial Products
group of AIG has written credit default swap contracts.
2
Includes only MBS purchases that have already settled.
… Not applicable.
Source: Federal Reserve Board, Statistical Release H.4.1, “Factors Affecting
Reserve Balances of Depository Institutions and Condition Statement of Federal
Reserve Banks.”

Federal Reserve holdings of agency MBS increased
about $18 billion as the policy of reinvesting principal payments from agency debt and agency MBS into
agency MBS continued.
In the first half of 2012, the Federal Reserve continued to reduce its exposure to facilities established
during the financial crisis to support specific institutions. The portfolio holdings of Maiden Lane LLC,
Maiden Lane II LLC, and Maiden Lane III LLC—

42

99th Annual Report | 2012

entities that were created during the crisis to acquire
certain assets from The Bear Stearns Companies,
Inc., and American International Group, Inc. (AIG),
to avoid the disorderly failures of those institutions—
declined, on net, primarily as a result of asset sales
and principal payments. Of note, proceeds from the
sales of all of the remaining assets in the Maiden
Lane II LLC portfolio in January and February
enabled the repayment of the entire remaining outstanding balance of the senior loan from the
FRBNY to Maiden Lane II LLC in March, with
interest and a $2.8 billion net gain. In addition, proceeds from the sales of assets from Maiden Lane
LLC and Maiden Lane III LLC in April and May
enabled the repayment, with interest, of the entire
remaining outstanding balances of the senior loans
from the FRBNY to Maiden Lane LLC and Maiden
Lane III LLC in June. Proceeds from further asset
sales from Maiden Lane III in June enabled repayment of the equity position of AIG in July. A net
gain on the sale of the remaining assets in Maiden
Lane III LLC is likely during the next few months.
Sales of most of the remaining assets in Maiden
Lane LLC should be completed by the end of the
year, but a few legacy assets may take longer to dispose of. Loans outstanding under the Term AssetBacked Securities Loan Facility (TALF) were slightly
lower, reflecting, in part, the first maturity of a
TALF loan with a three-year initial term.
On the liability side of the Federal Reserve’s balance
sheet, deposits held by depository institutions
declined about $42 billion in the first half of 2012,
while Federal Reserve notes in circulation increased
roughly $39 billion. As part of its ongoing program
to ensure the readiness of tools to drain reserves
when doing so becomes appropriate, the Federal
Reserve conducted a series of small-scale reverse
repurchase transactions involving all eligible collateral types with its expanded list of counterparties. In
the same vein, the Federal Reserve also continued to
offer small-value term deposits through the Term
Deposit Facility.
On March 20, the Federal Reserve System released its
2011 combined annual comparative audited financial
statements. The Federal Reserve reported net income
of about $77 billion for the year ending December 31, 2011, derived primarily from interest income
on securities acquired through open market operations (Treasury securities, federal agency and GSE
MBS, and GSE debt securities). The Reserve Banks
transferred about $75 billion of the $77 billion in
comprehensive income to the U.S. Treasury in 2011;

though down slightly from 2011, the transfer to the
U.S. Treasury remained historically very large.
International Developments
The European fiscal and banking crisis continued to
affect international financial markets and foreign
economic activity during the first half of 2012. Early
in the year, aggressive action by the ECB and some
progress in addressing the crisis by the region’s leaders contributed to a temporary easing of financial
stresses. (See the box “An Update on the European
Fiscal and Banking Crisis” on pages 34–35 of the
July 2012 Monetary Policy Report.) However, amid
ongoing political uncertainty in Greece and increased
concerns about the health of Spanish banks, financial
conditions deteriorated again in the spring. Foreign
economic growth picked up in the first quarter, but
this acceleration largely reflected temporary factors,
and recent data point to widespread slowing in the
second quarter.
International Financial Markets

Foreign financial markets have been volatile. Initially
in the first quarter, encouraging macroeconomic data
and some easing of tensions within the euro area led
to an improvement in global financial conditions.
This improvement was reversed in the spring as the
boost from previous policy measures, including the
ECB’s longer-term refinancing operations, faded and
political and banking stresses in vulnerable European
countries resurfaced. Euro-area leaders responded to
the worsening of the crisis by announcing additional
measures at a summit on June 28–29. The market
reaction was positive but short-lived.
Increased uncertainty and greater volatility have
pushed up the foreign exchange value of the dollar
about 4¼ percent on a trade-weighted basis against a
broad set of currencies since its low in early February, with most of the appreciation occurring in May.
Typical of periods of flight to safety, the dollar has
appreciated against most currencies but depreciated
against the Japanese yen for most of the period. The
Swiss franc has moved very closely with the euro as
the Swiss National Bank has intervened to maintain
a ceiling for the franc relative to the euro.
During the second quarter of this year, flight-tosafety flows and the deteriorating global economic
outlook helped push government bond yields for
Canada, Germany, and the United Kingdom to
record lows. Likewise, Japanese yields on 10-year
bonds fell well below 1 percent. By contrast, Spanish
sovereign spreads over German bunds rose more

Monetary Policy and Economic Developments

than 250 basis points between February and June
due to escalating concerns over Spain’s public
finances. Italian sovereign spreads moved up as well
over this period.
Equity prices abroad declined significantly in the second quarter, more so than in the United States.
Indexes tumbled in the nations at the center of the
euro-area fiscal and banking crisis, and the fall in
value from their March peaks was more than 10 percent across the advanced foreign economies (AFEs).
This fall was attenuated toward the end of the second
quarter by the positive market reaction to the June
summit. Equity markets in the EMEs were also
markedly down in the second quarter.
European banks faced renewed stresses in recent
months. In Greece, after inconclusive elections in
early May, deposit outflows from banks accelerated,
generating concerns that deposit flight could spread
to banking systems in the rest of the euro area. News
that Spain had partly nationalized the troubled
lender Bankia and would need to inject an additional
€19 billion into the bank and its holding company
added to unease about the region, eventually leading
to plans for an official aid package of up to €100 billion to recapitalize Spanish banks. Apprehension
about bank health was widespread, with major institutions in Italy, Germany, and several other European countries receiving credit ratings downgrades.
As a result, European bank stock prices have
tumbled since mid-March. At the same time, reflecting market views of increased risk of default, the
CDS premiums on the debt of many large banks in
Europe have risen substantially, while issuance of
unsecured bank debt, which had previously recovered, has fallen. Notwithstanding these developments, funding market stresses have remained relatively muted, as many banks accessed funds from the
Eurosystem—the system formed by the ECB and the
national central banks of the euro-area member
states—rather than interbank markets. A standard
measure of the cost of this interbank funding, the
implied basis spread from euro–dollar swaps, was
little changed at shorter maturities.
Advanced Foreign Economies

The European fiscal and banking crisis was at the
center of economic developments in the AFEs. Euroarea real GDP was flat in the first quarter of 2012
following a contraction in late 2011. Within the euro
area, output fell sharply in more vulnerable countries,
including Italy and Spain, whereas other countries,
especially Germany, performed better. Mounting

43

financial tensions and fiscal austerity measures
appear to have further restrained the euro-area
economy in the second quarter, as evidenced by
declining business confidence and a further drift of
purchasing managers indexes into contractionary
territory.
Economic performance in the other AFEs has been
uneven. In the United Kingdom, real GDP continued
to fall early in the year, and indicators point to further weakness fueled by tight fiscal policy and negative spillover effects from the euro area. In Japan,
output rose at a robust pace in the first quarter,
reflecting fiscal stimulus measures as well as a recovery from the shortage of parts supplies caused by the
floods in Thailand last year, but recent data suggest
that activity decelerated in the second quarter. The
Canadian economy continued to expand moderately
in the first three months of the year, supported by
solid domestic demand and a resilient labor market.
In most AFEs, headline inflation rates—measured on
a 12-month change basis—continued to decline in
the first half of the year as the effects of the large
run-up in commodity prices in early 2011 waned. The
smaller run-up in energy prices that took place early
this year exerted a less marked effect on consumer
prices, though it helped keep 12-month inflation rates
above 2 percent in the euro area and in the United
Kingdom. Japan appears to be emerging from several
years of deflation, but Japanese inflation remains
below the 1 percent inflation goal introduced by the
BOJ in February.
Several central banks eased further their monetary
policy stances. The BOJ increased the size of its asset
purchases from ¥30 trillion to ¥40 trillion in April,
and then to ¥45 trillion in July. The ECB, after having conducted the second of its three-year longerterm refinancing operations in late February, cut its
policy interest rates to record lows in early July. In
late June, the Bank of England (BOE) activated its
Extended Collateral Term Repo facility, offering sixmonth funds against a wide set of collateral. In addition, in July, the BOE increased the size of its asset
purchase program from £325 billion to £375 billion,
and, together with the U.K. Treasury, introduced a
new Funding for Lending Scheme designed to boost
lending to households and firms.
Emerging Market Economies

Following a disappointing performance at the end of
last year, real GDP growth rebounded in the first
quarter in most EMEs. Economic activity expanded

44

99th Annual Report | 2012

especially briskly in emerging Asia, largely reflecting
the reconnection of supply chains damaged by the
floods in Thailand. Economic growth, however, continued to slow in China and India. Moreover, recent
indicators suggest that the pace of economic activity
decelerated in most EMEs going into the second
quarter amid headwinds associated with the European crisis and relatively subdued growth in China.

In Brazil, real GDP—restrained by flagging investment and weather-related problems in the agricultural sector—increased slightly in the first quarter,
making it the fourth consecutive quarter of belowtrend growth. Industrial production, which has been
on a downward trend since early 2011, continued to
fall through May, suggesting that economic activity
in Brazil remained weak in the second quarter.

In China, real GDP increased at about a 7 percent
pace in the first half of the year, down from an
8½ percent pace in the second half of last year. The
slowdown reflected weaker demand for Chinese
exports as well as domestic factors, including moderating consumer spending and the restraining effects
on investment of previous government measures to
cool activity in the property sector. Macroeconomic
data for May and June suggest that economic activity
was picking up a bit toward the end of the second
quarter, with growth of investment, retail sales, and
bank lending edging higher. Headline 12-month
inflation fell to 2.2 percent in June, led by additional
moderation in food prices. As inflationary pressures
eased and concerns about growth mounted, the People’s Bank of China lowered banks’ reserve requirements by 50 basis points in both February and May
and then reduced the benchmark one-year lending
rate by 25 basis points in June and 31 basis points in
July, the first changes in that rate since an increase in
July of last year. Over the first half of the year, the
renminbi was little changed, on net, against the dollar, but it appreciated about 1½ percent on a real
trade-weighted basis, as the renminbi followed the
dollar upward against China’s other major trading
partners.

Headline inflation generally moderated in the EMEs
reflecting lower food price pressures and weaker economic growth. In addition to China, several other
central banks in the EMEs also loosened monetary
policy, including those in Brazil, Chile, India, Indonesia, the Philippines, South Korea, and Thailand.

In India, economic growth has also moderated as
slow progress on fiscal and structural reforms and
previous monetary tightening stalled investment.
Noting rising vulnerabilities from the country’s twin
fiscal and current account deficits, some credit rating
agencies warned that India’s sovereign debt risks losing its investment-grade status.
In Mexico, economic activity rebounded briskly in
the first quarter as the agricultural sector rebounded
from the fourth-quarter drought, domestic demand
gained momentum, and exports to the United States
picked up. Economic indicators, however, suggest
that growth moderated somewhat in the second quarter. On July 1, Enrique Peña Nieto of the Institutional Revolutionary Party, or PRI, won the Mexican
presidential election, promising to pursue marketoriented reforms to bolster economic growth.

Part 3
Monetary Policy:
Recent Developments and Outlook
Monetary Policy over the First Half of 2012
To promote the Federal Open Market Committee’s
(FOMC) objectives of maximum employment and
price stability, the Committee maintained a target
range for the federal funds rate of 0 to ¼ percent
throughout the first half of 2012.11 With the incoming data suggesting a somewhat slower pace of economic recovery than the Committee had anticipated,
and with inflation seen as settling at levels at or
below those consistent, over the long run, with its
statutory mandate, the Committee took steps during
the first half of 2012 to provide additional monetary
accommodation in order to support a stronger economic recovery and to help ensure that inflation, over
time, runs at levels consistent with its mandate. These
steps included lengthening the horizon of the forward rate guidance regarding the Committee’s expectations for the period over which economic conditions will warrant exceptionally low levels for the federal funds rate, continuing the Committee’s maturity
extension program (MEP) through the end of this
year rather than completing the program in June as
previously scheduled, retaining its existing policies
regarding the reinvestment of principal payments on
agency securities in agency-guaranteed mortgagebacked securities (MBS), and continuing to reinvest
the proceeds of maturing Treasury securities.
11

Members of the FOMC in 2012 consist of the members of the
Board of Governors of the Federal Reserve System plus the
presidents of the Federal Reserve Banks of Atlanta, Cleveland,
New York, Richmond, and San Francisco. As of the June
FOMC meeting, Governors Jerome H. Powell and Jeremy C.
Stein joined the Board of Governors increasing the number of
FOMC members to 12.

Monetary Policy and Economic Developments

The information reviewed at the January 24–25 meeting indicated that U.S. economic activity had
expanded moderately, while global growth appeared
to be slowing. Labor market indicators pointed to
some further improvement in labor market conditions, but progress was gradual and the unemployment rate remained elevated. Household spending
had continued to advance at a moderate pace despite
diminished growth in real disposable income, but
growth in business fixed investment had slowed. The
housing sector remained depressed. Inflation had
been subdued in recent months, and longer-term
inflation expectations had remained stable. Meeting
participants observed that financial conditions had
improved and financial market stresses had eased
somewhat during the intermeeting period, in part
because of the European Central Bank’s (ECB)
three-year refinancing operation. Nonetheless, participants expected that global financial markets
would remain focused on the evolving situation in
Europe, and they anticipated that further policy
efforts would be required to fully address the fiscal
and financial problems there.

45

increased. Household spending and business fixed
investment had advanced. Signs of improvement or
stabilization emerged in some local housing markets,
but overall housing activity continued to be
restrained by the substantial inventory of foreclosed
and distressed properties, tight credit conditions for
mortgage loans, and uncertainty about the economic
outlook and future home prices. Inflation continued
to be subdued, although prices of crude oil and gasoline had increased substantially. Longer-term inflation expectations had remained stable.
Many participants believed that policy actions in the
euro area, notably the Greek debt swap and the
ECB’s longer-term refinancing operations, had
helped ease strains in financial markets and reduced
the downside risks to the U.S. and global economic
outlook. Against that backdrop, equity prices had
risen and conditions in credit markets improved,
leading many meeting participants to see financial
conditions as more supportive of economic growth
than at the time of the January meeting.

With the economy facing continuing headwinds and
growth slowing in several U.S. export markets, members generally expected a modest pace of economic
growth over coming quarters, with the unemployment rate declining only gradually. At the same time,
members thought that inflation would run at levels at
or below those consistent with the Committee’s dual
mandate. Against this backdrop, members agreed to
keep the target range for the federal funds rate at 0 to
¼ percent, to continue the program of extending the
average maturity of the Federal Reserve’s holdings of
securities as announced in September, and to retain
the existing policies regarding the reinvestment of
principal payments from Federal Reserve holdings of
securities. In light of the economic outlook, most
members also agreed to indicate that the Committee
anticipates that economic conditions are likely to
warrant exceptionally low levels for the federal funds
rate at least through late 2014, longer than had been
indicated in recent FOMC statements. The Committee also stated that it is prepared to adjust the size
and composition of its securities holdings as appropriate to promote a stronger economic recovery in a
context of price stability.

Members viewed the information on U.S. economic
activity as suggesting that the economy would continue to expand moderately. However, despite the easing of strains in global financial markets, members
continued to perceive significant downside risks to
economic activity. Members generally anticipated
that the recent increase in oil and gasoline prices
would push up inflation temporarily, but that inflation subsequently would run at or below the rate that
the Committee judges most consistent with its mandate. As a result, the Committee decided to keep the
target range for the federal funds rate at 0 to ¼ percent, to reiterate its anticipation that economic conditions were likely to warrant exceptionally low levels
for the federal funds rate at least through late
2014, to continue the program of extending the average maturity of the Federal Reserve’s holdings of
securities that it had adopted in September, and to
maintain the existing policies regarding the reinvestment of principal payments from Federal Reserve
holdings of securities. The Committee again stated
that it is prepared to adjust the size and composition
of its securities holdings as appropriate to promote a
stronger economic recovery in a context of price
stability.

The data in hand at the March 13 FOMC meeting
indicated that U.S. economic activity had continued
to expand moderately. Although the unemployment
rate remained elevated, it had declined notably in
recent months and payroll employment had

By the time of the April 24–25 FOMC meeting, the
data again indicated that economic activity was
expanding moderately. Payroll employment had continued to move up, and the unemployment rate, while
still elevated, had declined a little further. Household

46

99th Annual Report | 2012

spending and business fixed investment had continued to expand. The housing sector showed signs of
improvement but from a very low level of activity.
Mainly reflecting the increase in the prices of crude
oil and gasoline earlier this year, inflation had picked
up somewhat; however, measures of long-run inflation expectations remained stable. Meeting participants judged that, in general, conditions in domestic
credit markets had improved further, but noted that
investors’ concerns about the sovereign debt and
banking situation in the euro area intensified during
the intermeeting period. Many U.S. financial institutions had been taking steps to bolster their resilience,
including expanding their capital levels and liquidity
buffers and reducing their European exposures.
Members expected growth to be moderate over coming quarters and then to pick up over time. Strains in
global financial markets stemming from the sovereign
debt and banking situation in Europe as well as
uncertainty about U.S. fiscal policy continued to pose
significant downside risks to economic activity both
here and abroad. Most members anticipated that the
increase in inflation would prove temporary and that
subsequently inflation would run at or below the rate
that the Committee judges to be most consistent with
its mandate. Against this backdrop, the Committee
members reached the collective judgment that it
would be appropriate to maintain the existing highly
accommodative stance of monetary policy. In particular, the Committee agreed to keep the target
range for the federal funds rate at 0 to ¼ percent, to
continue the program of extending the average maturity of the Federal Reserve’s holdings of securities as
announced last September, and to retain the existing
policies regarding the reinvestment of principal payments from Federal Reserve holdings of securities.
The Committee left the forward guidance for the target federal funds rate unchanged at this meeting.
Members emphasized that their forward guidance
was conditional on expected economic developments,
but they preferred adjusting the forward guidance
only once they were more confident that the mediumterm economic outlook or the risks to that outlook
had changed significantly.
Data received over the period leading up to the
June 19–20 FOMC meeting indicated that economic
activity was expanding at a somewhat more modest
pace than earlier in the year. Improvements in labor
market conditions had slowed in recent months, and
the unemployment rate seemed to have flattened out.
Household spending appeared to be rising at a somewhat slower rate, and business investment had con-

tinued to advance. Despite some ongoing signs of
improvement, the housing sector remained
depressed. Consumer price inflation had declined,
mainly reflecting lower prices of crude oil and gasoline, and longer-term inflation expectations remained
well anchored. Meeting participants observed that
financial markets were volatile over the intermeeting
period and that investor sentiment was strongly influenced by the developments in Europe and evidence of
slowing economic growth at home and abroad.
In the discussion of monetary policy, most members
agreed that the outlook had deteriorated somewhat
relative to the time of the April meeting, and that significant downside risks were present, importantly
including the financial stresses in the euro area and
uncertainty about the degree of fiscal restraint in the
United States, and its effects on economic activity
over the medium term. As a result, the Committee
decided that providing additional monetary policy
accommodation would be appropriate to support a
stronger economic recovery and to help ensure that
inflation, over time, was at a level consistent with the
Committee’s dual mandate. Specifically, the Committee agreed to continue the MEP through the end of
the year, instead of ending the program in June as
had been planned. In doing so, the Federal Reserve
will purchase Treasury securities with remaining
maturities of 6 years to 30 years and sell or redeem
an equal par value of Treasury securities with
remaining maturities of approximately 3 years or less.
This continuation of the MEP will proceed at about
the same pace as had been executed through the first
phase of the program, increasing the Federal
Reserve’s holdings of longer-term Treasury securities
by about $267 billion while reducing its holdings of
shorter-term Treasury securities by the same amount.
For the duration of this program, the Committee
directed the Open Market Desk to suspend its current policy of rolling over maturing Treasury securities into new issues at auction (and instead purchase
only additional longer-term securities with the proceeds of maturing securities). The Committee
expected the continuation of the MEP to put downward pressure on longer-term interest rates and help
make broader financial conditions more accommodative. In addition, the Committee decided to continue
reinvesting principal payments from its holdings of
agency debt and agency MBS in agency MBS. The
Committee also decided to keep the target range for
the federal funds rate at 0 to ¼ percent and to reaffirm its anticipation that economic conditions were
likely to warrant exceptionally low levels for the federal funds rate at least through late 2014. In its state-

Monetary Policy and Economic Developments

ment, the Committee noted that it was prepared to
take further action as appropriate to promote
stronger economic recovery and sustained improvement in labor market conditions in a context of price
stability.
FOMC Communications
Transparency is an essential principle of modern central banking because it contributes to the accountability of central banks to the government and to the
public and because it can enhance the effectiveness of
central banks in achieving their macroeconomic
objectives. To this end, the Federal Reserve provides
to the public a considerable amount of information
concerning the conduct of monetary policy. Following each meeting of the FOMC, the Committee
immediately releases a statement that lays out the
rationale for its policy decision and issues detailed
minutes of the meeting about three weeks later.
Lightly edited transcripts of FOMC meetings are
released to the public with a five-year lag.12 Moreover, beginning in April 2011, the Chairman has held
press conferences on an approximately quarterly
basis. At the press conferences, the Chairman
presents the current economic projections of FOMC
participants and provides additional context for the
Committee’s policy decisions.
The Committee continued to consider further
improvements in its communications approach in the
first half of 2012. At the January meeting, the
FOMC released a statement of its longer-run goals
and policy strategy in an effort to enhance the transparency, accountability, and effectiveness of monetary policy and to facilitate well-informed decisionmaking by households and businesses.13 The statement did not represent a change in the Committee’s
policy approach, but rather was intended to help
enhance the transparency, accountability, and effectiveness of monetary policy. The statement emphasizes the Federal Reserve’s firm commitment to pursue its congressional mandate to promote maximum
employment, stable prices, and moderate long-term
interest rates. To clarify its longer-term objectives, the
FOMC stated that inflation at the rate of 2 percent,
as measured by the annual change in the price index
12

13

FOMC statements, minutes, and transcripts, as well as other
related information, are available on the Federal Reserve
Board’s website at www.federalreserve.gov/monetarypolicy/
fomc.htm.
The FOMC statement of longer-run goals and policy strategy is
available on the Federal Reserve Board’s website at www
.federalreserve.gov/monetarypolicy/fomccalendars.htm.

47

for personal consumption expenditures, is most consistent over the longer run with the Federal Reserve’s
statutory mandate. While noting that the Committee’s assessments of the maximum level of employment are necessarily uncertain and subject to revision, the statement indicated that the central tendency of FOMC participants’ current estimates of
the longer-run normal rate of unemployment is
between 5.2 and 6.0 percent. It stressed that the Federal Reserve’s statutory objectives are generally
complementary, but when they are not, the Committee will follow a balanced approach in its efforts to
return both inflation and employment to levels consistent with its mandate.
In addition, in light of a decision made at the
December meeting, the Committee provided, starting
in the January Summary of Economic Projections
(SEP), information about each participant’s assessment of appropriate monetary policy. Specifically,
the SEP included information about participants’
estimates of the appropriate level of the target federal
funds rate in the fourth quarter of the current year
and the next few calendar years, and over the longer
run; the SEP also reported participants’ current projections of the likely timing of the appropriate first
increase in the target federal funds rate given their
assessments of the economic outlook. The accompanying narrative described the key factors underlying
those assessments and provided some qualitative
information regarding participants’ expectations for
the Federal Reserve’s balance sheet.
At the March meeting, participants discussed a range
of additional steps that the Committee might take to
help the public better understand the linkages
between the evolving economic outlook and the Federal Reserve’s monetary policy decisions, and thus
the conditionality in the Committee’s forward guidance. Participants discussed ways in which the Committee might include, in its postmeeting statements
and other communications, additional qualitative or
quantitative information that could convey a sense of
how the Committee might adjust policy in response
to changes in the economic outlook. However, participants also observed that the Committee had introduced several important enhancements to its policy
communications over the past year or so; these
included the Chairman’s postmeeting press conference as well as changes to the FOMC statement and
the SEP. Against this backdrop, some participants
noted that additional experience with the changes

48

99th Annual Report | 2012

implemented to date could be helpful in evaluating
potential further enhancements.
At the April meeting, the Committee discussed the
relationship between the postmeeting statement,
which expresses the collective view of the Committee,
and the policy projections of individual participants,
which are included in the SEP. The Chairman asked
the subcommittee on communications to consider
possible enhancements and refinements to the SEP
that might help clarify the link between economic
developments and the Committee’s view of the
appropriate stance of monetary policy. Following up
on this issue at the June meeting, participants discussed several possibilities for enhancing the clarity
and transparency of the Committee’s economic projections as well as the role they play in policy deci-

sions and policy communications. Many participants
indicated that if it were possible to construct a quantitative economic projection and associated path of
appropriate policy that reflected the collective judgment of the Committee, such a projection could
potentially be helpful in clarifying how the outlook
and policy decisions are related. However, many participants noted that developing a quantitative forecast that reflects the Committee’s collective judgment
could be challenging, given the range of their views
about the economy’s structure and dynamics. Participants agreed to continue to explore ways to increase
clarity and transparency in the Committee’s policy
communications, but many emphasized that further
changes in those communications should be considered carefully.

49

Supervision and Regulation

The Federal Reserve has supervisory and regulatory
authority over a variety of financial institutions and
activities with the goal of promoting a safe, sound,
and stable financial system that supports the growth
and stability of the U.S. economy. As described in
this report, the Federal Reserve carries out its supervisory and regulatory responsibilities and supporting
functions primarily by
• promoting the safety and soundness of individual
financial institutions supervised by the Federal
Reserve;
• developing supervisory policy (rulemakings, supervision and regulation letters (SR letters), policy
statements, and guidance);
• identifying requirements and setting priorities for
supervisory information technology initiatives;
• ensuring ongoing staff development to meet evolving supervisory responsibilities;
• regulating the U.S. banking and financial structure
by acting on a variety of proposals; and
• enforcing other laws and regulations.

2012 Developments
During 2012, the U.S. banking system and financial
markets continued to improve, at a slow pace, following their recovery from the financial crisis that
started in mid-2007.
Performance of bank holding companies. While an
improvement in bank holding companies’ (BHCs)
performance was evident during 2012, performance
remains weak by historical standards. U.S. BHCs, in
aggregate, reported earnings of $137 billion for 2012,
up from $108 billion for the year ending December 31, 2011. The proportion of unprofitable BHCs,
although down from 18 percent in 2011, remains
elevated at 10 percent; unprofitable BHCs encompass
roughly 5 percent of banking industry assets. Nonperforming assets continue to be a challenge to

industry recovery, with the nonperforming asset ratio
remaining elevated at 3.4 percent of loans and foreclosed assets, an improvement from 4.1 percent at
year-end 2011. Weaknesses were broad based,
encompassing residential mortgages (first-lien), commercial real estate—especially non-owner nonfarm
nonresidential and construction other than singlefamily—commercial and industrial (C&I) loans, and
construction and land development loans. (Also see
“Bank Holding Companies” on page 56.)
Performance of state member banks. The performance at state member banks in 2012 improved compared to the last few years. As a group, state member
banks reported a profit of $17.8 billion for 2012, up
from $11.5 billion for 2011 but still slightly below
pre-crisis levels. Provisions (as a percent of revenue)
have continued to decrease and are now 5.0 percent,
down from a crisis high of 32.4 percent at year-end
2009. Further, 6.4 percent of all state member banks
continued to report losses, down from 11 percent for
year-end 2011. Mirroring trends at BHCs, the nonperforming assets ratio remained elevated at 2.1 percent of loans and foreclosed assets, reflecting both
contracting loan balances and ongoing weaknesses in
asset quality. Growth in problem loans continued to
slow during 2012; however, weakness encompassed
nonfarm nonresidential lending, residential mortgages, and C&I loans. The risk-based capital ratios
for state member banks were basically unchanged
compared to the prior year in the aggregate, and
the percent of state member banks deemed well capitalized under prompt corrective action standards
remained high at 99 percent. In 2012, four state member banks with $1.3 billion in assets failed. (Also see
“State Member Banks” on page 55.)
Consolidated supervision framework for large financial
institutions. In December, the Board issued a new
framework for consolidated supervision of large
financial institutions. Building on lessons from the
recent financial crisis, this framework strengthens traditional microprudential supervision and regulation
to enhance the safety and soundness of individual

50

99th Annual Report | 2012

Box 1. Consolidated Supervision Framework for Large Financial Institutions
Building on lessons from the recent financial crisis,
the Federal Reserve issued a new framework for the
consolidated supervision of large financial institutions
in December 2012. This framework strengthens traditional microprudential supervision and regulation to
enhance the safety and soundness of individual firms
and incorporates macroprudential considerations to
reduce potential threats to the stability of the financial
system.
The new framework has two primary objectives:
1. Enhancing resiliency of a firm to lower the
probability of its failure or inability to serve as
a financial intermediary. Each firm is expected
to ensure that the consolidated organization (or
the combined U.S. operations in the case of foreign banking organizations) and its core business
lines can survive under a broad range of internal
or external stresses. This requires financial resilience by maintaining sufficient capital and liquidity, and operational resilience by maintaining
effective corporate governance, risk management, and recovery planning.
2. Reducing the impact on the financial system
and the broader economy in the event of a
firm’s failure or material weakness. Each firm
is expected to ensure the sustainability of its
critical operations and banking offices under a
broad range of internal or external stresses. This
requires, among other things, effective resolution
planning that addresses the complexity and the
interconnectivity of the firm’s operations.

firms, and incorporates macroprudential considerations to reduce potential threats to the stability of
the financial system. The consolidated supervision
framework for large financial institutions is being
implemented in a multi-stage approach. Additional
supervisory and operational guidance will be developed to support implementation of the framework
and to assess the progress of firms in meeting expectations. (See box 1 for more details.)
Enhanced prudential standards and early remediation
requirements for foreign banking organizations. In
December, the Board issued a notice of proposed
rulemaking (NPR) to strengthen the oversight of
U.S. operations of foreign banks. (See box 2 for
details.)
Proposed Basel III capital rules. In June, the federal
banking agencies jointly issued three NPRs to help
ensure banks maintain strong capital positions,

The framework is designed to support a tailored
supervisory approach that accounts for the unique
risk characteristics of each firm and applies to the
following institutions:
• Large Institution Supervision Coordinating
Committee (LISCC) firms: the largest, most complex U.S. and foreign financial organizations subject to consolidated supervision by the Federal
Reserve. Nonbank financial companies designated
by the Financial Stability Oversight Council for
supervision by the Federal Reserve are included in
the LISCC portfolio. LISCC firms are considered to
pose the greatest systemic risk to the U.S.
economy.
• Large Banking Organizations: domestic bank
and savings and loan holding companies with
consolidated assets of $50 billion or more that are
not included in the LISCC portfolio.
• Large Foreign Banking Organizations: foreign
banking organizations with combined assets of
U.S. operations of $50 billion or more that are not
included in the LISCC portfolio.
The consolidated supervision framework for large
financial institutions is being implemented in a multistage approach. Additional supervisory and operational guidance will be developed to support implementation of the framework and to assess the progress of firms in meeting these expectations.
For more information about the supervisory framework, see the Board’s press release and SR letter
12-17/CA 12-14 at www.federalreserve.gov/
newsevents/press/bcreg/20121217a.htm.

enabling them to continue lending to creditworthy
households and businesses even after unforeseen
losses and during severe economic downturns. (See
box 3 for details.)
Capital planning and stress testing. Since the financial
crisis, the Board has led a series of initiatives to
strengthen the capital positions of the largest banking organizations. Two related initiatives are the
Comprehensive Capital Analysis and Review
(CCAR) and the Dodd-Frank Act stress tests. (See
box 4 for details.)
Recovery and resolution planning. The Federal
Reserve continues to work with other regulatory
agencies to reduce the probability of failure of the
largest, most complex financial firms and to minimize the losses to the financial system and the
economy if such a firm should fail. In 2012, 11 financial institutions submitted their first plans for a rapid

Supervision and Regulation

51

Box 2. Enhanced Prudential Standards and Early Remediation Requirements
for Foreign Banking Organizations
In December 2012, the Board issued an NPR to
implement the enhanced prudential standards and
early remediation requirements in sections 165 and
166 of the Dodd-Frank Act for large foreign banking
organizations. The proposal generally applies to foreign banking organizations with a U.S. banking presence and total global consolidated assets of $50 billion or more. More stringent standards were proposed for foreign banking organizations with
combined U.S. assets of $50 billion or more.
The NPR proposes
A U.S. intermediate holding company requirement. A foreign banking organization with both
$50 billion or more in global consolidated assets and
U.S. subsidiaries with $10 billion or more in total
assets generally would be required to organize its
U.S. subsidiaries under a single U.S. intermediate
holding company (IHC). This structure would create a
platform for the consistent supervision and regulation
of the U.S. operations of foreign banking organizations and help facilitate the resolution of failing U.S.
operations of a foreign bank if needed. Direct U.S.
branches and agencies of foreign banking organizations would remain outside the U.S. IHC.
Risk-based capital and leverage requirements.
IHCs of foreign banking organizations would be subject to the same risk-based and leverage capital
standards applicable to U.S. bank holding companies. This proposed requirement would help bolster

and orderly resolution under the Bankruptcy Code in
the event of their material financial distress or failure,
in fulfillment of a Dodd-Frank Act requirement. The
public section of these plans, which are posted on the
Federal Reserve’s and FDIC’s public websites, provides a high-level description of the financial institution’s resolution strategy, core business lines and
material entities, corporate governance structure and
processes related to resolution planning, derivative
activities and hedging activities, and financial information.1 During 2013, the Federal Reserve and
FDIC will provide guidance to the remaining firms
that must file initial plans this year under the resolution plan requirement. Additionally, for the upcoming 2013 submissions, the Federal Reserve and FDIC
have publicly released the detailed guidance provided

1

The public sections of the resolution plans are available at www
.federalreserve.gov/bankinforeg/resolution-plans.htm.

the consolidated capital positions of the IHCs as well
as promote a level playing field among all banking
firms operating in the United States. IHCs with
$50 billion or more in consolidated assets also would
be subject to the Federal Reserve’s capital plan rule.
Liquidity requirements. The U.S. operations of foreign banking organizations with combined U.S.
assets of $50 billion or more would be required to
meet enhanced liquidity risk-management standards,
conduct liquidity stress tests, and hold a 30-day buffer of high-quality liquid assets. The liquidity requirements would help make the U.S. operations of foreign banking organizations more resilient to funding
shocks during times of stress.
Other requirements: The proposal also includes
measures regarding capital stress tests, singlecounterparty credit limits, risk management, and
early remediation.
The proposal includes a substantial phase-in period
to give foreign banking organizations time to adjust
to the new rules. Foreign banking organizations with
global consolidated assets of $50 billion or more on
July 1, 2014, would be required to meet the new
standards on July 1, 2015.
The comment period ends on March 31, 2013. See
press release and notice at www.federalreserve.gov/
newsevents/press/bcreg/20121214a.htm.

to the covered companies that submitted initial resolution plans in 2012.2

Supervision
The Federal Reserve is the federal supervisor and
regulator of all U.S. BHCs, including financial holding companies, and state-chartered commercial banks
that are members of the Federal Reserve System. The
Federal Reserve also has responsibility for supervising the operations of all Edge Act and agreement
corporations, the international operations of state
member banks and U.S. BHCs, and the U.S. operations of foreign banking organizations. Furthermore,
through the Dodd-Frank Act, the Federal Reserve
has been assigned responsibilities for nonbank financial firms and financial market utilities (FMUs) des2

The guidance is available at www.federalreserve.gov/newsevents/
press/bcreg/20130415c.htm.

52

99th Annual Report | 2012

Box 3. Proposed Basel III Capital Rule
In June 2012, the federal banking agencies jointly
proposed three NPRs that would restructure the
agencies’ current regulatory capital rules into a harmonized, comprehensive framework that would
implement Basel III for internationally-active U.S.
banking organizations and would modernize and
strengthen the regulatory capital rules for other U.S.
banking organizations. Taken together, the NPRs
would address shortcomings in regulatory capital
requirements that became apparent during the recent
financial crisis by (1) increasing both the quantity and
quality of regulatory capital banking organizations are
required to hold, (2) better reflecting banking organizations’ risk profiles, and (3) improving the resiliency
of the U.S. banking system during times of stress.
The proposed rulemaking was divided into three proposals to minimize burden on smaller and mid-sized
banking organizations and to allow firms to focus on
the aspects of the proposed revisions that are relevant to their organizations.
Basel III NPR
Consistent with the Basel framework, this proposal
would introduce a new common equity tier 1 capital
ratio of 4.5 percent of risk-weighted assets; increase
the minimum tier 1 capital ratio from 4 percent to
6 percent of risk-weighted assets; revise the definition of capital to improve the loss absorbency of
regulatory capital instruments; establish limitations
on capital distributions and certain discretionary
bonus payments if additional specified amounts, or
“buffers,” of common equity tier 1 capital are not
met; introduce a supplementary leverage ratio for
banking organizations subject to the advanced
approaches risk-based capital rule; and update the
prompt corrective action framework with the new
regulatory capital minimums and a revised definition
of tangible equity. The Basel III NPR would apply to
all depository institutions, savings and loan holding
companies, and those bank holding companies that
are not subject to the Board’s Small Bank Holding
Company Policy Statement.

ignated by the Financial Stability Oversight Council
as systemically important. In addition, the DoddFrank Act transferred authority for consolidated
supervision of more than 400 savings and loan holding companies (SLHCs) and their non-depository
subsidiaries from the Office of Thrift Supervision
(OTS) to the Federal Reserve.
In overseeing the institutions under its authority, the
Federal Reserve seeks primarily to promote safety

Standardized Approach NPR
This proposal would revise and harmonize the federal
banking agencies’ rules for calculating risk-weighted
assets to enhance risk sensitivity and address weaknesses that have been identified over the past several years. The changes would include revised methodologies for determining risk-weighted assets for
residential mortgages, securitization exposures, and
counterparty credit risk. In addition, the proposal
would modify the recognition of credit risk mitigation
to include greater recognition of financial collateral
and a wider range of eligible guarantors. The proposal would also eliminate references to and reliance
on credit ratings in the calculation of risk-weighted
assets. The Standardized Approach NPR would
apply to the same set of institutions as the Basel
III NPR.
Advanced Approaches and Market Risk NPR
This proposal would enhance the risk sensitivity of
the advanced approaches risk-based capital rule to
better address counterparty credit risk and interconnectedness among financial institutions, and would
extend application of the rule to savings and loan
holding companies. In addition, the proposal would
incorporate the market risk capital rule into an integrated capital framework and extend application of
the rule to savings and loan holding companies and
savings associations. This NPR would apply only to
those institutions that meet the relevant thresholds,
which are generally those that are internationally
active or that have significant trading activities.
The federal banking agencies received thousands of
comment letters on the NPRs and are working to
finalize the rulemaking in 2013.
See press release and notices at www.federalreserve
.gov/newsevents/press/bcreg/20120607a.htm.

and soundness, including compliance with laws and
regulations.

Safety and Soundness
The Federal Reserve uses a range of supervisory
activities to promote the safety and soundness of
financial institutions and maintain a comprehensive
understanding and assessment of each firm. These
activities include horizontal reviews, firm-specific

Supervision and Regulation

53

Table 1. State member banks and bank holding companies, 2008–2012
Entity/item
State member banks
Total number
Total assets (billions of dollars)
Number of examinations
By Federal Reserve System
By state banking agency
Top-tier bank holding companies
Large (assets of more than $1 billion)
Total number
Total assets (billions of dollars)
Number of inspections
By Federal Reserve System1
On site
Off site
By state banking agency
Small (assets of $1 billion or less)
Total number
Total assets (billions of dollars)
Number of inspections
By Federal Reserve System
On site
Off site
By state banking agency
Financial holding companies
Domestic
Foreign
1

2012

2011

2010

2009

2008

843
2,005
769
487
282

828
1,891
809
507
302

829
1,697
912
722
190

845
1,690
850
655
195

862
1,854
717
486
231

508
16,112
712
691
514
177
21

491
16,443
672
642
461
181
30

482
15,986
677
654
491
163
23

488
15,744
658
640
501
139
18

485
14,138
519
500
445
55
19

4,124
983
3,329
3,150
200
2,950
179

4,251
982
3,306
3,160
163
2,997
146

4,362
991
3,340
3,199
167
3,032
141

4,486
1,018
3,264
3,109
169
2,940
155

4,545
1,008
3,192
3,048
107
2,941
144

408
38

417
40

430
43

479
46

557
45

For large bank holding companies subject to continuous, risk-focused supervision, includes multiple targeted reviews.

examinations and inspections, continuous monitoring and surveillance activities, and implementation of
enforcement or other supervisory actions as necessary. The Federal Reserve also provides training and
technical assistance to foreign supervisors and
minority-owned and de novo depository institutions.
Examinations and Inspections
The Federal Reserve conducts examinations of state
member banks, FMUs, the U.S. branches and agencies of foreign banks, and Edge Act and agreement
corporations. In a process distinct from examinations, it conducts inspections of holding companies
and their nonbank subsidiaries. Whether an examination or an inspection is being conducted, the
review of operations entails
• an evaluation of the adequacy of governance provided by the board and senior management,
including an assessment of internal policies, procedures, controls, and operations;
• an assessment of the quality of the riskmanagement and internal control processes in
place to identify, measure, monitor, and control
risks;

• an assessment of the key financial factors of capital, asset quality, earnings, and liquidity; and
• a review for compliance with applicable laws and
regulations.
Table 1 provides information on examinations and
inspections conducted by the Federal Reserve during
the past five years.
Consolidated Supervision
Consolidated supervision, a method of supervision
that encompasses the parent company and its subsidiaries, allows the Federal Reserve to understand the
organization’s structure, activities, resources, risks,
and financial and operational resilience. Working
with other relevant supervisors and regulators, the
Federal Reserve seeks to ensure that financial, operational, or other deficiencies are addressed before they
pose a danger to the consolidated organization, its
banking offices, or the broader economy.3
3

"Banking offices" are defined as U.S. depository institution subsidiaries, as well as the U.S. branches and agencies of foreign
banking organizations.

54

99th Annual Report | 2012

Box 4. Capital Planning and Stress Testing
Since the financial crisis, the Board has led a series
of initiatives to strengthen the capital positions of
large, complex banking organizations, including
working with the organizations to bolster their internal processes for assessing capital needs and
enhancing the Board’s supervisory practices for
assessing capital adequacy. These efforts culminated in the Comprehensive Capital Analysis and
Review (CCAR), the annual supervisory review of
capital plans of large banking organizations, including any plans they had for increasing dividends or
buying back stock. The Board further strengthened
its supervisory approach to assessing capital
adequacy at the large financial companies by finalizing its Dodd-Frank Act capital stress testing rules in
October of 2012.
During the Board’s annual CCAR process, the Federal Reserve evaluates the capital adequacy; internal capital adequacy processes; and plans to make
capital distributions, such as dividend payments or
stock repurchases, of BHCs with $50 billion or more
in assets. The capital plan rule requires companies
to develop comprehensive capital policies to govern
their capital planning, capital issuance, usage, and
distribution. CCAR includes the Board’s evaluation
of each company’s capital plan to ensure that companies’ capital planning processes are sufficiently
comprehensive and forward-looking. As part of their

capital plans, companies are required to conduct
company-run stress tests under scenarios provided
by the Board and scenarios designed by the companies in order to assess each company’s view of its
idiosyncratic risks. The Board assesses a company’s ability to effectively identify, measure, and
assess its risks; its methodologies for estimating
company-wide losses and revenues under stress
scenarios; and its process for determining the
impact of a stressed operating environment on capital adequacy. Supervisory evaluations of individual
companies’ capital plans, including a quantitative
analysis that incorporates Dodd-Frank Act supervisory stress tests, are conducted simultaneously
across all participating companies, allowing a comparative analysis across the companies and providing the Federal Reserve with a broad view of U.S.
banking system assets and activities.
The Board finalized two Dodd-Frank stress testing
rules:
• covered company rule—provides details on the
process for annual supervisory stress tests and
requirements for semi-annual company-run stress
tests for BHCs with $50 billion or more in assets
and systemically important nonbank financial
companies.
(continued on next page)

Large financial institutions increasingly operate and
manage their integrated businesses across corporate
boundaries. Financial trouble in one part of a financial institution can spread rapidly to other parts of
the institution. Risks that cross legal entities or that
are managed on a consolidated basis cannot be
monitored properly through supervision that is
directed at any one of the legal entity subsidiaries
within the overall organization. A new framework for
the consolidated supervision of all large financial
institutions was issued in December 2012 (see box 1).
To strengthen its supervision of the largest, most
complex financial institutions, the Federal Reserve
created a centralized multidisciplinary body called
the Large Institution Supervision Coordinating
Committee (LISCC) to oversee the supervision and
evaluate conditions of supervised firms. The committee also develops cross-firm perspectives and monitors interconnectedness and common practices that
could lead to systemic risk.

The Federal Reserve uses a range of supervisory
activities to maintain a comprehensive understanding
and assessment of each large financial institution:
• Coordinated horizontal reviews. These reviews
involve examining several institutions simultaneously and encompass firm-specific supervision and
the development of cross-firm perspectives. The
Federal Reserve recognizes the priority of these
reviews through the dedication of experienced staff
with multidisciplinary skills. Examples include
analysis of capital adequacy and planning through
the Comprehensive Capital Analysis and Review
(CCAR), as well as horizontal evaluations of resolution plans and incentive compensation practices.
• Firm-specific examinations and/or inspections and
continuous monitoring activities. These activities are
designed to maintain an understanding and assessment across the core areas of supervisory focus.
These activities include review and assessment of
changes in strategy, inherent risks, control pro-

Supervision and Regulation

55

Box 4. Capital Planning and Stress Testing—continued
• other financial companies rule—requires annual
company-run stress tests at companies supervised by the Board, with more than $10 billion in
assets.
For more information on the stress test rules, see
the Board’s press release and Federal Register
notices at www.federalreserve.gov/newsevents/
press/bcreg/20121009a.htm.
The Dodd-Frank Act supervisory stress tests and
the annual company-run stress tests are conducted
under common scenarios (baseline, adverse, and
severely adverse) provided by the Board, making
the results of the supervisory and company-run
stress tests comparable (the “mid-cycle” companyrun stress test for covered companies uses scenarios designed by the companies). In November 2012, the Board published a policy document for
public comment on its development process for
supervisory stress test scenarios. (For more information on the stress testing scenario development,
see the Board’s press release and Federal Register
notice at www.federalreserve.gov/newsevents/press/
bcreg/20121115a.htm.)

tion to market participants about the capital
adequacy of large banking organizations under
hypothetical stressful circumstances (www
.federalreserve.gov/bankinforeg/stress-tests-capitalplanning.htm). Under the Dodd-Frank Act stress test
rules, companies must also publicly release a summary of their company-run stress tests under the
“severely adverse” scenario, including both quantitative results and qualitative information on the risks
captured in the stress tests and the stress testing
methodologies—as a complement to the publication
of the results of the Federal Reserve’s supervisory
stress tests.
Together CCAR and Dodd-Frank Act stress tests
help the Federal Reserve assess whether companies would have sufficient capital to withstand a significant decline in revenues and potentially large
losses and to continue functioning as sources of
credit and providers of other financial services, even
in the event of a worse-than-anticipated weakening
of the economy. These processes also provide a
means to assess capital adequacy across companies more fully and to support the Board’s financial
stability efforts.

In March 2013, the Board publicly released a summary of the results of CCAR and its Dodd-Frank Act
supervisory stress tests, providing valuable informa-

cesses, and key personnel, and follow-up on previously identified concerns (for example, areas subject to enforcement actions), or emerging
vulnerabilities.
• Interagency information sharing and coordination.
In developing and executing a detailed supervisory
plan for each firm, the Federal Reserve generally
relies to the fullest extent possible on the information and assessments provided by other relevant
supervisors and functional regulators. The Federal
Reserve actively participates in interagency information sharing and coordination, consistent with
applicable laws, to promote comprehensive and
effective supervision and limit unnecessary duplication of information requests. Supervisory agencies
continue to enhance formal and informal discussions to jointly identify and address key vulnerabilities, and to coordinate supervisory strategies
for large financial institutions.
• Internal audit and control functions. In certain
instances, supervisors may be able to rely on a
firm’s internal audit or internal control functions in

developing a comprehensive understanding and
assessment.
The Federal Reserve uses a risk-focused approach to
supervision, with activities directed toward identifying the areas of greatest risk to financial institutions
and assessing the ability of institutions’ management
processes to identify, measure, monitor, and control
those risks. For medium and small-sized financial
institutions, the risk-focused consolidated supervision program provides that examination and inspection procedures are tailored to each organization’s
size, complexity, risk profile, and condition. The
supervisory program for an institution, regardless of
its asset size, entails both off-site and on-site work,
including development of supervisory plans, preexamination visits, detailed documentation, and
preparation of examination reports tailored to the
scope and findings of the examination.
State Member Banks

At the end of 2012, 2,075 banks (excluding nondepository trust companies and private banks) were

56

99th Annual Report | 2012

members of the Federal Reserve System, of which
843 were state chartered. Federal Reserve System
member banks operated 58,714 branches, and
accounted for 34 percent of all commercial banks in
the United States and for 71 percent of all commercial banking offices. State-chartered commercial
banks that are members of the Federal Reserve, commonly referred to as state member banks, represented
approximately 14 percent of all insured U.S. commercial banks and held approximately 15 percent of all
insured commercial bank assets in the United States.
Under section 10 of the Federal Deposit Insurance
Act, as amended by section 111 of the Federal
Deposit Insurance Corporation Improvement Act of
1991 and by the Riegle Community Development
and Regulatory Improvement Act of 1994, the Federal Reserve must conduct a full-scope, on-site examination of state member banks at least once a year,4
although certain well-capitalized, well-managed organizations with total assets of less than $500 million
may be examined once every 18 months.5 The Federal Reserve conducted 487 exams of state member
banks in 2012.
Bank Holding Companies

At year-end 2012, a total of 5,210 U.S. BHCs were in
operation, of which 4,632 were top-tier BHCs. These
organizations controlled 5,088 insured commercial
banks and held approximately 99 percent of all
insured commercial bank assets in the United States.
Federal Reserve guidelines call for annual inspections
of large BHCs and complex smaller companies. In
judging the financial condition of the subsidiary
banks owned by holding companies, Federal Reserve
examiners consult examination reports prepared by
the federal and state banking authorities that have
primary responsibility for the supervision of those
banks, thereby minimizing duplication of effort and
reducing the supervisory burden on banking
organizations.
Inspections of BHCs, including financial holding
companies, are built around a rating system introduced in 2005. The system reflects the shift in supervisory practices away from a historical analysis of
4

5

The Office of the Comptroller of the Currency examines nationally chartered banks, and the FDIC examines state-chartered
banks that are not members of the Federal Reserve.
The Financial Services Regulatory Relief Act of 2006, which
became effective in October 2006, authorized the federal banking agencies to raise the threshold from $250 million to
$500 million, and final rules incorporating the change into existing regulations were issued on September 21, 2007.

financial condition toward a more dynamic, forwardlooking assessment of risk-management practices
and financial factors. Under the system, known as
RFI but more fully termed RFI/C(D), holding companies are assigned a composite rating (C) that is
based on assessments of three components: Risk
Management (R), Financial Condition (F), and the
potential Impact (I) of the parent company and its
nondepository subsidiaries on the subsidiary depository institution. The fourth component, Depository
Institution (D), is intended to mirror the primary
supervisor’s rating of the subsidiary depository institution.6 Noncomplex BHCs with consolidated assets
of $1 billion or less are subject to a special supervisory program that permits a more flexible approach.7
In 2012, the Federal Reserve conducted 691 inspections of large BHCs and 3,150 inspections of small,
noncomplex BHCs.
Financial Holding Companies

Under the Gramm-Leach-Bliley Act, BHCs that
meet certain capital, managerial, and other requirements may elect to become financial holding companies and thereby engage in a wider range of financial
activities, including full-scope securities underwriting, merchant banking, and insurance underwriting
and sales. As of year-end 2012, 408 domestic BHCs
and 38 foreign banking organizations had financial
holding company status. Of the domestic financial
holding companies, 38 had consolidated assets of
$15 billion or more; 118, between $1 billion and
$15 billion; 63, between $500 million and $1 billion;
and 189, less than $500 million.
Savings and Loan Holding Companies

On July 21, 2011, responsibility for supervision and
regulation of SLHCs transferred from the OTS to
the Federal Reserve, pursuant to the Dodd-Frank
Act. At year-end 2012, a total of 689 SLHCs were in
operation, of which 371 were top-tier SLHCs. These
SLHCs controlled 326 thrift institutions and
included 40 companies engaged primarily in nonbanking activities, such as insurance underwriting (21
SLHCs), securities brokerage (10 SLHCs), and com6

7

Each of the first two components has four subcomponents: Risk
Management— (1) Board and Senior Management Oversight;
(2) Policies, Procedures, and Limits; (3) Risk Monitoring and
Management Information Systems; and (4) Internal Controls.
Financial Condition— (1) Capital, (2) Asset Quality, (3) Earnings, and (4) Liquidity.
The special supervisory program was implemented in 1997 and
modified in 2002. See SR letter 02-01 for a discussion of the factors considered in determining whether a BHC is complex or
noncomplex (www.federalreserve.gov/boarddocs/srletters/2002/
sr0201.htm).

Supervision and Regulation

mercial activities (9 SLHCs). The 25 largest SLHCs
accounted for more than $2.7 trillion of total combined assets. The savings association subsidiaries of
all top-tier SLHCs accounted for just $680 billion
(approximately 22 percent) of total assets. Seven
institutions in the top 25 and approximately 90 percent of all SLHCs are engaged primarily in depository activities. These firms hold approximately
13 percent ($397 billion) of the total combined assets
of all SLHCs. The Office of the Comptroller of the
Currency (OCC) is the primary regulator for most of
the subsidiary savings associations of the firms
engaged primarily in depository activities.
Board staff continues to work on operational, technical, and practical transition issues while engaging the
industry, Reserve Banks, and other financial regulatory agencies. Board staff has also issued internal
policies and procedures, presented training sessions,
conducted bi-weekly conference calls, and developed
job aids to enhance the understanding of the SLHC
population and to ensure consistent supervisory
treatment of these institutions throughout the Federal Reserve System.
Although significant milestones have been achieved,
several complex policy issues still need to be
addressed by the Board, including those related to
consolidated capital requirements, intermediate holding companies, application of a formal rating system,
and the determination of the applicability of
enhanced prudential standards to the SLHC
population.
Financial Market Utilities

FMUs manage or operate multilateral systems for
the purpose of transferring, clearing, or settling payments, securities, or other financial transactions
among financial institutions or between financial
institutions and the FMU. Under the Federal
Reserve Act, the Federal Reserve supervises FMUs
that are chartered as member banks or Edge Act corporations and cooperates with other federal banking
supervisors to supervise FMUs organized as bank
service providers under the Bank Service Company Act.

57

to these FMUs that include promoting uniform riskmanagement standards, playing an enhanced role in
the supervision of FMUs, reducing systemic risk,
and supporting the stability of the broader financial
system. To ensure appropriate supervision of these
FMUs, the Federal Reserve established riskmanagement standards and expectations that are
articulated in Board Regulation HH (effective September 2012). In addition to setting minimum riskmanagement standards, Regulation HH also establishes requirements for the advance notice of proposed material changes to the rules, procedures, or
operations of a designated FMU for which the Federal Reserve is the supervisory agency under title VIII
of the Dodd-Frank Act.
The Federal Reserve’s risk-based supervision program for FMUs is administered by the FMU Supervision Committee (FMU-SC). The FMU-SC is a
multidisciplinary committee of senior supervision,
payment policy, and legal staff at the Board of Governors and Reserve Banks who are responsible for,
and knowledgeable about, supervisory issues for
FMUs. The FMU-SC’s primary objective is to provide senior level oversight, consistency, and direction
to the Federal Reserve’s supervisory process for
FMUs. The FMU-SC coordinates with the LISCC
on issues related to large financial institutions’ roles
in FMUs; the payment, clearing, and settlement
activities of large financial institutions; and the FMU
activities and implications for large financial
institutions.
In an effort to promote greater financial market stability and mitigate systemic risk, the Board also is
working with the U.S. Securities and Exchange Commission and the U.S. Commodity Futures Trading
Commission, both of which also have supervisory
authority for certain FMUs. The Federal Reserve’s
work with these agencies, including the sharing of
appropriate information and participation in certain
FMU examinations, aims to improve consistency in
FMU supervision, promote robust FMU risk management, and improve the regulators’ ability to monitor and mitigate systemic risk.
International Activities

In July 2012, the Financial Stability Oversight Council voted to designate eight FMUs as systemically
important under title VIII of the Dodd-Frank Act.
As a result of these designations, the Federal Reserve
assumed an expanded set of responsibilities related

The Federal Reserve supervises the foreign branches
and overseas investments of member banks, Edge
Act and agreement corporations, and BHCs (including the investments by BHCs in export trading companies). In addition, it supervises the activities that

58

99th Annual Report | 2012

foreign banking organizations conduct through entities in the United States, including branches, agencies, representative offices, and subsidiaries.
Foreign operations of U.S. banking organizations. In
supervising the international operations of state
member banks, Edge Act and agreement corporations, and BHCs, the Federal Reserve generally conducts its examinations or inspections at the U.S. head
offices of these organizations, where the ultimate
responsibility for the foreign offices resides. Examiners also visit the overseas offices of U.S. banking
organizations to obtain financial and operating information and, in some instances, to test their adherence
to safe and sound banking practices and compliance
with rules and regulations. Examinations abroad are
conducted with the cooperation of the supervisory
authorities of the countries in which they take place;
for national banks, the examinations are coordinated
with the OCC.
At the end of 2012, 45 member banks were operating
525 branches in foreign countries and overseas areas
of the United States; 25 national banks were operating 469 of these branches, and 20 state member
banks were operating the remaining 56. In addition,
16 nonmember banks were operating 24 branches in
foreign countries and overseas areas of the United
States.
Edge Act and agreement corporations. Edge Act corporations are international banking organizations
chartered by the Board to provide all segments of the
U.S. economy with a means of financing international business, especially exports. Agreement corporations are similar organizations, state or federally
chartered, that enter into agreements with the Board
to refrain from exercising any power that is not permissible for an Edge Act corporation. Sections 25
and 25A of the Federal Reserve Act grant Edge Act
and agreement corporations permission to engage in
international banking and foreign financial transactions. These corporations, most of which are subsidiaries of member banks, may (1) conduct a deposit
and loan business in states other than that of the parent, provided that the business is strictly related to
international transactions and (2) make foreign
investments that are broader than those permissible
for member banks.
At year-end 2012, 50 banking organizations, operating 8 branches, were chartered as Edge Act or agreement corporations. These corporations are examined
annually.

U.S. activities of foreign banks. Foreign banks continue to be significant participants in the U.S. banking system. As of fourth quarter 2012, 168 foreign
banks from 53 countries operated 195 state-licensed
branches and agencies, of which 6 were insured by
the FDIC, and 48 OCC-licensed branches and agencies, of which 4 were insured by the FDIC. These foreign banks also owned 10 Edge Act and agreement
corporations and 1 commercial lending company. In
addition, they held a controlling interest in 49 U.S.
commercial banks. Altogether, the U.S. offices of
these foreign banks controlled approximately 21 percent of U.S. commercial banking assets. These 168
foreign banks also operated 88 representative offices;
an additional 40 foreign banks operated in the
United States through a representative office. The
Federal Reserve—in coordination with appropriate
state regulatory authorities—examines state-licensed,
non-FDIC insured branches and agencies of foreign
banks on-site at least once every 18 months.8 In most
cases, on-site examinations are conducted at least
once every 12 months, but the period may be
extended to 18 months if the branch or agency meets
certain criteria. As part of the supervisory process, a
review of the financial and operational profile of
each organization is conducted to assess the organization’s ability to support its U.S. operations and to
determine what risks, if any, the organization poses
to the banking system through its U.S. operations.
The Federal Reserve conducted or participated with
state and federal regulatory authorities in 447 examinations in 2012.
Compliance with Regulatory Requirements
The Federal Reserve examines institutions for compliance with a broad range of legal requirements,
including anti-money-laundering (AML) and consumer protection laws and regulations, and other
laws pertaining to certain banking and financial
activities. Most compliance supervision is conducted
under the oversight of the Board’s Division of Banking Supervision and Regulation, but consumer compliance supervision is conducted under the oversight
of the Division of Consumer and Community
Affairs. The two divisions coordinate their efforts
with each other and also with the Board’s Legal Division to ensure consistent and comprehensive Federal
Reserve supervision for compliance with legal
requirements.

8

The OCC examines federally licensed branches and agencies,
and the FDIC examines state-licensed FDIC-insured branches
in coordination with the appropriate state regulatory authority.

Supervision and Regulation

59

Anti-Money-Laundering Examinations

Fiduciary Activities

The Treasury regulations implementing the Bank
Secrecy Act (BSA) generally require banks and other
types of financial institutions to file certain reports
and maintain certain records that are useful in criminal, tax, or regulatory proceedings. The BSA and
separate Board regulations require banking organizations supervised by the Board to file reports on suspicious activity related to possible violations of federal
law, including money laundering, terrorism financing, and other financial crimes. In addition, BSA and
Board regulations require that banks develop written
BSA compliance programs and that the programs be
formally approved by bank boards of directors. The
Federal Reserve is responsible for examining institutions for compliance with applicable AML laws and
regulations and conducts such examinations in accordance with the Federal Financial Institutions Examination Council’s (FFIEC) Bank Secrecy Act/AntiMoney Laundering Examination Manual.9

The Federal Reserve has supervisory responsibility
for state member banks and state member nondepository trust companies, which reported $53.9 trillion and $39.5 trillion of assets, respectively, as of
year-end 2012. These assets were held in various fiduciary and custodial capacities. On-site examinations
of fiduciary and custodial activities are risk-focused
and entail the review of an organization’s compliance
with laws, regulations, and general fiduciary principles, including effective management of conflicts of
interest; management of legal, operational, and reputational risk exposures; and audit and control procedures. In 2012, Federal Reserve examiners conducted
113 on-site fiduciary examinations, excluding transfer
agent examinations, of state member banks.

Specialized Examinations
The Federal Reserve conducts specialized examinations of supervised financial institutions in the areas
of information technology, fiduciary activities, transfer agent activities, and government and municipal
securities dealing and brokering. The Federal Reserve
also conducts specialized examinations of certain
nonbank entities that extend credit subject to the
Board’s margin regulations.

Transfer Agents

As directed by the Securities Exchange Act of 1934,
the Federal Reserve conducts specialized examinations of those state member banks and BHCs that
are registered with the Board as transfer agents.
Among other things, transfer agents countersign and
monitor the issuance of securities, register the transfer of securities, and exchange or convert securities.
On-site examinations focus on the effectiveness of an
organization’s operations and its compliance with
relevant securities regulations. During 2012, the Federal Reserve conducted on-site transfer agent examinations at 11 of the 30 state member banks and
BHCs that were registered as transfer agents.

Information Technology Activities

In recognition of the importance of information
technology to safe and sound operations in the financial industry, the Federal Reserve reviews the information technology activities of supervised financial
institutions, as well as certain independent data centers that provide information technology services to
these organizations. All safety-and-soundness examinations include a risk-focused review of information
technology risk-management activities. During 2012,
the Federal Reserve continued as the lead supervisory
agency for four of the 16 large, multiregional data
processing servicers recognized on an interagency
basis and assumed leadership of three more of the
large servicers.
9

The FFIEC is an interagency body of financial regulatory agencies established to prescribe uniform principles, standards, and
report forms and to promote uniformity in the supervision of
financial institutions. The Council has six voting members: the
Board of Governors of the Federal Reserve System, the FDIC,
the National Credit Union Administration, the OCC, the Consumer Financial Protection Bureau (CFPB), and the chair of the
State Liaison Committee.

Government and Municipal Securities
Dealers and Brokers

The Federal Reserve is responsible for examining
state member banks and foreign banks for compliance with the Government Securities Act of 1986
and with the Treasury regulations governing dealing
and brokering in government securities. Fourteen
state member banks and six state branches of foreign
banks have notified the Board that they are government securities dealers or brokers not exempt from
the Treasury’s regulations. During 2012, the Federal
Reserve conducted seven examinations of broker–
dealer activities in government securities at these
organizations. These examinations are generally conducted concurrently with the Federal Reserve’s
examination of the state member bank or branch.
The Federal Reserve is also responsible for ensuring
that state member banks and BHCs that act as
municipal securities dealers comply with the Securities Act Amendments of 1975. Municipal securities
dealers are examined, pursuant to the Municipal

60

99th Annual Report | 2012

Securities Rulemaking Board’s rule G-16, at least
once every two calendar years. Eight of the 12 entities supervised by the Federal Reserve that dealt in
municipal securities were examined during 2012.

In 2012, the Reserve Banks completed 198 informal
enforcement actions. Informal enforcement actions
include memoranda of understanding (MOU), commitment letters, and board of directors’ resolutions.

Securities Credit Lenders

Surveillance and Off-Site Monitoring
The Federal Reserve uses automated screening systems to monitor the financial condition and performance of state member banks and BHCs in the
period between on-site examinations. Such monitoring and analysis helps direct examination resources to
institutions that have higher risk profiles. Screening
systems also assist in the planning of examinations
by identifying companies that are engaging in new or
complex activities.

Under the Securities Exchange Act of 1934, the
Board is responsible for regulating credit in certain
transactions involving the purchasing or carrying of
securities. As part of its general examination program, the Federal Reserve examines the banks under
its jurisdiction for compliance with Board Regulation U (Credit by Banks and Persons other than Brokers or Dealers for the Purpose of Purchasing or
Carrying Margin Stock). In addition, the Federal
Reserve maintains a registry of persons other than
banks, brokers, and dealers who extend credit subject
to Regulation U. The Federal Reserve may conduct
specialized examinations of these lenders if they are
not already subject to supervision by the Farm Credit
Administration or the National Credit Union
Administration (NCUA).
At the end of 2012, 451 lenders other than banks,
brokers, or dealers were registered with the Federal
Reserve. Other federal regulators supervised 116 of
these lenders, and the remaining 335 were subject to
limited Federal Reserve supervision. The Federal
Reserve exempted 139 lenders from its on-site inspection program on the basis of their regulatory status
and annual reports. Forty-two inspections were conducted during the year.
Enforcement Actions
The Federal Reserve has enforcement authority over
the financial institutions it supervises and their affiliated parties. Enforcement actions may be taken to
address unsafe and unsound practices or violations
of any law or regulation. Formal enforcement actions
include cease-and-desist orders, written agreements,
prompt corrective action directives, removal and prohibition orders, and civil money penalties. In 2012,
the Federal Reserve completed 74 formal enforcement actions. Civil money penalties totaling
$1,043,700,000 were assessed. As directed by statute,
all civil money penalties are remitted to either the
Treasury or the Federal Emergency Management
Agency. Enforcement orders and prompt corrective
action directives, which are issued by the Board, and
written agreements, which are executed by the
Reserve Banks, are made public and are posted on
the Board’s website (www.federalreserve.gov/apps/
enforcementactions/).

The primary off-site monitoring tool used by the
Federal Reserve is the Supervision and Regulation Statistical Assessment of Bank Risk model (SRSABR). Drawing mainly on the financial data that
banks report on their Reports of Condition and
Income (Call Reports), SR-SABR uses econometric
techniques to identify banks that report financial
characteristics weaker than those of other banks
assigned similar supervisory ratings. To supplement
the SR-SABR screening, the Federal Reserve also
monitors various market data, including equity
prices, debt spreads, agency ratings, and measures of
expected default frequency, to gauge market perceptions of the risk in banking organizations. In addition, the Federal Reserve prepares quarterly Bank
Holding Company Performance Reports (BHCPRs)
for use in monitoring and inspecting supervised
banking organizations. The BHCPRs, which are
compiled from data provided by large BHCs in quarterly regulatory reports (FR Y-9C and FR Y-9LP),
contain, for individual companies, financial statistics
and comparisons with peer companies. BHCPRs are
made available to the public on the National Information Center (NIC) website, which can be accessed
at www.ffiec.gov.
Federal Reserve analysts use Performance Report
Information and Surveillance Monitoring (PRISM),
a querying tool, to access and display financial, surveillance, and examination data. In the analytical
module, users can customize the presentation of
institutional financial information drawn from Call
Reports, Uniform Bank Performance Reports, FR
Y-9 statements, BHCPRs, and other regulatory
reports. In the surveillance module, users can generate reports summarizing the results of surveillance
screening for banks and BHCs. During 2012, two

Supervision and Regulation

major upgrades to the web-based PRISM application
were completed.
The Federal Reserve works through the FFIEC Task
Force on Surveillance Systems to coordinate surveillance activities with the other federal banking
agencies.
Training and Technical Assistance
The Federal Reserve provides training and technical
assistance to foreign supervisors and minority-owned
and de novo depository institutions.
International Training and Technical Assistance

In 2012, the Federal Reserve continued to provide
technical assistance on bank supervisory matters to
foreign central banks and supervisory authorities.
Technical assistance involves visits by Federal
Reserve staff members to foreign authorities as well
as consultations with foreign supervisors who visit
the Board or the Reserve Banks. The Federal
Reserve, along with the OCC, the FDIC, and the
Treasury, was an active participant in the Middle
East and North Africa Financial Regulators’ Training Initiative, which is part of the U.S. government’s
Middle East Partnership Initiative. The Federal
Reserve also contributes to the regional training provision under the Asia Pacific Economic Cooperation
Financial Regulators’ Training Initiative.
In 2012, the Federal Reserve offered a number of
training courses exclusively for foreign supervisory
authorities, both in the United States and in a number of foreign jurisdictions. Federal Reserve staff also
took part in technical assistance and training missions led by the International Monetary Fund, the
World Bank, the Asian Development Bank, the Basel
Committee on Banking Supervision, and the Financial Stability Institute.
The Federal Reserve is also an associate member of
the Association of Supervisors of Banks of the
Americas (ASBA), an umbrella group of bank supervisors from countries in the Western Hemisphere.
The group, headquartered in Mexico,
• promotes communication and cooperation among
bank supervisors in the region;

61

The Federal Reserve contributes significantly to
ASBA’s organizational management and to its training and technical assistance activities.
Initiatives for Minority-Owned and
De Novo Depository Institutions

The Federal Reserve System implements its responsibilities under section 367 of the Dodd-Frank Act primarily through its Partnership for Progress (PFP)
program. Established in 2008, this program promotes
the viability of minority-owned institutions (MOIs)
by facilitating activities designed to strengthen their
business strategies, maximize their resources, and
increase their awareness and understanding of regulatory topics. In addition, the Federal Reserve continues to maintain the PFP website, which supports
MOIs by providing them with technical information
and links to useful resources (www.fedpartnership
.gov). Representatives from each of the 12 Reserve
Bank districts, along with staff from the Board of
Governors, continue to offer personalized technical
assistance to MOIs by providing targeted supervisory
guidance, identifying additional resources, and fostering mutually beneficial partnerships between MOIs
and community organizations. Currently, 16 state
member banks and 120 BHCs supervised by the Federal Reserve are MOIs.
During 2012, the Federal Reserve System undertook
several specific actions to strengthen its MOI support
efforts. For example, the Federal Reserve
• revised its processing procedures to implement prescreening of MOI applications, resulting in early
identification and resolution of factors that may
cause processing delays;
• increased staff resources for MOI oversight;
• partnered with the National Bankers Association,
the National Urban League, and the Minority
Council of the Independent Community Bankers
Association in outreach events;
• in conjunction with the Division of Consumer and
Community Affairs, conducted several joint outreach efforts to educate MOIs on supervisory
topics;

• coordinates training programs throughout the
region with the help of national banking supervisors and international agencies; and

• conducted training at a National Bankers Association convention to respond to concerns about the
potential effect of Basel III capital proposals on
community banks, including MOIs;

• aims to help members develop banking laws, regulations, and supervisory practices that conform to
international best practices.

• educated potential investors in MOIs about benefits under Board Regulation BB (Community
Reinvestment, section 228.21(f)); and

62

99th Annual Report | 2012

• participated in an interagency taskforce to consider
and address supervisory challenges facing MOIs.
During 2012, PFP representatives hosted and participated in numerous banking workshops and seminars
aimed at promoting and preserving MOIs, including
the National Bankers Association’s Legislative and
Regulatory Conference and the Interagency Minority
Depository Institutions National Conference. Further, program representatives collaborated with community leaders, trade groups, the Small Business
Administration, and other organizations to seek support for MOIs.
Business Continuity
In 2012, the Federal Reserve continued its efforts to
strengthen the resilience of the U.S. financial system
in the event of unexpected disruptions, including
focused supervisory efforts to evaluate the resiliency
of the banking institutions under its jurisdiction. The
Mid-Atlantic derecho windstorm in June, Hurricane
Sandy in October, and the distributed denial of service attacks against U.S. financial institutions during
the second half of the year presented major challenges to the financial system. The resiliency of the
financial system in the aftermath of these events,
however, proved to be effective in protecting the
safety and soundness of critical systems and customer information. The Federal Reserve, together
with other federal and state financial regulators, is a
member of the Financial and Banking Information
Infrastructure Committee (FBIIC), which was
formed to improve coordination and communication
among financial regulators, enhance the resiliency of
the financial sector, and promote the public/private
partnership. The FBIIC has established emergency
protocols to maintain effective communication
among member agencies and convenes by conference
call no later than 90 minutes following the first public
report of an event to share situational and operational status reports. During aforementioned events
of 2012, the Federal Reserve participated in the
FBIIC, the FFIEC, and internal communications to
promote the resiliency of the financial sector.

Supervisory Policy
The Federal Reserve’s supervisory policy function,
carried out by the Board, is responsible for developing regulations and guidance for financial institutions
under the Federal Reserve’s supervision, as well as
guidance for examiners. The Board, (often in concert
with the other federal banking agencies) issues rule-

makings, public SR letters, and other policy statements and guidance in order to carry out its supervisory policy function. Federal Reserve staff also take
part in supervisory and regulatory forums, provide
support for the work of the FFIEC, and participate
in international policymaking forums, including the
Basel Committee on Banking Supervision, the
Financial Stability Board, and the Joint Forum.
Capital Adequacy Standards
In 2012, the Board issued several rulemakings and
guidance documents related to capital adequacy standards, including joint proposed rulemakings with the
other federal banking agencies that would implement
certain revisions to the Basel capital framework and
that address certain provisions of the Dodd-Frank
Act.
• The federal banking agencies published a final rule
in June that amended the market risk capital rule to
implement certain revisions made by the Basel
Committee on Banking Supervision to its market
risk framework between 2005 and 2010. The revisions will increase capital requirements for market
risk by better capturing positions for which the
market risk capital rule is appropriate, reducing
pro-cyclicality in market risk capital requirements,
enhancing sensitivity to risks that were not
adequately captured by the previous regulatory
methodologies, and increasing transparency
through enhanced disclosures. Consistent with section 939A of the Dodd-Frank Act, the final rule
does not include those aspects of the Basel Committee’s market risk framework that rely on credit
ratings. Instead, the final rule includes alternative
standards of creditworthiness for determining specific risk capital requirements for certain debt and
securitization positions. The rule is available at
www.gpo.gov/fdsys/pkg/FR-2012-08-30/pdf/201216759.pdf.
• In June, the federal banking agencies issued for
comment three notices of proposed rulemaking
(NPRs) to amend the regulatory capital rules.
Taken together, the proposals would establish an
integrated regulatory capital framework that
addresses shortcomings in regulatory capital
requirements that became apparent during the
recent financial crisis. For internationally active
banking organizations, the proposed rule would
implement in the United States the Basel III regulatory capital reforms adopted by the Basel Committee on Banking Supervision. The proposed rule
would also make changes required by the Dodd-

Supervision and Regulation

Frank Act, including removal of references to and
reliance on credit ratings. The NPRs are available
at
• www.gpo.gov/fdsys/pkg/FR-2012-08-30/pdf/
2012-16757.pdf (Regulatory Capital Rules: Regulatory Capital, Implementation of Basel III, Minimum Regulatory Capital Ratios, Capital
Adequacy, Transition Provisions, and Prompt Corrective Action, “Basel III NPR”);
• www.gpo.gov/fdsys/pkg/FR-2012-08-30/pdf/
2012-17010.pdf (Regulatory Capital Rules: Standardized Approach for Risk-weighted Assets; Market Discipline and Disclosure Requirements,
“Standardized Approach NPR”); and
• www.gpo.gov/fdsys/pkg/FR-2012-08-30/pdf/
2012-16761.pdf (Regulatory Capital Rules:
Advanced Approaches Risk-based Capital Rule;
Market Risk Capital Rule, “Advanced
Approaches and Market Risk NPR”). (Also see
box 3.)
• In September, the federal banking agencies
announced the availability of a regulatory capital
estimation tool to help community banking organizations and other interested parties evaluate the
regulatory capital proposals issued in June. The
tool was developed to assist these organizations in
estimating the potential effects on their capital
ratios of the agencies’ Basel III and Standardized
Approach NPRs. The announcement and the capital estimation tool are available at www
.federalreserve.gov/newsevents/press/bcreg/
20120924a.htm.
In 2012, Board and Reserve Bank staff conducted
in-depth supervisory analyses of a number of complex capital issuances and private capital investments
to evaluate their qualification for inclusion in regulatory capital. For certain transactions, banking organizations were required to make changes necessary
for instruments to satisfy regulatory capital criteria,
whereas other instruments were disallowed from
inclusion in a banking organization’s regulatory
capital.
International Coordination on
Supervisory Policies
As a member of the Basel Committee on Banking
Supervision, the Federal Reserve actively participates
in efforts to advance sound supervisory policies for
internationally active banking organizations and
enhance the strength and stability of the international banking system.

63

Basel Committee

During 2012, the Federal Reserve participated in
ongoing international initiatives to track the progress
of implementation of the Basel framework in member countries. Participation in this assessment not
only included examining the progress made by other
countries, but also an assessment of progress made
by the United States. The preliminary report on the
United States’ progress is available at www.bis.org/
bcbs/implementation/l2_us.pdf.
The Federal Reserve contributed to supervisory
policy recommendations, reports, and papers issued
for consultative purposes or finalized by the Basel
Committee that were designed to improve the supervision of banking organizations’ practices and to
address specific issues that emerged during the financial crisis. The listing below includes key final and
consultative papers from 2012.
Final papers:
• Composition of capital disclosure requirements
(issued in June and available at www.bis.org/publ/
bcbs221.htm).
• Capital requirements for bank exposures to central
counterparties (issued in July and available at www
.bis.org/publ/bcbs227.htm).
• Core principles for effective banking supervision
(issued in September and available at www.bis.org/
publ/bcbs230.htm).
• A framework for dealing with domestic systemically
important banks (issued in October and available at
www.bis.org/publ/bcbs233.htm).
Consultative papers:
• Fundamental review of the trading book (issued in
May and available at www.bis.org/publ/bcbs219
.htm).
• Margin requirements for non-centrally-cleared
derivatives (issued jointly with the Board of the
International Organization of Securities Commissions in July and available at www.bis.org/publ/
bcbs226.htm).
• Supervisory guidance for managing risks associated
with the settlement of foreign exchange transactions
(issued in August and available at www.bis.org/
publ/bcbs229.htm).
• Revisions to the Basel Securitisation Framework
(issued in December and available at www.bis.org/
press/p121218.htm).

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99th Annual Report | 2012

Joint Forum

In 2012, the Federal Reserve continued its participation in the Joint Forum—an international group of
supervisors of the banking, securities, and insurance
industries established to address various cross-sector
issues, including the regulation of financial conglomerates. The Joint Forum operates under the aegis of
the Basel Committee, the International Organization
of Securities Commissions, and the International
Association of Insurance Supervisors.
In September, the Joint Forum issued Principles for
the supervision of financial conglomerates, which
supersedes similar principles developed by the Joint
Forum in 1999. The principles include guidance for
policymakers on the powers and authority necessary
for the supervision of financial conglomerates. The
document is available at www.bis.org/publ/joint29
.htm.
Financial Stability Board

In 2012, the Federal Reserve continued its active participation in the Financial Stability Board (FSB)—an
international group that helps coordinate the work of
national financial authorities and international standard setting bodies, and develops and promotes the
implementation of financial sector policies in the
interest of financial stability. Through the FSB
Standing Committee on Supervisory and Regulatory
Cooperation, the FSB is engaged in several issues,
including the regulation of shadow banking, the
regulation and supervision of globally systemically
important financial institutions, and the development
of effective resolution regimes for large financial
institutions. Consultative papers issued by the FSB in
2012 can be found at www.financialstabilityboard
.org/list/fsb_publications/tid_150/index.htm.
Accounting Policy
The Federal Reserve strongly endorses sound corporate governance and effective accounting and auditing practices for all regulated financial institutions.
Accordingly, the Federal Reserve’s supervisory policy
function is responsible for monitoring major domestic and international proposals, standards, and other
developments affecting the banking industry in the
areas of accounting, auditing, internal controls over
financial reporting, financial disclosure, and supervisory financial reporting.
During 2012, Federal Reserve staff addressed numerous issues related to financial sector accounting and
reporting, including loan accounting, troubled debt
restructurings, deferred taxes, other real estate

accounting, insurance accounting, business combinations, securitizations, fair value accounting, financial
instrument accounting and reporting, balance sheet
offsetting, securities financing transactions, consolidation of structured entities, and external and internal audit processes.
To address these and other issues, Federal Reserve
staff consulted with key constituents in the accounting and auditing professions, including standardsetters, accounting firms, accounting and financial
sector trade groups, and other financial sector regulators. The Federal Reserve also participated in meetings of the Basel Committee’s Accounting Task
Force, which represents the Basel Committee at international meetings on accounting, auditing, and disclosure issues affecting global banking organizations.
These efforts helped inform our understanding of
domestic and international practices—as well as proposed accounting, auditing, and regulatory standards—and helped in our formulation of policy positions using insight obtained through these forums.
During 2012, the Federal Reserve shared its views
with accounting and auditing standard-setters
through informal discussions and public comment
letters. Comment letters on the following proposals
were issued during the past year:
• Financial Accounting Standards Board’s proposals
related to disclosures about liquidity risk and interest rate risk, revenue recognition, and principal versus agent analysis in consolidation guidance.
• Financial Accounting Foundation’s proposal to
establish the Private Company Standards Improvement Council to address the needs of private companies in the standard-setting process.
Working with international bank supervisors, Federal
Reserve staff contributed to the development of
numerous other comment letters related to accounting and auditing matters that were submitted to standard setters through the Basel Committee.
Federal Reserve staff also participated in other supervisory activities to assess interactions between
accounting standards and regulatory reform efforts.
These activities included supporting Dodd-Frank
Act initiatives related to stress testing of banks and
credit-risk retention requirements for securitizations,
as well as various Basel III activities.
The Federal Reserve issued supervisory guidance to
financial institutions and supervisory staff on

Supervision and Regulation

accounting matters, as appropriate, and participated
in a number of supervisory-related activities. For
example, Federal Reserve staff
• issued guidance to address allowance estimation
practices related to junior lien loans and lines of
credit;
• developed and participated in a number of domestic and international supervisory training programs
and external education sessions to educate supervisors and bankers about new and emerging accounting and reporting topics affecting financial institutions; and
• supported the efforts of the Reserve Banks in
financial institution supervisory activities related to
financial accounting, auditing, reporting, and
disclosure.
Credit-Risk Management
The Federal Reserve works with the other federal
banking agencies to develop guidance on the management of credit risk; to coordinate the assessment
of regulated institutions’ credit risk; and to ensure
that institutions properly identify, measure, and manage credit risk.
Guidance on Credit Risk

In 2012, the Federal Reserve issued final guidance to
banks on Allowance for Loan Loss Estimation Practices for Junior Lien Loans and Lines of Credit, on
rental of Residential Other Real Estate Owned
(OREO) properties, and on stress testing for banks
with greater than $10 billion in assets.10 It also issued
for public comment guidance relating to Leveraged
Lending practices.11
Shared National Credit Program

In August, the Federal Reserve and the other banking agencies released summary results of the 2012
annual review of the Shared National Credit (SNC)
Program. The agencies established the program in
1977 to promote an efficient and consistent review
and classification of shared national credits. A SNC
10

11

Final guidance documents are available at www.federalreserve
.gov/newsevents/press/bcreg/bcreg20120131a1.pdf; and www
.federalreserve.gov/newsevents/press/bcreg/bcreg20120405a1
.pdf. For more information on stress testing, see box 4.
See Federal Register notice at www.gpo.gov/fdsys/pkg/FR-201203-30/html/2012-7620.htm

65

is any loan or formal loan commitment—and any
asset, such as other real estate, stocks, notes, bonds,
and debentures taken as debts previously contracted—extended to borrowers by a supervised institution, its subsidiaries, and affiliates. A SNC must
have an original loan amount that aggregates to
$20 million or more and either (1) is shared by three
or more unaffiliated supervised institutions under a
formal lending agreement or (2) a portion of which is
sold to two or more unaffiliated supervised institutions, with the purchasing institutions assuming their
pro rata share of the credit risk.
The 2012 SNC review was based on analyses prepared in the second quarter of 2012 using creditrelated data provided by federally supervised institutions as of December 31, 2011, and March 31, 2012.
The 2012 SNC portfolio totaled $2.79 trillion, with
roughly 8,700 credit facilities to approximately 5,600
borrowers. From the previous period, the dollar volume of the portfolio commitment amount rose by
$268 billion or 10.6 percent, and the number of credits increased by over 660, or 8.2 percent.
The number of SNCs originated in 2011 rose by
61 percent compared to 2010 loan originations, and
equaled approximately 114 percent of the large volume of credits originated in 2007. While the overall
quality of underwriting in 2011 was significantly better than in 2007, some easing of standards was
noted, specifically in leveraged finance credits, compared with the relatively tighter standards present in
2009 and the latter half of 2008. The primary underwriting deficiencies identified during the 2012 SNC
Review were minimal or no loan covenants, liberal
repayment terms, repayment dependent on refinancing, and inadequate collateral valuations. The easing
in standards may be due to aggressive competition
and market liquidity and was more pronounced in
leveraged finance transactions.
Refinancing risk has declined in the SNC portfolio as
only 37.1 percent of SNCs will mature over the next
three years compared with 63.4 percent for the same
time frame in the 2011 SNC Review. Poorly underwritten credits originated in 2006 and 2007 continued
to adversely affect the SNC portfolio. During 2011
and into 2012, syndications continued to modify loan
agreements to extend maturities. These transactions

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99th Annual Report | 2012

had the effect of relieving near-term refinancing risk,
but may not improve borrowers’ ability to repay their
debts in the longer term.
For more information on the 2012 SNC review, visit
the Board’s website at www.federalreserve.gov/
newsevents/press/bcreg/20120827a.htm
Compliance Risk Management
The Federal Reserve works with international and
domestic supervisors to develop guidance that promotes compliance with Bank Secrecy Act and AntiMoney-Laundering Compliance (BSA/AML) and
counter terrorism laws.
Bank Secrecy Act and
Anti-Money-Laundering Compliance

In 2012, the Federal Reserve continued to actively
promote the development and maintenance of effective BSA/AML compliance risk-management programs. For example, the Federal Reserve offered an
“Ask the Fed” session in November 2012 devoted
entirely to BSA/AML.12 Supervisory trends such as
examination findings, bulk currency transactions,
outsourcing of BSA/AML responsibilities, and thirdparty payment processors were discussed, along with
updates on customer due diligence, electronic filing
of reports, Iranian sanctions, and other international
concerns. Also, Federal Reserve supervisory staff
participated in a number of industry conferences to
continue to communicate regulatory expectations.
The Federal Reserve is a member of the Treasury-led
BSA Advisory Group, which includes representatives
of regulatory agencies, law enforcement, and the
financial services industry and covers all aspects of
the BSA. In addition, the Federal Reserve also participated in several Treasury-led private/public sector
dialogues with Latin American and Mexican financial institutions, regulators, and supervisors. The
objective of these dialogues is to optimize correspondent relations between U.S. and country-specific
financial sectors. The Federal Reserve also participates in the FFIEC BSA/AML working group, a
monthly forum for the discussion of pending BSA
policy and regulatory matters. In addition to the
FFIEC agencies, the BSA/AML working group
includes the Financial Crimes Enforcement Network
(FinCEN) and, on a quarterly basis, the U.S. Securities and Exchange Commission, the Commodity
Futures Trading Commission, the Internal Revenue
12

“Ask the Fed” is a free program that covers the latest financial
and regulatory developments for senior banking officials and
boards of directors.

Service, and the Office of Foreign Assets Control
(OFAC).
The FFIEC BSA/AML working group is responsible
for updating the FFIEC Bank Secrecy Act/AntiMoney Laundering Examination Manual). The
FFIEC developed this manual as part of its ongoing
commitment to provide current and consistent interagency guidance on risk-based policies, procedures,
and processes for financial institutions to comply
with the BSA and safeguard their operations from
money laundering and terrorist financing.
Throughout 2012, the Federal Reserve and other federal banking agencies continued to regularly share
examination findings and enforcement proceedings
with FinCEN under the interagency MOU that was
finalized in 2004.
In 2012, the Federal Reserve continued to regularly
share examination findings and enforcement proceedings with OFAC under the 2006 interagency
MOU. The Federal Reserve also provided a speaker
for and participated in OFAC’s day-long Financial
Institution Symposium.
In 2012, the Federal Reserve joined the U.S. Treasury’s Interagency Task Force on Strengthening and
Clarifying the BSA/AML Framework (Task Force),
which includes representatives from the Department
of Justice, OFAC, FinCEN, the federal banking
agencies, the Securities and Exchange Commission,
and the Commodity Futures Trading Commission.
The primary focus of the Task Force is to review the
BSA, its implementation, and its enforcement with
respect to U.S. financial institutions that are subject
to these requirements, and to develop recommendations for ensuring the continued effectiveness of the
BSA and efficiency in agency efforts to monitor
compliance.
International Coordination on
Sanctions, Anti-Money-Laundering, and
Counter-Terrorism Financing

The Federal Reserve participates in a number of
international coordination initiatives related to sanctions, money laundering, and terrorism financing.
For example, the Federal Reserve has a long-standing
role in the U.S. delegation to the intergovernmental
Financial Action Task Force (FATF) and its working
groups, contributing a banking supervisory perspective to formulation of international standards. In
addition, the Federal Reserve has provided input and
review of ongoing work to revise the FATF Recom-

Supervision and Regulation

mendations to ensure that they continue to provide a
comprehensive and current framework for combating
money laundering and terrorist financing. Finally,
the Federal Reserve continues to participate in a subcommittee of the Basel Committee that focuses on
AML/counter-terrorism financing issues.
Other Policymaking Initiatives
• In May, the federal banking agencies issued final
supervisory guidance regarding stress-testing practices at banking organizations with total consolidated assets of more than $10 billion. The guidance highlights the importance of stress testing at
banking organizations as an ongoing riskmanagement practice that supports a banking
organization’s forward-looking assessment of its
risks and better equips it to address a range of
adverse outcomes. This guidance builds upon previously issued supervisory guidance and outlines
general principles for a satisfactory stress testing
framework and describes various stress testing
approaches and how stress testing should be used
at various levels within an organization. The guidance also discusses the importance of stress testing
in capital and liquidity planning and the importance of strong internal governance and controls as
part of an effective stress-testing framework. The
guidance is available at www.gpo.gov/fdsys/pkg/
FR-2012-05-17/pdf/2012-11989.pdf. (Also see
box 4.)
• In May, the Board announced the approval of a
final rule outlining the procedures for securities
holding companies (SHCs) to elect to be supervised
by the Federal Reserve. An SHC is a nonbank
company that owns at least one registered broker
or dealer. The rule specifies the information that an
SHC will need to provide to the Board as part of
registration for supervision, including information
related to organizational structure, capital, and
financial condition. In addition, the rule provides
that upon an effective registration, an SHC would
be supervised and regulated as if it were a bank
holding company with the exception that the
restrictions on nonbanking activities in the Bank
Holding Company Act would not apply to a supervised SHC. The rule is available at www.gpo.gov/
fdsys/pkg/FR-2012-06-04/pdf/2012-13311.pdf.
Regulatory Reports
The Federal Reserve’s supervisory policy function is
also responsible for developing, coordinating, and
implementing regulatory reporting requirements for
various financial reporting forms filed by domestic

67

and foreign financial institutions subject to Federal
Reserve supervision. Federal Reserve staff members
interact with other federal agencies and relevant state
supervisors, including foreign bank supervisors as
needed, to recommend and implement appropriate
and timely revisions to the reporting forms and the
attendant instructions.
Bank Holding Company Regulatory Reports

The Federal Reserve requires that U.S. BHCs periodically submit reports that provide information
about their financial condition and structure. This
information is essential to formulating and conducting bank regulation and supervision. It is also used in
responding to requests by Congress and the public
for information about BHCs and their nonbank subsidiaries. Foreign banking organizations also are
required to periodically submit reports to the Federal
Reserve.
• FR Y-9 series reports—the FR Y-9C, FR Y-9LP,
FR Y-9SP and FR Y-9ES—provide standardized
financial statements for BHCs on both a consolidated and a parent-only basis. The reports are used
to detect emerging financial problems, to review
performance and conduct pre-inspection analysis,
to monitor and evaluate risk profiles and capital
adequacy, to evaluate proposals for BHC mergers
and acquisitions, and to analyze a holding company’s overall financial condition.
• Nonbank subsidiary reports—the FR Y-11, FR
2314, FR Y-7N, and FR 2886b—help the Federal
Reserve determine the condition of BHCs that are
engaged in nonbank activities and also aid in monitoring the number, nature, and condition of the
companies’ nonbank subsidiaries.
• The FR Y-8 report provides information on transactions between an insured depository institution
and its affiliates that are subject to section 23A of
the Federal Reserve Act; it is used to monitor bank
exposures to affiliates and to ensure banks’ compliance with section 23A of the Federal Reserve Act.
• The FR Y-10 report provides data on changes in
organization structure at domestic and foreign
banking organizations.
• The FR Y-6 and FR Y-7 reports gather additional
information on organization structure and shareholders from domestic banking organizations and
foreign banking organizations, respectively; the
information is used to monitor structure so as to
determine compliance with provisions of the Bank
Holding Company Act (BHC Act) and Regula-

68

99th Annual Report | 2012

tion Y and to assess the ability of a foreign banking organization to continue as a source of strength
to its U.S. operations.
During 2012, the Federal Reserve implemented the
following revisions to the FR Y-9C to better understand BHCs’ risk exposures and to collect certain
information prescribed by changes in accounting
standards: (1) added two data items to Schedule HC-P, 1–4 Family Residential Mortgage Banking
Activities, to collect the amount of representation
and warranty reserves for one- to four-family residential mortgage loans sold; (2) added a data item to
Schedule HC-N, Past Due and Nonaccrual Loans,
Leases, and Other Assets, to collect the outstanding
balance of purchased credit impaired loans by past
due and nonaccrual status; and (3) modified the
reporting instructions to clarify the reporting and
accounting treatment of specific valuation
allowances.
Savings and Loan Holding Company
Regulatory Reports

During 2012, the first phase of Federal Reserve
reporting began for the non-exempt SLHCs. These
SLHCs began reporting the FR Y-9 series of reports
and the FR Y-6 or FR Y-7. The exempt SLHCs also
began filing the FR Y-6 and FR Y-7 reports.13 Several training sessions on the various Federal Reserve
reports were provided to the SLHCs.
On June 11, 2012, the Board issued a proposal to
expand the entities that must file the FR Y-10 report
to include SLHCs and security holding companies,
effective December 1, 2012. In addition, a one-time
verification of an SLHC’s organization structure was
proposed. After consideration of the comments
received on the proposal, the Board issued in the Federal Register on September 14, 2012, (77 Fed. Reg.
86842) the final requirements with modifications. The
requirement that the FR Y-10 be filed by all SLHCs,
including their savings associations and branches, as
13

A final notice was published in the Federal Register on December 29, 2011, (76 Fed. Reg. 81933) in which the Board retained
the two-year phase-in approach for most SLHCs and modified
the exemption criteria for commercial SLHCs and certain insurance SLHCs. The exemption for commercial SLHCs will be
reviewed periodically and may be rescinded if the Board determines that FR Y–9 financial information and other regulatory
reports are needed to effectively and consistently assess compliance with capital and other regulatory requirements. Insurance
SLHCs will be exempt only until consolidated regulatory capital
rules are finalized for SLHCs, at which time they may be
required to file consolidated financial statements—to demonstrate their compliance with the capital rules—and other Federal
Reserve reports.

of December 1, 2012, was retained; however, the onetime verification was scaled back to include only
select information on nonbanks that would be
required to file financial reports (FR Y-11 or FR
2314) beginning in March 31, 2013. Additionally, a
phased-in approach for reporting nonbank subsidiaries on the FR Y-10 based on the frequency of financial reporting by the nonbank subsidiaries was
approved.
Commercial Bank Regulatory Reports

As the federal supervisor of state member banks, the
Federal Reserve, along with the other banking agencies (through the FFIEC), requires banks to submit
quarterly Call Reports. Call Reports are the primary
source of data for the supervision and regulation of
banks and the ongoing assessment of the overall
soundness of the nation’s banking system. Call
Report data provide the most current statistical data
available for evaluating institutions’ corporate applications, for identifying areas of focus for both on-site
and off-site examinations, and for considering monetary and other public policy issues. Call Report
data, which also serve as benchmarks for the financial information required by many other Federal
Reserve regulatory financial reports, are widely used
by state and local governments, state banking supervisors, the banking industry, securities analysts, and
the academic community.
During 2012, the FFIEC implemented the following
revisions to the Call Report to better understand
banks’ risk exposures and to collect certain information prescribed by changes in accounting standards:
(1) added new Schedule RI-C –Disaggregated Data
on the Allowance for Loan and Lease Losses to collect information on the allowance for loan and lease
losses by major loan category (effective March 2013);
(2) added two data items to Schedule RC-P, 1–4 Family Residential Mortgage Banking Activities, to collect the amount of representation and warranty
reserves for one- to four-family residential mortgage
loans sold; (3) added a data item to Schedule RC-N,
Past Due and Nonaccrual Loans, Leases, and Other
Assets, to collect the outstanding balance of purchased credit impaired loans by past due and nonaccrual status; (4) added new items in Schedule RC-M,
Memoranda, in which savings associations and certain state savings and cooperative banks would
report on the tests they use to determine compliance
with the Qualified Thrift Lender requirement and
whether they have remained in compliance with this
requirement; (5) revised two existing items in Schedule RC-R, Regulatory Capital, used to calculate the

Supervision and Regulation

leverage ratio denominator to accommodate certain
differences between the regulatory capital standards
that apply to the leverage capital ratios of banks versus savings associations; and (6) modified the reporting instructions to clarify the reporting and accounting treatment of specific valuation allowances.

Supervisory Information Technology
The Federal Reserve’s supervisory information technology function, carried out by the Board’s Division
of Banking Supervision and Regulation and the
Reserve Banks under the guidance of the Subcommittee on Supervisory Administration and Technology, works to identify and set priorities for information technology initiatives within the supervision and
regulation business line.
In 2012, the supervisory information technology
function focused on
• Large Bank Supervision. Improved the supervision
of large and regional financial institutions with
new processes and linked workflows to enable continuous updates of information provided through
examinations and ongoing monitoring activities.
• Community and Regional Bank Supervision.
Worked with community and regional bank examiners and other regulators to implement enhanced
tools to support community and regional bank
examinations.
• Collaboration. (1) Enhanced information sharing
among staff at the Board and Reserve Banks
through new and enhanced collaboration tools;
(2) implemented an electronic solution to support
exam teams’ ability to share documents, and
(3) leveraged an Interagency Steering Group to
improve methods for sharing work among state
and federal regulators.
• Modernization. Acquired products to modernize
business capabilities in the areas of document management, resource prioritization, and scheduling.
• Information Security. Commenced several initiatives to improve overall information security and
the efficiency of our information security practices.
National Information Center
The National Information Center (NIC) is the Federal Reserve’s comprehensive repository for supervisory, financial, and banking structure data. It is also
the main repository for many supervisory documents.
The NIC includes (1) data on banking structure

69

throughout the United States as well as foreign banking concerns; (2) the National Examination Data
(NED), an application that enables supervisory personnel as well as federal and state banking authorities
to access NIC data; (3) the Banking Organization
National Desktop, an application that facilitates
secure, real-time electronic information sharing and
collaboration among federal and state banking regulators for the supervision of banking organizations;
and (4) the Central Document and Text Repository
(CDTR), an application that contains documents
supporting the supervisory processes.
Within the NIC, the supporting systems continue to
be modified over time to extend their usefulness and
improve business workflow efficiency, especially for
the sourcing transactional data systems. Throughout
2012, the NIC supervisory and structure databases
continued to be modified to support Dodd-Frank
Act changes and to facilitate the supervision of
SLHCs. Business changes were implemented to the
NED application for inspections of SLHCs and
CFPB-led examinations. A significant amount of
progress occurred to successfully capture and integrate the former OTS data and documents into several NIC databases, making substantially more
SLHC examination and enforcement action data
available. Also, SLHCs were added to the reporting
panel for the structure reporting forms, with an
emphasis on the Report of Changes in Organizational Structure (FR Y-10), and data changes to the
structure reporting forms resulted in additional
modifications to the NIC structure databases. Other
significant database enhancements included a geocoding web service and a new Legal Entity Identifier
field, being developed for use by the international
community.
The NIC also supports the interagency Shared
National Credit (SNC) Program and the SNC Modernization initiative (SNCMod). The SNC Program
is the annual review of large syndicated loans while
the SNCMod initiative is a multiyear, interagency
information technology development effort to
improve the efficiency and effectiveness of the systems that support the SNC Program. SNCMod
focuses on a complete redesign of the current legacy
systems to take advantage of modern technology to
enhance and extend the system’s capabilities, including automating tasks and providing tools for the
examination and analysis of loan data for the agencies’ staff. During 2012, the agencies finalized
requirements for automating the appeals process,

70

99th Annual Report | 2012

loan matching, and concordance, and for creating
additional analytical and reporting capabilities with
the SNC data.
In 2012, the NIC team continued to implement
changes to the NIC public website in response to the
Dodd-Frank Act. These changes included adding the
Quarterly Savings and Loan Holding Company
Report (FR 2320) data to the website and adding
SLHCs to the listing of holding companies (based on
consolidated assets). The NIC team also worked
extensively toward adding the Risk-Based Capital
Reporting for Institutions Subject to the Advanced
Capital Adequacy Framework (FFIEC 101) data to
the website; this is expected to be placed into production by mid-year 2013.
In mid-2012, the NIC staff, in partnership with
System and other supervisory staff, issued internal
guidance to System staff regarding the acquisition
and use of purchased data across the System to
achieve cost effectiveness, reduce duplicative purchases, and achieve greater coordination of contract
services.
Begun in 2011, the Supervision and Regulation National Data Inventory Project, a Federal
Reserve System strategic initiative, is being implemented in two phases over several years. Overall, this
initiative focuses on providing transparency and
awareness of data collections that support broad risk
monitoring and emerging macro-prudential supervision analysis in LISCC and other supervisory business portfolios. Phase I, which produced a data
inventory proof of concept, brought visibility to
supervision and regulation ad hoc data collections
for large complex banking organizations and was
placed into production in November 2011. Development for Phase II was completed in December 2012
and is expected to be placed into production in
March 2013. Once in production the Phase II
changes, which built upon the Phase I proof of concept, would allow other business lines to utilize various functionalities, such as automated feeds from
other data inventories, extensibility and segregation
of the inventory and institutions by business lines,
reporting services, and enhanced workflows.
Throughout 2012, in an effort to best serve supervisory business sponsors, NIC staff provided project
management for the maturation of the CCAR, Capital Plan Review, and Dodd-Frank Act Stress Testing
program initiatives and for the automation of the
Capital Assessment and Stress Testing information

collection (FR Y-14). The NIC staff also managed
the third-party data aggregator contractual relationships for the FR Y-14 monthly credit card and mortgage data collections.
Finally, supervisory staff participated in a number of
interagency technology-related initiatives as part of
FFIEC task forces and interagency committees.
These efforts support standardized data collections
and cross-agency information sharing. Work in this
area will continue to be important as the agencies
work through the implementation of the remaining
Dodd-Frank Act initiatives. One such technologyrelated initiative required Board staff to collaborate
with the FDIC and OCC to develop and release a
Request for Proposal for the Central Data Repository, the data collection and validation system for the
FFIEC commercial bank Consolidated Reports of
Condition and Income (Call Reports: FFIEC 031
and FFIEC 041) and the Uniform Bank Performance
Report. Another technology-related initiative, started
in 2012, required Board staff to collaborate with the
CFPB on a document exchange initiative that would
require implementing changes to the CDTR in 2013.

Staff Development
The Federal Reserve’s staff development program
has oversight of the ongoing development of about
3,100 professional supervisory staff to ensure that
they have the skills necessary to meet their evolving
supervisory responsibilities. The Federal Reserve also
provides course offerings to staff at state banking
agencies. Training activities in 2012 are summarized
in table 2.
Examiner Commissioning Program
The Examiner Commissioning Program (ECP)
involves approximately 22 weeks of instruction. Individuals move through a combination of classroom
offerings, self-paced assignments, and on-the-job
training over a period of two to four years. Achievement is measured by two professionally validated
proficiency examinations: the first exam is required
of all ECP participants, and the second exam is
offered in two specialty areas—(1) safety and soundness and (2) consumer compliance. A third specialty,
information technology, requires that individuals
earn the Certified Information Systems Auditor certification offered by the Information Systems Audit
Control Association. In 2012, 291 examiners passed
the first proficiency exam and 135 passed the second
proficiency exam (106 in safety and soundness and
29 in consumer compliance).

Supervision and Regulation

71

Table 2. Training for banking supervision and regulation, 2012
Number of enrollments
Course sponsor or type

Federal Reserve
personnel

State and federal
banking agency
personnel

1,689
822
12
12,913

262
267
3
1,170

Federal Reserve System
FFIEC
The Options Institute2
Rapid ResponseTM
1
2

Instructional time
(approximate training
days)1

Number of course
offerings

525
394
3
11

105
91
1
86

Training days are approximate. System courses were calculated using five days as an average, with FFIEC courses calculated using four days as an average.
The Options Institute, an educational arm of the Chicago Board Options Exchange, provides a three-day seminar on the use of options in risk management.

Continuing Professional Development
Other formal and informal learning opportunities are
available to examiners, including other schools and
programs offered within the System and FFIECsponsored schools. System programs are also available to state and federal banking agency personnel.
The Rapid Response® program, introduced in 2008,
offers System and state personnel 60–90 minute teleconference presentations on emerging issues or
urgent training needs associated with implementation
or issuance of new laws, regulations, or guidance.

Regulation
The Federal Reserve exercises important regulatory
influence over entry into the U.S. banking system
and the system structure through its administration
of several federal statutes. The Federal Reserve is also
responsible for imposing margin requirements on
securities transactions. In carrying out its responsibilities, the Federal Reserve coordinates supervisory
activities with the other federal banking agencies,
state agencies, functional regulators (that is, regulators for insurance, securities, and commodities
firms), and foreign bank regulatory agencies.

Regulation of the U.S. Banking Structure
The Federal Reserve administers six federal statutes
that apply to BHCs, financial holding companies,
member banks, SLHCs, and foreign banking organizations: the BHC Act, the Bank Merger Act, the
Change in Bank Control Act, the Federal Reserve
Act, section 10 of the Home Owners’ Loan Act
(HOLA (applies to SLHCs)), and the International
Banking Act.
In administering these statutes, the Federal Reserve
acts on a variety of applications that directly or indi-

rectly affect the structure of the U.S. banking system
at the local, regional, and national levels; the international operations of domestic banking organizations;
or the U.S. banking operations of foreign banks. The
applications concern BHC and SLHC formations
and acquisitions, bank mergers, and other transactions involving banks and savings associations or
nonbank firms. In 2012, the Federal Reserve acted on
1,029 applications filed under the six statutes. Many
of these applications involved target banking organizations in less than satisfactory financial condition.
Bank Holding Company Act Applications
Under the BHC Act, a corporation or similar legal
entity must obtain the Federal Reserve’s approval
before forming a BHC through the acquisition of
one or more banks in the United States. Once
formed, a BHC must receive Federal Reserve
approval before acquiring or establishing additional
banks. Also, BHCs generally may engage in only
those nonbanking activities that the Board has previously determined to be closely related to banking
under section 4(c)(8) of the BHC Act.14 Depending
on the circumstances, these activities may or may not
require Federal Reserve approval in advance of their
commencement.
When reviewing a BHC application or notice that
requires prior approval, the Federal Reserve may consider the financial and managerial resources of the
applicant, the future prospects of both the applicant
and the firm to be acquired, financial stability factors, the convenience and needs of the community to
be served, the potential public benefits, the competi14

Since 1996, the act has provided an expedited prior notice procedure for certain permissible nonbank activities and for acquisitions of small banks and nonbank entities. Since that time, the
act has also permitted well-run BHCs that satisfy certain criteria
to commence certain other nonbank activities on a de novo
basis without first obtaining Federal Reserve approval.

72

99th Annual Report | 2012

tive effects of the application, and the applicant’s
ability to make available to the Federal Reserve information deemed necessary to ensure compliance with
applicable law. In the case of a foreign banking organization seeking to acquire control of a U.S. bank,
the Federal Reserve also considers whether the foreign bank is subject to comprehensive supervision or
regulation on a consolidated basis by its homecountry supervisor. In 2012, the Federal Reserve
acted on 288 applications and notices filed by BHCs
to acquire a bank or a nonbank firm, or to otherwise
expand their activities, including applications involving private equity firms.
A BHC may repurchase its own shares from its
shareholders. When the company borrows money to
buy the shares, the transaction increases the company’s debt and decreases its equity. The Federal
Reserve may object to stock repurchases by holding
companies that fail to meet certain standards, including the Board’s capital adequacy guidelines. In 2012,
the Federal Reserve acted on six stock repurchase
applications by BHCs.
The Federal Reserve also reviews elections submitted
by BHCs seeking financial holding company status
under the authority granted by the Gramm-LeachBliley Act. BHCs seeking financial holding company
status must file a written declaration with the Federal
Reserve. In 2012, 32 domestic financial holding company declarations were approved.
Bank Merger Act Applications
The Bank Merger Act requires that all applications
involving the merger of insured depository institutions be acted on by the relevant federal banking
agency. The Federal Reserve has primary jurisdiction
if the institution surviving the merger is a state member bank. Before acting on a merger application, the
Federal Reserve considers the financial and managerial resources of the applicant, the future prospects of
the existing and combined organizations, the convenience and needs of the communities to be served,
and the competitive effects of the proposed merger.
The Federal Reserve also must consider the views of
the U.S. Department of Justice regarding the competitive aspects of any proposed bank merger involving unaffiliated insured depository institutions. In
2012, the Federal Reserve approved 60 merger applications under the act.
Change in Bank Control Act Applications
The Change in Bank Control Act requires individuals
and certain other parties that seek control of a U.S.

bank, BHC, or SLHC to obtain approval from the
relevant federal banking agency before completing
the transaction. The Federal Reserve is responsible
for reviewing changes in the control of state member
banks, BHCs, and SLHCs. In its review, the Federal
Reserve considers the financial position, competence,
experience, and integrity of the acquiring person; the
effect of the proposed change on the financial condition of the bank, BHC, or SLHC being acquired; the
future prospects of the institution to be acquired; the
effect of the proposed change on competition in any
relevant market; the completeness of the information
submitted by the acquiring person; and whether the
proposed change would have an adverse effect on the
Deposit Insurance Fund. A proposed transaction
should not jeopardize the stability of the institution
or the interests of depositors. During its review of a
proposed transaction, the Federal Reserve may contact other regulatory or law enforcement agencies for
information about relevant individuals. In 2012, the
Federal Reserve approved 140 change in control
notices related to state member banks, BHCs, and
SLHCs, including applications involving private
equity firms.
Federal Reserve Act Applications
Under the Federal Reserve Act, a bank must seek
Federal Reserve approval to become a member bank.
A member bank may be required to seek Federal
Reserve approval before expanding its operations
domestically or internationally. State member banks
must obtain Federal Reserve approval to establish
domestic branches, and all member banks (including
national banks) must obtain Federal Reserve
approval to establish foreign branches. When reviewing applications for membership, the Federal Reserve
considers, among other things, the bank’s financial
condition and its record of compliance with banking
laws and regulations. When reviewing applications to
establish domestic branches, the Federal Reserve considers, among other things, the scope and nature of
the banking activities to be conducted. When reviewing applications for foreign branches, the Federal
Reserve considers, among other things, the condition
of the bank and the bank’s experience in international banking. In 2012, the Federal Reserve acted on
membership applications for 48 banks, and new and
merger-related branch applications for 382 domestic
branches and two foreign branches.
State member banks must also obtain Federal
Reserve approval to establish financial subsidiaries.
These subsidiaries may engage in activities that are
financial in nature or incidental to financial activities,

Supervision and Regulation

including securities-related and insurance agencyrelated activities. In 2012, no financial subsidiary
applications were submitted.
Home Owners’ Loan Act Applications
Under HOLA, a corporation or similar legal entity
must obtain the Federal Reserve’s approval before
forming an SLHC through the acquisition of one or
more savings associations in the United States. Once
formed, an SLHC must receive Federal Reserve
approval before acquiring or establishing additional
savings associations. Also, SLHCs generally may
engage in only those nonbanking activities that are
specifically enumerated in HOLA or which the Board
has previously determined to be closely related to
banking under section 4(c)(8) of the BHC Act.
Depending on the circumstances, these activities may
or may not require Federal Reserve approval in
advance of their commencement. In 2012, the Federal Reserve acted on 17 applications and notices
filed by SLHCs to acquire a bank or a nonbank firm,
or to otherwise expand their activities.
Under HOLA, a savings association reorganizing to
a mutual holding company (MHC) structure must
receive Federal Reserve approval prior to its reorganization. In addition, an MHC must receive Federal
Reserve approval before converting to stock form,
and MHCs must receive Federal Reserve approval
before waiving dividends declared by the MHC’s
subsidiary. In 2012, the Federal Reserve acted on no
applications for MHC reorganizations. In 2012, the
Federal Reserve acted on eight applications filed by
MHCs to convert to stock form, and nine applications to waive dividends.
When reviewing an SLHC application or notice that
requires prior approval, the Federal Reserve may consider the financial and managerial resources of the
applicant, the future prospects of both the applicant
and the firm to be acquired, the convenience and
needs of the community to be served, the potential
public benefits, the competitive effects of the application, and the applicant’s ability to make available to
the Federal Reserve information deemed necessary to
ensure compliance with applicable law.
The Federal Reserve also reviews elections submitted
by SLHCs seeking treatment as financial holding
companies under the authority granted by the DoddFrank Act. SLHCs seeking financial holding company treatment must file a written declaration with
the Federal Reserve. In 2012, four SLHC financial
holding company declarations were approved.

73

Overseas Investment Applications by
U.S. Banking Organizations
U.S. banking organizations may engage in a broad
range of activities overseas. Many of the activities are
conducted indirectly through Edge Act and agreement corporation subsidiaries. Although most foreign investments are made under general consent procedures that involve only after-the-fact notification to
the Federal Reserve, large and other significant
investments require prior approval. In 2012, the Federal Reserve approved 31 applications and notices for
overseas investments by U.S. banking organizations,
many of which represented investments through an
Edge Act or agreement corporation.
International Banking Act Applications
The International Banking Act, as amended by the
Foreign Bank Supervision Enhancement Act of
1991, requires foreign banks to obtain Federal
Reserve approval before establishing branches, agencies, commercial lending company subsidiaries, or
representative offices in the United States.
In reviewing applications, the Federal Reserve generally considers whether the foreign bank is subject to
comprehensive supervision or regulation on a consolidated basis by its home-country supervisor. It
also considers whether the home-country supervisor
has consented to the establishment of the U.S. office;
the financial condition and resources of the foreign
bank and its existing U.S. operations; the managerial
resources of the foreign bank; whether the homecountry supervisor shares information regarding the
operations of the foreign bank with other supervisory authorities; whether the foreign bank has provided adequate assurances that information concerning its operations and activities will be made available
to the Federal Reserve, if deemed necessary to determine and enforce compliance with applicable law;
whether the foreign bank has adopted and implemented procedures to combat money laundering and
whether the home country of the foreign bank is
developing a legal regime to address money laundering or is participating in multilateral efforts to combat money laundering; and the record of the foreign
bank with respect to compliance with U.S. law. In
2012, the Federal Reserve approved two applications
by foreign banks to establish branches, agencies, or
representative offices in the United States.
Public Notice of Federal Reserve Decisions
Certain decisions by the Federal Reserve that involve
an acquisition by a BHC, a bank merger, a change in

74

99th Annual Report | 2012

control, or the establishment of a new U.S. banking
presence by a foreign bank are made known to the
public by an order or an announcement. Orders state
the decision, the essential facts of the application or
notice, and the basis for the decision; announcements
state only the decision. All orders and announcements are made public immediately; they are subsequently reported in the Board’s weekly H.2 statistical
release. The H.2 release also contains announcements
of applications and notices received by the Federal
Reserve upon which action has not yet been taken.
For each pending application and notice, the related
H.2A release gives the deadline for comments. The
Board’s website provides information on orders and
announcements (www.federalreserve.gov/newsevents/
press/orders/2013orders.htm) as well as a guide for
U.S. and foreign banking organizations that wish to
submit applications (www.federalreserve.gov/
bankinforeg/afi/afi.htm).

Enforcement of Other Laws and
Regulations
The Federal Reserve’s enforcement responsibilities
also extend to the disclosure of financial information
by state member banks and the use of credit to purchase and carry securities.
Financial Disclosures by State Member Banks
State member banks that issue securities registered
under the Securities Exchange Act of 1934 must disclose certain information of interest to investors,
including annual and quarterly financial reports and
proxy statements. By statute, the Board’s financial
disclosure rules must be substantially similar to those
of the SEC. The enactment of the Jumpstart Our
Business Startups Act (JOBS Act) in April 2012

changed the registration threshold under the Securities Exchange Act and resulted in a significant
decline in the number of state member banks
required to register with the Board. At the end of
2012, four state member banks were registered with
the Board under the Securities Exchange Act.
Securities Credit
Under the Securities Exchange Act of 1934, the
Board is responsible for regulating credit in certain
transactions involving the purchasing or carrying of
securities. The Board’s Regulation T limits the
amount of credit that may be provided by securities
brokers and dealers when the credit is used to purchase debt and equity securities. The Board’s Regulation U limits the amount of credit that may be provided by lenders other than brokers and dealers when
the credit is used to purchase or carry publicly held
equity securities if the loan is secured by those or
other publicly held equity securities. The Board’s
Regulation X applies these credit limitations, or margin requirements, to certain borrowers and to certain
credit extensions, such as credit obtained from foreign lenders by U.S. citizens.
Several regulatory agencies enforce the Board’s securities credit regulations. The SEC, the Financial
Industry Regulatory Authority, and the Chicago
Board Options Exchange examine brokers and dealers for compliance with Regulation T. With respect to
compliance with Regulation U, the federal banking
agencies examine banks under their respective jurisdictions; the Farm Credit Administration and the
NCUA examine lenders under their respective jurisdictions; and the Federal Reserve examines other
Regulation U lenders.

75

Consumer and Community Affairs

The Division of Consumer and Community Affairs
(DCCA) has primary responsibility for carrying out
the Board’s consumer financial protection and community development programs. DCCA conducts
consumer-focused supervision, research, and policy
analysis, as well as implements statutory requirements
and facilitates community development. These activities promote a fair and transparent consumer financial services market, including for traditionally underserved households and neighborhoods.
Throughout 2012, the division engaged in numerous
consumer and community-related functions and
policy activities in the following areas:
• Consumer-focused supervision and examinations.
The division provided leadership for the Reserve
Bank consumer compliance supervision and examination programs in state member banks and bank
holding companies through: policy development,
examiner training, supervision oversight, fair lending, Unfair or Deceptive Acts or Practices (UDAP)
and flood enforcement, analysis of bank and bank
holding company applications in regard to consumer protection, and processing consumer
complaints.
• Consumer research and emerging-issues and policy
analysis. The division analyzed emerging issues in
consumer financial services policies and practices
in order to understand their implications for the
economic and supervisory policies that are core to
the central bank’s functions, as well as to gain
insight into consumer decisionmaking.
• Community development activities. The division
continued to promote fair and informed access to
financial markets for all consumers, recognizing the
particular needs of underserved populations by
engaging lenders, government officials, and community leaders. Throughout the year, DCCA convened programs to share information and research
on effective community development policies and
strategies.

• Consumer laws and regulations. The division continued to administer the Board’s regulatory responsibilities with respect to certain entities and specific
statutory provisions of the consumer financial services and fair lending laws. DCCA also drafts regulations and official interpretations and issues regulatory interpretations and compliance guidance for
the industry, the Reserve Banks, other federal agencies, and congressional staff.

Supervision and Examinations
The Board’s Division of Consumer and Community
Affairs develops and supports supervisory policy and
examination procedures for consumer protection
laws and regulations, as well as the Community Reinvestment Act (CRA), as part of its supervision of the
organizations for which it has authority, including
holding companies, state member banks, and foreign
banking organizations. The division also administers
the Federal Reserve System’s risk-focused program
for assessing consumer compliance risk at the largest
bank and financial holding companies in the System,
with division staff ensuring that consumer compliance risk is effectively integrated into the consolidated supervision oversight of the holding company.
The division oversees the efforts of the 12 Reserve
Banks to ensure that compliance with consumer protection laws and regulations is fully evaluated and
fairly enforced. Division staff provides guidance and
expertise to the Reserve Banks on consumer protection laws and regulations, bank and bank holding
company application analysis and processing, examination and enforcement techniques and policy matters, examiner training, and emerging issues. Staff
review Reserve Bank supervisory reports, examination work products, and consumer complaint analyses and responses. Finally, staff members participate
in interagency activities that promote uniformity in
examination principles, standards, and processes.
Examinations are the Federal Reserve’s primary
method of enforcing compliance with consumer pro-

76

99th Annual Report | 2012

tection laws and assessing the adequacy of consumer
compliance risk-management systems within regulated entities. During the 2012 reporting period
(July 1, 2011, through June 30, 2012), the Reserve
Banks conducted 282 consumer compliance examinations of state member banks and 11 examinations
of foreign banking organizations.

Bank Holding Company Consolidated
Supervision Program
During 2012, staff in the Bank Holding Company
(BHC) Consolidated Supervision Program had
responsibility for reviewing more than 110 bank and
financial holding companies to ensure consumer
compliance risk was appropriately incorporated into
the consolidated risk assessment for the organization.
Through a combination of risk-focused, on-/off-site
examination and monitoring activities, supervisory
staff were able to assess the impact enterprise-wide
consumer issues had on the overall risk profiles of
the consolidated entity. In addition, as a result of
changes brought about by the Dodd-Frank Wall
Street Reform and Consumer Protection Act (the
Dodd-Frank Act), supervisory functions related to
savings and loan holding companies (SLHCs) were
transferred to the Board, and SLHCs were added to
the portfolio of entities covered by the Consolidated
Supervision Program.
On December 17, 2012, the Federal Reserve issued
guidance entitled “Consolidated Supervision Framework for Large Financial Institutions,”1 which sets
forth a new framework for the consolidated supervision of large financial institutions. The framework
strengthens traditional microprudential supervision
and regulation to enhance the safety and soundness
of individual firms. It also incorporates macroprudential considerations to reduce potential threats to
the stability of the financial system and to provide
insights into financial market trends. The consolidated supervision framework has two primary
objectives:

1. enhance the resiliency of firms to lower the probability of failure or inability to serve as a financial
intermediary
2. reduce the impact on the financial system and the
broader economy in the event of a firm’s failure
or material weakness
BHC Consolidated Supervision Program staff also
participated jointly with staff of the Board’s Division
of Banking Supervision and Regulation on numerous
Dodd-Frank Act-related implementation projects
regarding supervisory assessment fees, consolidated
supervision, and thrift holding company integration.
Also, as part of the consolidated supervision of
BHCs, staff continued to monitor compliance with
the provisions in the consent orders that were implemented in 2011 at the four mortgage servicers and 10
BHCs for which the Federal Reserve has supervisory
authority. Staff’s oversight is designed to determine if
the servicers and BHCs have corrected the noted
deficiencies, that future abuses in the loan modification and foreclosure process are prevented, and that
borrowers are compensated for financial injury they
suffered as a result of errors, misrepresentations, or
other deficiencies in the foreclosure process.
On July 11, 2012, the Federal Reserve issued “Guidance on a Lender’s Decision to Discontinue Foreclosure Proceedings,”2 which emphasizes the importance
of appropriate risk management practices and controls in connection with a decision not to complete
foreclosure proceedings after they have been initiated.
The objective of the supervisory process related to
abandoned foreclosures is to confirm that an institution manages its decision to initiate and/or discontinue foreclosure proceedings in a prudent manner.
The policy letter notes four key concepts that banking organizations with residential mortgage servicing
operations should ensure are covered in their policies
and procedures:
1. notification to borrowers
2. communication methods
3. notification to local authorities

1

Board of Governors of the Federal Reserve System, Division of
Banking Supervision and Regulation and Division of Consumer
and Community Affairs (2012), “Consolidated Supervision
Framework for Large Financial Institutions,” Supervision and
Regulation Letter SR 12-17 and CA 12-14 (December 17), www
.federalreserve.gov/bankinforeg/srletters/sr1217.htm.

2

Board of Governors of the Federal Reserve System, Division of
Banking Supervision and Regulation and Division of Consumer
and Community Affairs (2012), “Guidance on a Lender’s Decision to Discontinue Foreclosure Proceedings,” Supervision and
Regulation Letter SR 12-11 and CA 12-10 (July 11), www
.federalreserve.gov/bankinforeg/srletters/sr1211.htm.

Consumer and Community Affairs

4. obtaining and monitoring collateral values

Mortgage Servicing and Foreclosure:
Implementing and Overseeing the
Independent Foreclosure Review
Throughout 2012, the Federal Reserve continued to
work with the Office of the Comptroller of the Currency (OCC) and the Office of Thrift Supervision
(OTS) to provide remediation to consumers who
were harmed by certain banking organizations in
their residential mortgage loan servicing and foreclosure processing operations.3 (See box 1.)

3

During the first half of the year, the agencies worked
to develop a remediation framework to provide
examples of situations where compensation or other
remediation would be required for those borrowers
who had been deemed to be financially harmed as a
result of errors, misrepresentations, and other deficiencies in the foreclosure process. In June, the Federal Reserve and the OCC issued guidance to help
ensure that similarly-situated borrowers would be
treated in the same manner, with remediation for
injuries, including lump-sum payments (from $500 to
$125,000 plus equity), suspension or rescission of a
foreclosure, loan modification or other loss mitigation assistance, correction of credit reports, or cor-

For more information on the Independent Foreclosure Review,
go to www.federalreserve.gov/consumerinfo/independentforeclosure-review.htm and www.independentforeclosurereview
.com.

Box 1. Independent Foreclosure Review:
Developing the Program, Reaching Borrowers
In 2010, the federal banking agencies (the Federal
Reserve Board of Governors, the Office of the
Comptroller of the Currency (OCC), and the Office
of Thrift Supervision (OTS)) launched a coordinated
and targeted review of 14 of the nation’s largest
mortgage servicing organizations, which handled
more than two-thirds of all mortgage servicing from
November 2010 to January 2011. The reviews
revealed a range of misconduct and negligence by
certain banking organizations in their residential
mortgage loan servicing and foreclosure processing
operations. In April 2011, the Board issued consent
orders against 10 parent bank holding companies,1
including four servicing entities regulated by the
Board, for deficient, unsafe, and unsound practices
in mortgage loan servicing and foreclosure
processing.2
These enforcement actions required each of the
organizations to correct deficient practices and provide remediation to borrowers who suffered financial
injury. Over the course of several months, the federal banking agencies worked with the 14 organizations to develop a program to implement the actions
mandated under the foreclosure review provision in
1

2

The 10 institutions are: Bank of America Corporation; Citigroup
Inc.; Ally Financial Inc.; HSBC North America Holdings, Inc.;
JPMorgan Chase & Co.; MetLife, Inc.; The PNC Financial Services Group, Inc.; SunTrust Banks, Inc.; U.S. Bancorp; and
Wells Fargo & Company.
Board of Governors of the Federal Reserve System (2011),
“Federal Reserve issues enforcement actions related to deficient
practices in residential mortgage loan servicing and foreclosure
processing,” press release, April 13, www.federalreserve.gov/
newsevents/press/enforcement/20110413a.htm.

77

the consent orders. The resulting program, known
as the Independent Foreclosure Review (IFR),
required the organizations to retain independent
consultants to review foreclosures that were initiated, pending, or completed during 2009 or 2010 to
determine if borrowers suffered financial harm
resulting from errors, misrepresentations, or other
deficiencies that may have occurred during the foreclosure process. In addition, the Board issued monetary penalties of $766.5 million against five banking
organizations, in conjunction with the Department of
Justice and the State Attorneys General.
Outreach to more than four million borrowers that
were eligible for the IFR program, to make them
aware of the opportunity to submit a request for a
review, presented challenges to the servicers and
the agencies. The goal was to cast the widest net
possible, so the Federal Reserve and the OCC
directed mortgage servicers to conduct an extensive
outreach campaign about the IFR. Print, radio, television, and online advertising campaigns targeted
the communities hardest hit by mortgage foreclosures, with materials available in English, Spanish,
Mandarin, Korean, Vietnamese, Hmong, Russian,
Creole, and Tagalog. Additional outreach efforts
included direct contact with eligible borrowers by
mail, e-mail, and telephone, as well as coordinated
efforts by community, housing, and faith-based
groups. Over the course of the program, in order to
provide adequate time for borrowers to submit a
request for review, the agencies extended the deadline three times, ultimately to December 31, 2012. In
the end, more than 500,000 borrowers submitted a
request for review.

78

99th Annual Report | 2012

rection of deficiency amounts and records.4 The
results of the independent consultants’ file review
were originally intended to determine whether a borrower was eligible for remediation, with regular oversight and review of the process, including testing of
files by Federal Reserve and OCC examiners.
Throughout the second half of 2012, the agencies
and consultants worked diligently to expand outreach to potentially affected borrowers and to conduct case-by-case reviews of mortgage files. The
reviews of the mortgage files was necessarily detailoriented and time consuming, and the agencies, servicers, community organizations, and financial institutions shared great concern about the delay in compensating borrowers. This concern reached a critical
level by the end of 2012, and the agencies and the
majority of the financial institutions involved agreed
to renegotiate the terms of the consent orders to
expedite payments to all borrowers in the 2009–10
period. In early January 2013, 13 mortgage servicing
companies subject to the consent orders for deficient
practices in mortgage loan servicing and foreclosure
processing agreed to pay more than $9.3 billion in
cash payments and other assistance to help borrowers.5 The sum includes $3.6 billion in cash payments
to eligible borrowers and $5.7 billion in other assistance, such as loan modifications and forgiveness of
deficiency judgments.6
As a result of this agreement, participating servicers
ceased the Independent Foreclosure Review (IFR)
program, replacing it with a broader framework
4

5

6

Board of Governors of the Federal Reserve System (2012),
“Agencies release financial remediation guidance, extend deadline for requesting a free independent foreclosure review to September 30, 2012,” press release, June 21, www.federalreserve.gov/
newsevents/press/bcreg/20120621a.htm.
Board of Governors of the Federal Reserve System (2013),
“Independent foreclosure review to provide $3.3 billion in payments, $5.2 billion in mortgage assistance,” press release, January 7, www.federalreserve.gov/newsevents/press/bcreg/20130107a
.htm.
Although not part of the Independent Foreclosure Review, on
January 16, 2013, Goldman Sachs and Morgan Stanley reached
similar agreements in principle with the Federal Reserve related
to enforcement actions for deficient practices in mortgage loan
servicing and foreclosure processing. See Board of Governors of
the Federal Reserve System (2013), “Federal Reserve Board
reaches agreements in principle with Goldman Sachs and Morgan Stanley to provide $557 million in payments and other
mortgage assistance to borrowers,” press release, January 16,
www.federalreserve.gov/newsevents/press/bcreg/20130116a.htm
and Board of Governors of the Federal Reserve System and
Office of the Comptroller of the Currency (2013), “OCC and
Federal Reserve reach agreement with HSBC to provide
$249 million in payments and assistance,” press release, January 18, www.federalreserve.gov/newsevents/press/bcreg/
20130118b.htm.

allowing eligible borrowers to receive compensation
significantly more quickly. The OCC and the Federal
Reserve accepted this agreement because it provides
the greatest benefit to consumers subject to unsafe
and unsound mortgage servicing and foreclosure
practices during the relevant period in a more timely
manner than would have occurred under the review
process. The agreement also includes additional
incentives for servicers to provide more foreclosure
assistance to borrowers. Borrowers covered under the
agreement will receive compensation whether or not
they filed a request-for-review form, and borrowers
do not need to take further action to be eligible for
compensation. For those servicers that are not participating in the agreement, the IFR process will
continue.
The resolution of the IFR marks an important milestone and, combined with the other corrective measures in the consent orders, a major step forward
toward improving mortgage servicing. In addition, all
remaining articles in the original consent orders
remain in full force and effect to correct the servicers’
deficient foreclosure practices. OCC and Federal
Reserve examiners continue to monitor the servicers’
implementation of corrective actions required by the
original consent orders to address unsafe and
unsound mortgage servicing and foreclosure
practices.

Supervisory Matters
In October 2012, the Board issued a formal enforcement action, including a $9 million civil money penalty, against American Express Company (Amex)
and American Express Travel Related Services Company (TRS) to address deceptive marketing and debt
collection practices and associated deficiencies in
compliance risk management and internal audit programs. Amex and TRS are both bank holding companies located in New York.
TRS, which provides debt collection and marketing
services to subsidiary banks (American Express Centurion Bank and American Express Bank, FSB),
allegedly led customers to believe that their defaulted
debt would be “waived” or “forgiven” by acting on
settlement offers without disclosing the effect that
settling for less than the full debt would have on the
customers’ future abilities to obtain credit. TRS also
allegedly made deceptive representations in credit
card solicitations concerning the benefits customers
would receive by acting on the offer. Finally, the Federal Reserve found deficiencies in compliance risk

Consumer and Community Affairs

management and internal audit, which are firm-wide
functions at Amex. The Board’s action was taken in
coordination with formal actions taken by the Consumer Financial Protection Bureau (CFPB), the Federal Deposit Insurance Corporation (FDIC), the
Office of the Comptroller of the Currency (OCC),
and the Utah Department of Financial Institutions
against the entities that they supervise.

Community Reinvestment Act
The CRA requires that the Federal Reserve and other
federal banking and thrift agencies encourage financial institutions to help meet the credit needs of the
local communities in which they do business, consistent with safe and sound operations. To carry out this
mandate, the Federal Reserve
• examines state member banks to assess their compliance with the CRA
• analyzes applications for mergers and acquisitions
by state member banks and bank holding companies in part within the context of CRA
performance
• disseminates information about community development techniques to bankers and the public
through Community Development offices at the
Reserve Banks
The Federal Reserve assesses and rates the CRA performance of state member banks in the course of
examinations conducted by staff at the 12 Reserve
Banks. During the 2012 reporting period, the Reserve
Banks conducted 256 CRA examinations of state
member banks. Of those banks examined, 28 were
rated “Outstanding,” 228 were rated “Satisfactory,”
none were rated “Needs to Improve,” and none were
rated “Substantial Non-Compliance.”
Mergers and Acquisitions
During 2012, the Board considered and approved
seven banking merger applications that were protested on CRA or fair lending grounds or that raised
issues involving consumer compliance or the CRA.7
• An application by Capital One Financial Corporation, McLean, Virginia, to acquire ING Bank,
FSB, Wilmington, Delaware, was approved in
February.
7

Another protested application was withdrawn by the applicant.
For more information on Orders on Banking Applications in
2012, go to www.federalreserve.gov/newsevents/press/orders/
2012orders.htm.

79

• An application by Adam Bank Group, Inc.,
Tampa, Florida, to acquire Brazos Valley Bank,
N.A., College Station, Texas, was approved in
March.
• Applications by Industrial and Commercial Bank
of China Limited, China Investment Corporation,
and Central Huijin Investment Ltd., all of Beijing,
People’s Republic of China, to become bank holding companies by acquiring up to 80 percent of the
voting shares of The Bank of East Asia (U.S.A.)
National Association, New York, New York, were
approved in May.
• An application by BB&T Corporation, WinstonSalem, North Carolina, to acquire BankAtlantic, a
subsidiary federal savings association of BankAtlantic Bancorp, Inc., both of Ft. Lauderdale,
Florida, was approved in July.
• An application by Sumitomo Mitsui Financial
Group, Inc. and Sumitomo Mitsui Banking Corporation, both of Tokyo, Japan, to increase their
ownership interest to up to 9.9 percent of the outstanding shares of The Bank of East Asia, Limited, Hong Kong SAR, People’s Republic of China
and thereby increase their interest in The Bank of
East Asia (U.S.A.) National Association, New
York, New York, was approved in October.
• An application by Mitsubishi UFJ Financial
Group, Inc., The Bank of Tokyo-Mitsubishi UFJ,
Ltd., both of Tokyo, Japan, and UnionBanCal
Corporation, San Francisco, California, to acquire
Pacific Capital Bancorp and, indirectly, its subsidiary, Santa Barbara Bank Trust, N.A., both of
Santa Barbara, California, was approved in
November.
Members of the public submitted comments on each
of the above applications. Public comments raised
various issues for staff to consider in their analyses of
the supervisory and lending records of the applicants. Several commenters alleged that various institutions failed to make credit available to certain
minority groups and to low- and moderate-income
(LMI) individuals and in LMI geographies or inadequate marketing through minority outlets. Commenters also alleged predatory and discriminatory
lending practices with respect to tax refund anticipation loans, residential mortgages, checking accounts,
and small business loans. Several commenters raised
CRA-related concerns about applicants with weak
CRA records following recent acquisitions or inadequate plans to meet communities’ credit needs,
potential branch closures that would disproportion-

80

99th Annual Report | 2012

ately exclude LMI consumers, inadequate branches
in predominantly minority tracts, and inaccuracies in
a CRA public disclosure.
In evaluating the merits of these comments, the
Board considered information provided by applicants
and analyzed relevant lending data in markets of
interest to the commenters. The Board also incorporated other information, including examination
reports with on-site evaluations of compliance with
fair lending and other consumer protection laws and
regulations and conferred with other regulators for
their supervisory views.
The application by Capital One Financial Corporation (Capital One), to acquire ING Bank, FSB
(ING) was one of the first of its kind to be subject to
the financial stability factor mandated by the DoddFrank Act. The application was filed in July 2011,
and more than 900 comments were submitted by
individuals and community groups, almost two-thirds
of which opposed the merger. In addition, the Board
held three public meetings—in Washington, D.C.,
Chicago, and San Francisco—related to this case.8
Commenters expressed concerns about Capital One’s
lending activities, including its concentration in credit
card lending, and urged the Board to delay or deny
the proposal until the CRA regulation has been
reformed to accommodate such nationwide lenders.
Commenters also contended that any public benefits
would be inadequate to offset the increase in risk
posed to the financial system given projected
increases in Capital One’s size and complexity.
In its February 14, 2012, order approving the proposal, the Board referenced various consumer complaints and legal actions against Capital One which
suggested that Capital One’s processes and procedures for enterprise-wide compliance transaction
testing could be improved.9 The Board conditioned
its approval on Capital One adopting, within 90 days
of the date of approval, a plan acceptable to the Federal Reserve Bank of Richmond, to augment its
enterprise-wide compliance transaction testing. The
8

9

Minutes for the Washington, D.C., meeting are available at www
.federalreserve.gov/foia/files/Capital_One-ING_Meeting_
Transcript_09-20-2011.pdf; for Chicago at www.federalreserve
.gov/foia/files/Capital-One-ING-Chicago-Meeting-Transcript_
09-27-2011.pdf; and for San Francisco at www.federalreserve
.gov/foia/files/Capital-One-ING-Hearing-Transcript-SanFrancisco-20111005.pdf.
Federal Reserve System (2012), “Capital One Financial Corporation, McLean, Virginia: Order Approving the Acquisition of a
Savings Association and Nonbanking Subsidiaries,” FRB Order
No. 2012-2 (February 14), www.federalreserve.gov/newsevents/
press/orders/order20120214.pdf.

plan was to specify areas in which transaction testing
would be conducted, address the scope and frequency of testing, provide for periodic reporting,
provide for improved employee training, and include
a requirement for an annual review of internal audit
of the testing implementation for at least the next
three years. Compliance with this condition was to be
monitored as part of the supervisory process.
The application by Mitsubishi UFJ Financial Group,
Inc., The Bank of Tokyo-Mitsubishi UFJ, Ltd., both
of Tokyo, Japan, and UnionBanCal Corporation,
San Francisco, California, to acquire Pacific Capital
Bancorp, Santa Barbara, California, was of particular interest because it represented the first application
of the financial stability statutory factor to a proposal by a globally systemically important banking
organization to acquire a bank in the United States.
The Board also considered 90 applications with outstanding issues involving compliance with consumer
protection statutes and regulations, including fair
lending laws and the CRA. Some of those issues
involved the existence of a consent order due to
weaknesses in foreclosure processes, as well as concerns about unfair and deceptive practices. Eightyone of those applications were approved and 10 were
withdrawn.

Fair Lending Enforcement
The Federal Reserve supervises 836 state member
banks. Pursuant to provisions of the Dodd-Frank
Act, effective on July 21, 2011, the CFPB supervises
state member banks with assets of more than $10 billion for compliance with the Equal Credit Opportunity Act (ECOA), and the Board has supervisory
authority for compliance with the Fair Housing Act.
For the approximately 815 state member banks with
assets of $10 billion or less, the Board retains the
authority to enforce both the ECOA and the Fair
Housing Act.
Fair lending reviews are conducted regularly within
the supervisory cycle. Additionally, examiners may
conduct fair lending reviews outside of the usual
supervisory cycle, if warranted by fair lending risk.
When examiners find evidence of potential discrimination, they work closely with DCCA’s Fair Lending
Enforcement Section, which provides additional legal
and statistical expertise and ensures that fair lending
laws are enforced consistently and rigorously
throughout the Federal Reserve System.

Consumer and Community Affairs

Pursuant to the ECOA, if the Board has reason to
believe that a creditor has engaged in a pattern or
practice of discrimination in violation of the ECOA,
the matter will be referred to the U.S. Department of
Justice (DOJ). The DOJ reviews the referral and
determines whether further investigation is warranted. A DOJ investigation may result in a public
civil enforcement action or settlement. Alternatively,
the DOJ may decide to return the matter to the
Board for administrative enforcement. When a matter is returned to the Board, staff ensures that the
institution takes all appropriate corrective action.
During 2012, the Board referred the following two
matters to the DOJ:
• One referral involved discrimination on the basis of
national origin, in violation of the ECOA. The
lender charged Hispanic borrowers higher interest
rates than non-Hispanic borrowers for unsecured
consumer loans. Legitimate pricing factors failed to
explain the pricing disparities.
• One referral involved discrimination on the basis of
marital status, in violation of the ECOA. The bank
improperly required spousal signatures on home
equity loans, in violation of Regulation B.
If a fair lending violation does not constitute a pattern or practice, the Federal Reserve acts on its own
to ensure that the violation is remedied by the bank.
Most lenders readily agree to correct fair lending violations. In fact, lenders often take corrective action as
soon as they become aware of a problem. Thus, the
Federal Reserve generally uses informal supervisory
tools (such as memoranda of understanding between
banks’ boards of directors and the Reserve Banks, or
board resolutions) to ensure that violations are corrected. If necessary to protect consumers, however,
the Board can bring public enforcement actions.

Financial Fraud Enforcement Task
Force and Other Outreach
As an active member of the Financial Fraud
Enforcement Task Force (FFETF), the Board coordinates with other agencies to facilitate consistent
and effective enforcement of the fair lending laws.10
The Director of the Board’s Division of Consumer
and Community Affairs co-chairs the FFETF’s NonDiscrimination Working Group with the Assistant
Attorney General for DOJ’s Civil Rights Division,
10

For more information about the FFETF, go to www.stopfraud
.gov.

81

the Deputy General Counsel of the U.S. Department
of Housing and Urban Development, the Assistant
Director of the CFPB’s Office of Fair Lending and
Equal Opportunity, and the National Association of
Attorneys General, represented by the Attorney General for the State of Illinois. In 2012, the Board and
the Non-Discrimination Working Group sponsored a
free interagency webinar that had more than 5,000
registrants, most of which were community banks.
In addition, the Federal Reserve participates in
numerous meetings, conferences, and trainings sponsored by consumer advocates, industry representatives, and interagency groups. Fair Lending Enforcement staff meets regularly with consumer advocates,
supervised institutions, and industry representatives
to discuss fair lending matters and receive feedback.
Through this outreach, the Board is able to address
emerging fair lending issues and promote sound fair
lending compliance.

Flood Insurance
The National Flood Insurance Act imposes certain
requirements on loans secured by buildings or mobile
homes located in, or to be located in, areas determined to have special flood hazards. Under the Federal Reserve’s Regulation H, which implements the
act, state member banks are generally prohibited
from making, extending, increasing, or renewing any
such loan unless the building or mobile home, as well
as any personal property securing the loan, are covered by flood insurance for the term of the loan. The
law requires the Board and other federal financial
institution regulatory agencies to impose civil money
penalties when they find a pattern or practice of violations of the regulation. The civil money penalties
are payable to the Federal Emergency Management
Agency (FEMA) for deposit into the National Flood
Mitigation Fund.
On July 6, 2012, the Biggert-Waters Flood Insurance
Reform Act of 2012 was signed into law. Among
other things, the act raised the civil money penalty
cap when a pattern or practice of flood violations
exists. Specifically, the cap was raised from $385 per
violation to $2,000 per violation. In addition, the
overall calendar year cap on penalties was removed.

Coordination with Other Federal
Banking Agencies
The member agencies of the Federal Financial Institutions Examination Council (FFIEC) develop uni-

82

99th Annual Report | 2012

form examination principles, standards, procedures,
and report formats.11 In 2012, the FFIEC member
organizations issued examination procedures for
three regulations.12
Interagency Examination Procedures
for Regulation Z
Procedures were revised to reflect an interim final
rule published by the CFPB on December 22, 2011,
which restated Regulation Z to reflect the transfer of
authority and certain other changes made by the
Dodd-Frank Act on July 21, 2011. The interim final
rule did not impose any new substantive obligations
on persons subject to the existing Regulation Z previously published by the Board.

their mortgage loans if they are unable to sell their
homes to pay off the mortgage debt.
The guidance reminds mortgage loan servicers that
their employees should be adequately trained about
the options available for assisting military homeowners with PCS orders. It also directs servicers to provide accurate, clear, and readily understandable information about available options for which homeowners may qualify based on the information known
when the homeowners notify their servicers that they
have received PCS orders. The guidance also reminds
servicers to communicate decisions on assistance
requests in a timely manner.

Examiner Training
Interagency Examination Procedures for
the Fair Credit Reporting Act (FCRA)
Procedures were revised to reflect amendments to the
FCRA pursuant to the Dodd-Frank Act and related
amendments to Regulation V, which implements portions of the FCRA. The Dodd-Frank Act amended
sections 615(a) and 615(h) of the FCRA to require
the disclosure of credit scores and information relating to credit scores in (1) adverse action notices if a
consumer’s credit score is used in taking adverse
action and (2) risk-based pricing notices if a consumer’s credit score is used in setting the material terms
of credit. These new credit score disclosure requirements became effective on August 15, 2011.
Interagency Guidance on Mortgage Servicing
for Military Homeowners
In June, the FFIEC member agencies jointly
announced guidance concerning mortgage servicing
practices that might pose risks to homeowners serving in the military.13 The guidance addresses risks
related to military homeowners who have informed
their loan servicer that they have received Permanent
Change of Station (PCS) orders to relocate to a new
duty station and who might need assistance with
11

12

13

FFIEC member agencies include the Board of Governors of the
Federal Reserve System, the FDIC, the National Credit Union
Administration (NCUA), the OCC, the State Liaison Committee (SLC), and the CFPB.
In prior years, the Board included in this section the findings
and rate of compliance with the consumer protection rules for
which it had rulemaking authority as reported by the various
federal agencies with supervisory authority for those regulations.
This reporting responsibility transferred to the CFPB in
July 2011. For more information see www.consumerfinance.gov/
reports.
Board of Governors of the Federal Reserve System (2012),
“Agencies issue guidance concerning mortgage servicing practices that impact servicemembers,” press release, June 21, www
.federalreserve.gov/newsevents/press/bcreg/20120620a.htm.

Ensuring that financial institutions comply with laws
that protect consumers and encourage community
reinvestment is an important part of the bank examination and supervision process. As the number and
complexity of consumer financial transactions grow,
training examiners becomes even more important.
The examiner staff development function is responsible for the ongoing development of the professional
consumer compliance supervisory staff, and ensuring
that these staff members have the skills necessary to
meet their supervisory responsibilities now and in the
future.
Consumer Compliance Examiner
Training Curriculum
The consumer compliance examiner training curriculum consists of five courses focused on various consumer protection laws, regulations, and examining
concepts. In 2012, these courses were offered in 13
sessions, and training was delivered to a total of 277
System consumer compliance examiners and staff
members and five state banking agency examiners.
When appropriate, courses are delivered via alternative methods, such as the Internet or other distancelearning technologies. For instance, several courses
use a combination of instructional methods:
(1) classroom instruction focused on case studies and
(2) specially developed computer-based instruction
that includes interactive self-check exercises.
Board and Reserve Bank staff regularly review the
core curriculum for examiner training, updating subject matter and adding new elements as appropriate.
During 2012, staff initiated one interim curriculum
review. The Fair Lending Examination Techniques
course was reviewed in order to incorporate lessons

Consumer and Community Affairs

learned from previous courses. This course is
designed to equip assistant level examiners with the
skills and knowledge to plan and conduct a riskfocused fair lending examination, and incorporates
the FFIEC fair lending examination procedures.
Life-long Learning
In addition to providing core examiner training, the
examiner staff development function emphasizes the
importance of continuing life-long learning. Opportunities for continuing learning include special projects and assignments, self-study programs, rotational
assignments, the opportunity to instruct at System
schools, mentoring programs, and an annual consumer compliance examiner forum, where senior consumer compliance examiners receive information on
emerging compliance issues and are able to share best
practices from across the System.
In 2012, the System continued to offer “Rapid
Response” sessions, which provide a powerful delivery method for just-in-time training. Debuted in
2008, Rapid Response sessions offer examiners onehour teleconference presentations on emerging issues
or urgent training needs that result from the implementation of new laws, regulations, or supervisory
guidance. A total of nine consumer compliance
Rapid Response sessions were designed, developed,
and presented to System staff during 2012.

Responding to Consumer
Complaints and Inquiries
The Federal Reserve investigates complaints against
state member banks and selected nonbank subsidiaries of bank holding companies (Federal Reserveregulated entities), and forwards complaints against
other creditors and businesses to the appropriate
enforcement agency. Each Reserve Bank investigates
complaints against state member banks and selected
nonbank subsidiaries in its District. The Federal
Reserve also responds to consumer inquiries on a
broad range of banking topics, including consumer
protection questions.
In late 2007, the Federal Reserve established Federal
Reserve Consumer Help (FRCH) to centralize the
processing of consumer complaints and inquiries. In
2012, FRCH processed 39,246 cases. Of these cases,
more than half (25,841) were inquiries and the
remainder (13,405) were complaints, with most cases

83

Table 1. Complaints against state member banks and
selected nonbank subsidiaries of bank holding companies
about regulated practices, by Regulation/Act, 2012
Regulation/Act
Regulation AA (Unfair or Deceptive Acts or Practices)
Regulation B (Equal Credit Opportunity)
Regulation BB (Community Reinvestment)
Regulation C (Home Mortgage Disclosure)
Regulation CC (Expedited Funds Availability)
Regulation D (Reserve Requirements)
Regulation DD (Truth in Savings)
Regulation E (Electronic Funds Transfers)
Regulation G (Disclosure/Reporting of CRA-Related
Agreements)
Regulation H (National Flood Insurance Act/Insurance Sales)
Regulation M (Consumer Lending)
Regulation P (Privacy of Consumer Financial Information)
Regulation Q (Payment of Interest)
Regulation V (Fair and Accurate Credit Transactions)
Regulation Z (Truth in Lending)
Fair Credit Reporting Act
Fair Debt Collection Practices Act
Fair Housing Act
Home Ownership Counseling
HOPA (Homeowners Protection Act)
Real Estate Settlement Procedures Act
Right to Financial Privacy Act
Protecting Tenants at Foreclosure Act
Servicemembers Civil Relief Act
Total

Number
7
26
2
0
65
3
55
67
0
20
0
17
1
14
51
49
15
14
0
2
31
3
2
3
447

received directly from consumers. Approximately
6 percent of cases were referred to the Federal
Reserve from other agencies.
While consumers can contact FRCH by telephone,
fax, mail, e-mail, or online (at www
.federalreserveconsumerhelp.gov), most FRCH consumer contacts occurred by telephone (56 percent).
Forty-one percent (15,947) of complaint and inquiry
submissions were made electronically (via e-mail,
online submissions, and fax), and the online form
page received 333,281 visits during the year.
Consumer Complaints
Complaints against Federal Reserve-regulated entities totaled 2,194 in 2012. Approximately 43 percent
of these complaints were closed without investigation
pending the receipt of additional information from
consumers. Nearly 7 percent of the total complaints
are still under investigation. Of the remaining complaints (1,109), 60 percent (662) involved unregulated

84

99th Annual Report | 2012

Table 2. Complaints against state member banks and selected nonbank subsidiaries of bank holding companies about
regulated practices, by product type, 2012
Subject of complaint/product type

All complaints
Number

Total
Discrimination alleged
Real estate loans
Credit cards
Other loans
Nondiscrimination complaints
Checking accounts
Real estate loans
Credit cards
Other

practices and 40 percent (447) involved regulated
practices.
Complaints about Regulated Practices

The majority of regulated practices complaints concerned checking accounts (27 percent), real estate14
(23 percent), and credit cards (18 percent). The most
common checking account complaints related to
funds availability not as expected (37 percent), insufficient funds or overdraft charges and procedures
(18 percent), forgery/fraud/embezzlement (9 percent),
and disputed rates, terms, or fees (8 percent). The
most common real estate complaints by problem
code related to flood insurance (18 percent), debt
collection/foreclosure concerns (15 percent), disputed
rates, terms, and fees (14 percent), and payment
errors or delays (5 percent). The most common credit
card complaints related to inaccurate credit reporting
(32 percent), payment errors and delays (10 percent),
bank debt collection tactics (9 percent), billing error
resolutions (9 percent), and interest rates, terms, and
fees (8 percent).
Twenty-five regulated practices complaints alleging
discrimination were received. Of these, 12 complaints
(3 percent of total regulated complaints) alleged discrimination on the basis of prohibited borrower
traits or rights.15 Twenty-eight percent of discrimination complaints was related to the race, color,
national origin, or ethnicity of the applicant or bor14

15

Real estate loans include adjustable-rate mortgages, residential
construction loans, open-end home equity lines of credit, home
improvement loans, home purchase loans, home refinance/
closed-end loans, and reverse mortgages.
This includes alleged discrimination on the basis of race, color,
religion, national origin, sex, marital status, age, applicant
income derived from public assistance programs, or applicant
reliance on provisions of the Consumer Credit Protection Act.

447

Complaints involving violations
Percent
100

Number

Percent

6

1.3

15
4
6

3.4
0.8
1.3

0
0
0

0
0
0

119
87
77
139

27.0
19.5
17.0
31.0

3
1
0
2

0.07
0.02
0
0.04

rower. Eight percent of discrimination complaints
was related to either the age or handicap of the applicant or borrower. Of the complaints alleging discrimination based on a prohibited basis, there were
no violations.
In 96 percent of investigated complaints against Federal Reserve-regulated entities, evidence revealed that
institutions correctly handled the situation. Of the
remaining 4 percent of investigated complaints,
1 percent was deemed violations of law, 3 percent
was identified errors which were corrected by the
bank, and the remainder included matters involving
litigation or factual disputes, withdrawn complaints,
internally referred complaints, or information was
provided to the consumer.
Complaints about Unregulated Practices

The Board continued to monitor complaints about
banking practices not subject to existing regulations.
In 2012, the Board received 662 complaints against
Federal Reserve-regulated entities that involved these
unregulated practices. The complaints were related to
credit cards (24 percent), checking account activity
(24 percent), and real estate concerns (18 percent).
Complaint Referrals

In 2012, the Federal Reserve forwarded 11,230 complaints against other banks and creditors to the
appropriate regulatory agencies and government
offices for investigation. To minimize the time
required to re-route complaints to these agencies,
referrals were transmitted electronically.
The Federal Reserve forwarded 11 complaints to the
Department of Housing and Urban Development
(HUD) that alleged violations of the Fair Housing

Consumer and Community Affairs

Act.16 The Federal Reserve’s investigation of these
complaints revealed no instances of illegal credit
discrimination.
Consumer Inquiries
The Federal Reserve received 25,841 consumer inquiries in 2012, covering a wide range of topics. Consumers were typically directed to other resources,
including other federal agencies or written materials,
to address their inquiries.

Consumer Research and
Emerging-Issues and Policy Analysis
Throughout 2012, DCCA analyzed emerging issues
in consumer financial services policies and practices
in order to understand their implications for the economic and supervisory policies that are core to the
Federal Reserve’s functions, as well as to gain insight
into consumer decisionmaking.

Consumer Financial Services Research
Consumers’ Use of Mobile Financial Services
The evolution of technologies that enable consumers
to conduct financial transactions using mobile
devices has dramatically affected how consumers
conduct their financial lives; however, little research
has explored this topic. The division has been monitoring trends and developments in mobile financial
services for several years and undertook efforts to
delve more formally into the topic in 2012. (See
box 2.)
To further understand consumers’ use of, and opinions about, mobile financial services, the division
commissioned an online survey, polling nearly 2,300
respondents to learn whether and how they use
mobile devices for banking and payments. This survey was among the first to integrate questions about
using mobile devices for shopping and comparing
products along with questions about using mobile
devices for banking and payments. The findings of
the survey were published and released in the report,
Consumers and Mobile Financial Services, and was
the topic of Congressional testimony.17 A second survey was conducted in November to update the first
16

17

A memorandum of understanding between HUD and the federal bank regulatory agencies requires that complaints alleging a
violation of the Fair Housing Act be forwarded to HUD.
See Sandra F. Braunstein, Director, Division of Consumer and
Community Affairs (2012), “Mobile payments,” Before the
Committee on Banking, Housing, and Urban Affairs, U.S. Sen-

85

survey, with the findings compiled and published in
early 2013.

Emerging-Issues Analysis
The Policy Analysis function of DCCA provides key
insights, information, and analysis on emerging
financial services issues that affect the well-being of
consumers and communities. To this end, Policy
Analysis staff follow and analyze trends, lead
Division-wide working groups, and organize expert
roundtables to identify emerging risks and inform
policy recommendations.
In 2012, the Policy Analysis team was actively
engaged in a broad set of issues and activities to promote household financial security and sustainable
recovery from the financial crisis. Staff contributed to
broad analysis of policy considerations for housing
market recovery. In conjunction with other divisions
of the Board, the team was involved in proposals for
re-use strategies for bank-owned foreclosure properties (also referred to as “real estate owned,” or REO)
and developing guidance to address some banks’
practice of abandoning a foreclosure process without
notification to borrowers or local authorities.18
Policy Analysis continued its work on residential
mortgage foreclosure issues by assisting with the
implementation of the Independent Foreclosure
Review (IFR). As part of the 2011 enforcement
actions against 14 mortgage servicers for deficient
practices in mortgage loan servicing and foreclosure
processing, the IFR process was created to remediate
borrowers financially harmed from improper foreclosure actions in 2009 and 2010.19 Policy staff led the
effort to make public data that could be used to
inform a more targeted approach to reaching borrowers potentially eligible for an IFR review, and also
developed web-based communication materials to
broaden IFR outreach efforts.

18

19

ate, March 29, www.federalreserve.gov/newsevents/testimony/
braunstein20120329a.htm.
Board of Governors of the Federal Reserve System, Division of
Banking Supervision and Regulation and Division of Consumer
and Community Affairs (2012), “Guidance on a Lender’s Decision to Discontinue Foreclosure Proceedings,” Supervision and
Regulation Letter SR 12-11 and CA 12-10 (July 11) www
.federalreserve.gov/bankinforeg/srletters/sr1211.htm.
Board of Governors of the Federal Reserve System (2011),
“Federal Reserve issues enforcement actions related to deficient
practices in residential mortgage loan servicing and foreclosure
processing,” press release, April 13, www.federalreserve.gov/
newsevents/press/enforcement/20110413a.htm.

86

99th Annual Report | 2012

Box 2. Consumers’ Evolving Use of Mobile Financial Services
In recent years, an increasing array of financial services—including banking services, shopping tools,
and payment options—have become available for
consumers using cell phones and other mobile
devices. Collectively, these developments may ultimately have significant effects on the ways in which
consumers conduct their financial lives. Several
functions of the Federal Reserve Board—including
the Division of Consumer and Community Affairs
(DCCA)—have been monitoring these new developments in recent years. As mobile financial services
are becoming increasingly common, DCCA set out
to conduct a survey to assess: the extent of consumers’ adoption of these services, how these services are being used, how they could help consumers in their financial decisionmaking, how they could
expand access to financial services for underserved
populations, and where there may be areas of
concern.
Through a nationally representative survey conducted by DCCA in early 2012, the Board learned
that 21 percent of all mobile phone users, and
42 percent of smartphone users, had used mobile
banking services in the preceding 12 months.1
1

See Board of Governors of the Federal Reserve System (2012),
Consumers and Mobile Financial Services, (Washington: Board
of Governors, March), www.federalreserve.gov/econresdata/
mobile-devices/files/mobile-device-report-201203.pdf. See also
Matthew B. Gross, Jeanne M. Hogarth, and Maximilian D.
Schmeiser (2012), “Use of Financial Services by the Unbanked
and Underbanked and the Potential for Mobile Financial Services Adoption,” Federal Reserve Bulletin, vol. 94, no. 4, www
.federalreserve.gov/pubs/bulletin/2012/articles/
MobileFinancialServices/mobile-financial-services.htm.

As part of an ongoing effort to understand various
aspects of consumers’ financial lives, Policy Analysis
conducted inquiries into specific issues. For example,
together with the Consumer Research group, Policy
Analysis hosted expert roundtables to discuss
changes in post-secondary education financing and
the possible implications of the trends in student
indebtedness for individuals, households, and for the
broader economy. The group also facilitated expert
dialogues and initiated research into the financial
lives and needs of older adults, a growing demographic in the U.S. population with potentially distinct patterns of use of financial services.

Community Economic Development
The Federal Reserve System’s Community Development function promotes economic growth and finan-

30

444

Fewer consumers reported that they had used their
mobile devices to make some form of payment in
the prior 12 months—just 12 percent of all mobile
phone users and 23 percent of smartphone users.
For both mobile banking and mobile payments, the
two primary reasons why people chose not to adopt
the service were: (1) concerns about the security of
the technology and (2) the belief that these new services did not provide sufficient benefits over existing
services to justify their usage.
The survey further showed that the increasing availability of just-in-time financial information may
change the way that consumers make financial decisions. For example, among the respondents who
indicated that they receive text message alerts telling them that they have a low balance, 86 percent
reported taking action—such as transferring funds
into the account, making a deposit, or reducing their
spending—in response to those messages. Consumers are also making use of their mobile phones
to inform their decisions when shopping. For
instance, among smartphone users, 41 percent
reported using their phones to comparison shop
over the Internet while at a store. Of these people,
68 percent indicated that the price comparison
resulted in them purchasing the product somewhere
other than the store they were in.
As the mobile financial services market is quickly
evolving, DCCA plans to conduct a follow-up survey
to track trends and recent developments in consumers’ use of mobile services. It will report the resulting
information in 2013.

cial stability for low- and moderate-income (LMI)
communities and individuals through a range of
activities: convening stakeholders, conducting and
sharing research, and identifying emerging issues. As
a decentralized function, the Community Affairs
Officers (CAOs) at each of the 12 Reserve Banks
design activities to respond to the specific needs of
the communities they serve, with oversight from
Board staff. The Board’s Community Development
staff promote and coordinate Systemwide priorities;
in particular, Community Development has five strategic goals:
1. support programs and promote policies that
improve the financial stability of LMI households
2. strengthen LMI communities by advancing comprehensive neighborhood revitalization and stabilization strategies

Consumer and Community Affairs

3. foster innovative strategies that assist LMI communities and individuals in launching, growing,
and sustaining small businesses
4. advance innovation and efficiency in community
development programs, funding, and infrastructure to promote scale, sustainability, and impact
5. strategically communicate key findings of the
Community Development function and share
emerging community development issues and
trends that have national implications

Growing Economies in Indian Country
Even as the national economy shows signs of
improvement, communities in rural areas of the
United States—particularly on tribal lands—still face
considerable obstacles in attracting investment,
accessing financial services, and supporting entrepreneurship. The Growing Economies in Indian Country
(GEIC) initiative was an innovative interagency and
Systemwide endeavor focused on a singular cause:
Indian Country. The 2011 GEIC workshop series
was an interagency effort to address economic development issues, raise awareness of federal assistance
programs, and highlight best practices of economic
development strategies for Indian Country. The most
important objective of GEIC was to hear from members of the community about the barriers to economic development in Native American communities
and strategies being employed to overcome those barriers. Nine federal agencies and four Federal Reserve
Banks participated in this effort to host workshops at
six locations across the country.
In May 2012, the working group released a report
and hosted a national summit in Washington, D.C.,
to share the wide range of views and ideas that surfaced in the GEIC series.20 The summit provided a
venue for tribal leaders, policymakers, financial
industry professionals, and community development
service providers to discuss challenges to economic
development in Indian country, opportunities to
strengthen Tribal enterprise development, opportunities to expand Native American entrepreneurship
and access to small business capital, and opportunities to strengthen governance and legal structures.
20

Board of Governors of the Federal Reserve System (2012),
“Growing Economies in Indian Country: Taking Stock of Progress and Partnerships,” (Board of Governors of the Federal
Reserve System: Washington, D.C., April), www.federalreserve
.gov/newsevents/conferences/GEIC-white-paper-20120501.pdf.

87

The working group continues to meet and share
resources as it looks to increase its collaborative
efforts and form new partnerships. The hope is that
the GEIC series will serve as a model and launching
pad for future interagency efforts in Indian Country.

Stabilizing Communities through
Strategic Use of Resources
Fallout from the economic crisis has included large
inventories of foreclosed properties that stand vacant
and abandoned and can have significant destabilizing
effects on communities, including increased crime
and decreased property values. The challenge of disposing of these real estate owned (REO) properties
often outstrips resources, particularly in low-income
communities. Throughout 2012, the Federal
Reserve’s Community Development function and its
national partner organizations supported efforts to
transform how community investments are made to
stabilize communities. Many communities have a
mismatch between development needs and available
resources to meet these needs. Strategic use of data
and other available tools to target limited resources is
one method increasingly used to more effectively stabilize distressed neighborhoods. The Federal Reserve
is providing information on innovative practices in
communities across the nation and on tools available
to practitioners and policymakers to aid local efforts.

Labor Markets and Human Capital
Given the attenuating effects of long-term unemployment on the broader economic recovery and the particular issues facing LMI communities, in the fall of
2011, the Community Development function
designed an initiative to explore regional perspectives
on this issue through a series of forums held throughout the country. Some of these regional forums consisted of small focus groups or listening sessions; others were larger in scope, with more formal agendas
focusing on a particular demographic or employment
sector. In most cases, forum participants represented
either intermediary organizations that are involved in
the delivery of workforce development services, local
employers, or both. The objective of this initiative
was to better understand the complex factors creating long-term unemployment conditions particularly
in LMI communities and to identify promising workforce development strategies. In December 2012, the
Board released “A Perspective from Main Street:
Long-Term Unemployment and Workforce Develop-

88

99th Annual Report | 2012

ment,”21 a paper that provides a summary of the key
topics that emerged from the forums and examples of
how those issues were reflected in different parts of
the country and for different populations.

Community Data Initiative
In 2011, the Community Data Initiative (CDI) was
launched with the goal of leveraging informationsharing and partnership roles with a rigorous analytical capacity to provide reliable market intelligence
that helps identify and close data gaps for LMI communities. The Board and each of the Reserve Banks
participate in this collaborative research project to
provide systematic and relevant community conditions and trend information on a consistent basis.
Through the use of quarterly or biannual e-polling of
selected district community stakeholders, the CDI
captures current and emerging community development issues. In 2012, all 12 of the Reserve Banks
were administering web-based polls and surveys. To
provide a national context for the regional results of
Reserve Bank polls, the Board continued to survey
NeighborWorks® America affiliates and grantees.
Board staff manage this System initiative, working
with Reserve Banks, to aggregate the data with the
mission of:
• implementing a more systematic approach to gathering and disseminating market intelligence on current and emerging challenges facing LMI
communities

communications, including speeches and press
releases.
The CDI staff also continues to explore various
graphical and trend analysis, as well as visual capture,
of LMI community conditions’ variability across
Reserve Bank districts. The Board team is collaborating with Reserve Bank CDI working groups on the
following topics: new statistical methodologies,
reporting comparative and aggregate information,
and deep-dive/drill-down sector-specific surveys on
issues that continue to display fragile or no recovery
capacity.
NeighborWorks-Board National Survey for 2012:Q4
closed on January 11, 2013, with 396 respondents
across all 12 Reserve Bank districts. The survey provides national information on housing counselors
experience with Treasury’s Home Affordable Modification Program, workforce development issues,
affordable rental housing issues, and a national ranking of the top three current issues impacting LMI
communities currently, as well as the top three emerging issues (expected within the next six months). The
survey findings serve as a baseline comparison for the
Reserve Bank district web-based survey findings.
As the CDI data set continues to build over time, it
has the potential to serve as a robust source of information to augment other Federal Reserve data collection efforts and to bring insight into the economic
and financial issues of LMI communities.

• enabling staff to differentiate between anecdotes
and trends over time
• capturing regional dispersion of issues and variability of conditions over Reserve Bank districts

Consumer Laws and Regulations

• providing specialized data of interest to a particular district and Board leadership, such as community indicators on affordable housing, workforce
development, and small businesses credit

Throughout 2012, DCCA continued to administer
the Board’s regulatory responsibilities with respect to
certain entities and specific statutory provisions of
the consumer financial services and fair lending laws.
DCCA also drafts regulations and official interpretations and issues regulatory interpretations and compliance guidance for the industry, the Reserve Banks,
other federal agencies, and congressional staff.

In 2012, Board staff began to utilize text analytics
software to analyze open-ended text from some community stakeholder respondents, including the Board
survey administered by NeighborWorks. Current and
emerging trends from such analysis will inform survey question design and language used in Board
21

Board of Governors of the Federal Reserve System (2012), “A
Perspective from Main Street: Long-Term Unemployment and
Workforce Development (Board of Governors of the Federal
Reserve System: Washington, D.C., December), www
.federalreserve.gov/communitydev/pdfs/Workforce_errata_final2
.pdf.

Appraisal Requirements for
“Higher-Risk Mortgage Loans”
In August, the Board and five other federal financial
regulatory agencies jointly announced proposed rules
to implement amendments to the Truth in Lending
Act that would establish new appraisal requirements

Consumer and Community Affairs

for “higher-risk mortgage loans.”22 The proposal
would implement provisions of the Dodd-Frank Act,
and would apply to loans secured by a consumer’s
home that have interest rates above a certain threshold. For such loans, the proposed rule would require
creditors to use a licensed or certified appraiser to
prepare a written report based on a physical inspection of the interior of the property. The proposed
rule also would require creditors to disclose to applicants information about the purpose of the appraisal
22

The proposal was issued jointly with the CFPB, FDIC, NCUA,
OCC, and the Federal Housing Finance Agency (FHFA). See
Board of Governors of the Federal Reserve System, CFPB,
FDIC, FHFA, NCUA, and OCC (2012), “Agencies issue proposed rule on appraisals for higher-risk mortgages,” joint press
release, August 15, www.federalreserve.gov/newsevents/press/
bcreg/20120815a.htm.

89

and provide consumers with a free copy of any
appraisal report. Under the proposal, creditors also
would have to obtain an additional appraisal at no
cost to the consumer if the consumer is buying a
home that the seller acquired for a lower price during
the prior six months.
The public comment period closed in October. Consistent with the requirements of the Dodd-Frank
Act, final regulations to implement these provisions
were issued on January 18, 2013.23
23

Board of Governors of the Federal Reserve System, CFPB,
FDIC, FHFA, NCUA, and OCC (2013), “Agencies issue final
rule on appraisals for higher-priced mortgage loans,” joint press
release, January 18, www.federalreserve.gov/newsevents/press/
bcreg/20130118a.htm.

91

Federal Reserve Banks

The Federal Reserve Banks provide payment services
to depository and certain other institutions, distribute
the nation’s currency and coin to depository institutions, and serve as fiscal agents and depositories for
the U.S. government and other entities. The Reserve
Banks also contribute to setting national monetary
policy and supervision of banks and other financial
entities operating in the United States (discussed in
the preceding sections of this report).

Federal Reserve Priced Services
Federal Reserve Banks provide a range of payment
and related services to depository institutions,
“priced services” that include collecting checks, operating an automated clearinghouse (ACH) service,
transferring funds and securities, and providing a
multilateral settlement service.
The Federal Reserve Banks, working with the financial industry, have made substantial progress in their
effort to migrate to a more efficient electronic payment system by expanding the use of ACH payments
and by converting from a paper-based check clearing
process to an electronic one. Over the past several
years, the Reserve Banks have capitalized on efficiencies gained from increased electronic processing by
bundling payment services and offering information
and risk management services, which help depository
institutions manage effectively both their payment
operations and associated operational and credit risk.
The Reserve Banks have also been engaged in a number of multiyear technology initiatives that will modernize their priced services processing platforms over
the next several years. In 2012, the Banks successfully
implemented a new electronic check-processing
system; they also continued efforts to migrate the
FedACH, Fedwire Funds, and Fedwire Securities services off a mainframe system and to a distributed
computing environment.

Further, the Reserve Banks announced in October 2012 their intention to expand efforts to improve
the speed and security of payment networks and services and to work more with the industry on standards and processes to further improve overall efficiency. As part of this effort, the Reserve Banks
intend to engage on a deeper level with various end
users in payment transactions to understand both
needs and challenges.

Recovery of Direct and Indirect Costs
The Monetary Control Act of 1980 requires that the
Federal Reserve establish fees for priced services provided to depository institutions so as to recover, over
the long run, all direct and indirect costs actually
incurred as well as the imputed costs that would have
been incurred—including financing costs, taxes, and
certain other expenses—and the return on equity
(profit) that would have been earned if a private business firm had provided the services.1 The imputed
costs and imputed profit are collectively referred to
as the private-sector adjustment factor (PSAF).2 Over
the past 10 years, Reserve Banks have recovered
99.5 percent of their priced services costs, including
the PSAF (see table 1).3
1

2

3

Financial data reported throughout this chapter—including revenue, other income, costs, income before taxes, and net
income—will reference to the “Pro Forma Financial Statements
for Federal Reserve Priced Services” at the end of this chapter.
In addition to income taxes and the return on equity, the PSAF
includes three other imputed costs: interest on debt, sales taxes,
and an assessment for deposit insurance by the Federal Deposit
Insurance Corporation (FDIC). Board of Governors assets and
costs that are related to priced services are also allocated to
priced services; in the pro forma financial statements for priced
services at the end of this chapter, Board assets are part of longterm assets, and Board expenses are included in operating
expenses. The discontinuation of the clearing balance program
in July 2012 had a significant effect on the PSAF, as described in
the pro forma financial statements.
Effective December 31, 2006, the Reserve Banks implemented
the Financial Accounting Standards Board’s Statement of
Financial Accounting Standards (SFAS) No. 158, Employers’
Accounting for Defined Benefit Pension and Other Postretirement

92

99th Annual Report | 2012

Table 1. Priced Services Cost Recovery, 2003–2012
Millions of dollars, except as noted
Year
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2003–2012

Revenue from services1

Operating expenses and
imputed costs2

Targeted return on equity3

Total costs

Cost recovery (percent)4, 5

881.7
914.6
993.8
1,029.7
1,012.3
873.8
675.4
574.7
478.6
449.8
7,884.3

931.3
842.6
834.4
874.8
912.9
820.4
707.5
532.8
444.4
423.0
7,324.2

104.7
112.4
103.0
72.0
80.4
66.5
19.9
13.1
16.8
8.9
597.7

1,036.0
955.0
937.4
946.8
993.3
886.9
727.5
545.9
461.2
432.0
7,921.9

85.1
95.8
106.0
108.8
101.9
98.5
92.8
105.3
103.8
104.1
99.5

Note: Here and elsewhere in this chapter, components may not sum to totals or yield percentages shown because of rounding.
For the 10-year period, includes revenue from services of $7,370.1 million and other income and expense (net) of $514.2 million.
2
For the 10-year period, includes operating expenses of $7,037.0 million, imputed costs of $42.4 million, and imputed income taxes of $244.8 million.
3
Beginning in 2009, the PSAF has been adjusted to reflect the actual clearing balance levels maintained; previously, the PSAF was calculated based on a projection of clearing
balance levels.
4
Revenue from services divided by total costs.
5
For the 10-year period, cost recovery is 92.1 percent, including the effect of accumulated other comprehensive income (AOCI) reported by the priced services under ASC
715. For details on changes to the estimation of priced services accumulated other comprehensive income and their effect on the pro forma financial statements, refer to
note 4 to the "Pro Forma Financial Statements for Federal Reserve Priced Services" at the end of this chapter.
1

In 2012, Reserve Banks recovered 104.1 percent of
total priced services costs, including the PSAF.4 The
Banks’ operating costs and imputed expenses totaled
$423.0 million. Revenue from operations totaled
$449.3 million and other income was $0.5 million,
resulting in net income from priced services of
$26.8 million.5

net income of $21.9 million. In 2012, check-service
revenue from operations decreased $39.2 million
from 2011.6 Reserve Banks handled 6.6 billion checks
in 2012, a decrease of 2.3 percent from 2011 (see
table 2). The decline in Reserve Bank check volume
continues to be influenced by nationwide trends away
from the use of checks.

Commercial Check-Collection Service

By year-end 2012, 99.9 percent of check deposits
processed by the Reserve Banks and 99.9 percent of
checks presented by the Reserve Banks to paying
banks were processed electronically. In addition,
99.2 percent of unpaid checks were returned electronically to a Reserve Bank and 95.0 percent were
delivered electronically by the Reserve Bank to the
bank of first deposit. The Reserve Banks in 2012
continued to reduce check-service operating costs by
consolidating further their check-processing offices
into one site that supports both paper and electronic
check processing.7

In 2012, Reserve Banks recovered 108.8 percent of
the total costs of their commercial check-collection
service, including the related PSAF. The Banks’ operating expenses and imputed costs totaled $198.4 million. Revenue from operations totaled $220.0 million
and other income totaled $0.3 million, resulting in

4

5

Plans [Accounting Standards Codification (ASC) Topic 715
(ASC 715), Compensation–Retirement Benefits], which has
resulted in the recognition of a $643.0 million reduction in
equity related to the priced services’ benefit plans through 2012.
Including this reduction in equity, which represents a decline in
economic value, results in cost recovery of 92.1 percent for the
10-year period. For details on how implementing ASC 715
affected the pro forma financial statements, refer to note 4 to the
pro forma financial statements at the end of this chapter.
Total cost is the sum of operating expenses, imputed costs
(income taxes, interest on debt, interest on float, sales taxes, and
the FDIC assessment), and the targeted return on equity.
Other income is investment income earned on clearing balances
net of the cost of earnings credits, an amount termed net
income on clearing balances, and income from expired earning
credits.

6

7

Section 17 of the Check-Clearing for the 21st Century Act
requires the Federal Reserve Board’s Annual Report to include
costs of and revenue from inter-District commercial check transportation. In 2008, the Reserve Banks discontinued the transportation of commercial checks between their check-processing
offices. As a result, in 2012, there were no costs or imputed revenues associated with the transportation of commercial checks
between Reserve Bank check-processing offices.
The Reserve Banks completed in 2010 a multiyear initiative,
which began in 2003, that reduced the number of offices at
which they process paper checks from 45 to one. Since

Federal Reserve Banks

93

Table 2. Activity in Federal Reserve Priced Services, 2010–2012
Thousands of items
Percent change
Service

2012

2011

2010
2011 to 2012

Commercial check
Commercial ACH
Fedwire funds transfer
National settlement
Fedwire securities

6,622,265
10,664,613
134,409
663
6,441

6,779,607
10,348,802
129,734
571
7,271

7,711,833
10,232,757
127,762
522
7,913

2010 to 2011

-2.3
3.1
3.6
16.0
-11.4

-12.1
1.1
1.5
9.4
-8.3

Note: Activity in commercial check is the total number of commercial checks collected, including processed and fine-sort items; in commercial ACH, the total number of
commercial items processed; in Fedwire funds transfer and securities transfer, the number of transactions originated online and offline; and in national settlement, the number
of settlement entries processed.

Commercial Automated
Clearinghouse Services
The Automated Clearinghouse Service enables
depository institutions and their customers to process large volumes of payments effectively through
electronic, batch processes. In 2012, the Reserve
Banks recovered 101.0 percent of the total costs of
their commercial ACH services, including the related
PSAF. Reserve Bank operating expenses and imputed
costs totaled $111.4 million.
Revenue from ACH operations totaled $114.8 million
and other income totaled $0.1 million, resulting in
net income of $3.6 million. The Reserve Banks processed 10.7 billion commercial ACH transactions, an
increase of 3.1 percent from 2011.

Fedwire Funds and National
Settlement Services
In 2012, Reserve Banks recovered 98.8 percent of the
costs of their Fedwire Funds and National Settlement Services, including the related PSAF. Reserve
Bank operating expenses and imputed costs for these
operations totaled $89.8 million in 2012. Revenue
from these services totaled $90.5 million, and other
income amounted to $0.1 million, resulting in a net
income of $0.8 million.
Fedwire Funds Service
The Fedwire Funds Service allows its participants to
use their balances at Reserve Banks to transfer funds
to other participants in the service. In 2012, the numFebruary 2010, the Cleveland Reserve Bank operated the only
paper check-processing site for the System, while the Atlanta
Reserve Bank served as the System’s electronic check-processing
site. As of December 31, 2012, the Atlanta Reserve Bank alone
processes both paper and electronic checks for the System.

ber of Fedwire funds transfers originated by depository institutions increased 3.6 percent from 2011, to
approximately 134.4 million. The average daily value
of Fedwire funds transfers in 2012 was $2.4 trillion, a
decrease of 9.7 percent from the previous year.
The Reserve Banks in 2012 introduced payment notification functionality, which allows a sending bank
that is a Fedwire Funds Service participant to request
an e-mail notification from a beneficiary’s bank
when the beneficiary’s bank credits or otherwise pays
the beneficiary of a particular funds transfer. This
functionality facilitates transparency and responds to
needs expressed by both depository institutions and
their corporate customers.
National Settlement Service
The National Settlement Service is a multilateral
settlement system that allows participants in privatesector clearing arrangements to settle transactions
using Federal Reserve balances. In 2012, the service
processed settlement files for 16 local and national
private-sector arrangements, the same number of
arrangements as were active in 2011. The Reserve
Banks processed slightly more than 8,500 files that
contained around 663,000 settlement entries for these
arrangements in 2012. Activity in 2012 represents an
increase from the 571,000 settlement entries processed in 2011.

Fedwire Securities Service
In 2012, the Reserve Banks recovered 100.3 percent
of the total costs of the priced-service component of
their Fedwire Securities Service, including the related
PSAF. The Banks’ operating expenses and imputed
costs for providing this service totaled $23.5 million
in 2012. Revenue from the service totaled $24.1 mil-

94

99th Annual Report | 2012

lion and there was no other income, resulting in a net
income of $0.6 million.

coins from circulation, a 1.5 percent decrease from
2011.

The Fedwire Securities Service allows its participants
to transfer electronically to other service participants
certain securities issued by the U.S. Treasury, federal
government agencies, government-sponsored enterprises, and certain international organizations.8 In
2012, the number of non-Treasury securities transfers
processed via the service decreased 11.4 percent from
2011, to approximately 6.4 million.

Improvements to Efficiency and
Risk Management

Float
In 2012, the Reserve Banks had daily average credit
float of $ 767.1 million, compared with daily average
credit float of $1,151.8 million in 2011.9

Currency and Coin
The Federal Reserve Board is the issuing authority
for the nation’s currency (in the form of Federal
Reserve notes). In 2012, the Board paid the U.S.
Treasury Department’s Bureau of Engraving and
Printing (BEP) approximately $687.7 million to produce 7.8 billion Federal Reserve notes. The Federal
Reserve Banks distribute and receive currency and
coin through depository institutions in response to
public demand.
In 2012, the Reserve Banks distributed 37.4 billion
Federal Reserve notes into circulation (payments), a
1.2 percent increase from 2011, and received 35.6 billion Federal Reserve notes from circulation, a
1.3 percent increase from 2011.
The value of Federal Reserve notes in circulation
increased nearly 9 percent in 2012, to $1,126.7 billion
at year-end, largely because of international demand
for $100 notes. In 2012, the Reserve Banks also distributed 69.1 billion coins into circulation, a 1.7 percent increase from 2011, and received 58.7 billion
8

9

The expenses, revenues, volumes, and fees reported here are for
transfers of securities issued by federal government agencies,
government-sponsored enterprises, and certain international
organizations. Reserve Banks provide Treasury securities services in their role as the U.S. Treasury’s fiscal agent. These services are not considered priced services. For details, see “Treasury Securities Services” on page 95.
Credit float occurs when the Reserve Banks present checks and
other items to the paying bank prior to providing credit to the
depositing bank (debit float occurs when the Reserve Banks
credit the depositing bank before presenting checks and other
items to the paying bank).

The Reserve Banks have increased operational efficiency and improved risk management. Advances in
currency-processing equipment and sensor technology have increased productivity and improved note
authentication and fitness measurement, thereby
reducing the premature destruction of fit currency
while maintaining the quality and integrity of currency in circulation.
Since 2009, policy changes and improvements to the
Reserve Banks’ high-speed currency-processing
equipment have increased productivity almost 20 percent and Reserve Banks have reduced staffing levels
in cash services approximately 8 percent. Adoption of
a risk{based approach to business processes has
increased efficiency by using technology more extensively and calibrating risk controls to the level of
inherent risk. As a result of these changes, the Federal Reserve has increased its ability to adapt operations and implement new policies that improve its
ability to meet currency demand efficiently. The
Reserve Banks are investigating additional opportunities to improve processing technology to further
increase productivity, reduce unit costs, and enhance
risk management.

Other Improvements and Efforts
Reserve Banks continue to develop a new cash automation platform that will replace legacy software
applications, automate business concepts and processes, and employ technologies to meet the cash
business’s current and future needs cost effectively.
The new platform will also facilitate business continuity and contingency planning and enhance the support provided to Reserve Bank customers. In 2012,
the Reserve Banks implemented one of the first
major components of the new platform, the National
Cash Data Warehouse, a central repository for the
Reserve Banks’ cash data. The full automation platform is scheduled to be complete in 2017.
The Board continues to work with the Treasury
Department and its BEP and the U.S. Secret Service
in preparing for issuing the new-design $100 note.
During 2012, the BEP met the Board’s order of
nearly 1.6 billion new-design $100 notes and the
Board ordered an additional 2.0 billion of these

Federal Reserve Banks

95

Table 3. Expenses of the Federal Reserve Banks for Fiscal Agency and Depository Services, 2010–2012
Thousands of dollars
Agency and service

2012

Department of the Treasury
Treasury Securities Services
Treasury retail securities
Treasury securities safekeeping and transfer
Treasury auction
Computer infrastructure development and support
Other services
Total
Payment, Collection, and Cash-Management Services
Payment services
Collection services
Cash-management services
Computer infrastructure development and support
Other services
Total
Other Treasury
Total
Total, Treasury
Other Federal Agencies
Total, other agencies
Total reimbursable expenses

notes for 2013 to build inventories in preparation for
issuance.
The Board and its consulting firm continue to partner with the BEP in developing a new, comprehensive
quality-assurance program at the BEP. During 2012,
the Board, the BEP, and the consultants formed
cross-functional teams to improve product and technology development, quality-system management,
standard operating procedures, process changes,
training programs, inspection of incoming raw materials, supplier management, and equipment calibration and maintenance. This program will enable the
BEP to more efficiently and effectively meet the
Board’s print order requirements and the production
of more-technologically complex bank notes into the
future.

Fiscal Agency and Government
Depository Services
As fiscal agents and depositories for the federal government, the Federal Reserve Banks auction Treasury
securities, process electronic and check payments for
Treasury, collect funds owed to the federal government, maintain Treasury’s bank account, and
develop, operate, and maintain a number of automated systems to support Treasury’s mission. The
Reserve Banks also provide certain fiscal agency and

2011

2010

60,208
14,131
30,648
4,990
3,340
113,317

79,346
11,187
29,258
1,969
4,036
125,796

73,104
10,136
30,750
1,980
1,646
117,615

141,534
41,456
58,975
70,075
9,075
321,115

125,196
38,707
53,832
67,014
9,536
294,285

112,224
37,611
48,226
66,461
8,815
273,337

37,011
471,443

36,233
456,314

37,793
428,744

34,569
506,012

27,893
484,207

27,700
456,445

depository services to other entities; these services are
primarily related to book-entry securities. Treasury
and other entities fully reimbursed the Reserve Banks
for the costs of providing fiscal agency and depository services.
In 2012, fiscal agency expenses amounted to
$506.0 million, a 4.5 percent increase from 2011 (see
table 3). These costs increased as a result of requests
from Treasury’s Bureau of the Fiscal Service.10 Support for Treasury programs accounted for 93.2 percent of the cost, and support for other entities
accounted for 6.8 percent.

Treasury Securities Services
The Reserve Banks work closely with Treasury’s Fiscal Service in support of the borrowing needs of the
federal government. The Banks auction, issue, maintain, and redeem securities; provide customer service;
and operate the automated systems supporting U.S.
savings bonds and marketable Treasury securities
(bills, notes, and bonds). Treasury securities services
consist of retail securities programs (which primarily
serve individual investors) and wholesale securities
programs (which serve institutional customers).
10

Treasury consolidated the Financial Management Service and
Bureau of Public Debt into the new Bureau of the Fiscal
Service, effective October 7, 2012.

96

99th Annual Report | 2012

Retail Securities Programs
Reserve Bank operating expenses for the retail securities programs were $60.2 million in 2012, a 24 percent
decrease compared with $79.3 million in 2011. This
cost decrease is largely explained by the Fiscal Service’s decision to consolidate Reserve Bank savings
bond operations, and to effect other operational
changes. Treasury relied on a recently completed
Reserve Bank initiative that takes advantage of
developments in image processing to handle savings
bond redemptions and has allowed the Reserve
Banks to retire some savings-bond unique software
that was built solely to support Treasury. In addition,
the Reserve Banks continue to support Treasury’s
Retail E-Services initiative, which will create a new
customer service and support environment for the
Treasury and the Reserve Banks.

Wholesale Securities Programs
The Reserve Banks support wholesale securities programs through the sale, issuance, safekeeping, and
transfer of marketable Treasury securities for institutional investors. In 2012, Reserve Bank operating
expenses in support of Treasury securities auctions
were $30.6 million, compared with $29.2 million in
2011. The Banks conducted 264 Treasury securities
auctions, compared with 269 in 2011.
Operating expenses associated with Treasury securities safekeeping and transfer activities were $14.1 million in 2012, compared with $11.2 million in 2011.
The cost increase is attributable to the Reserve
Banks’ ongoing technological effort to migrate securities services from a mainframe system to a distributed computing environment as well as lower government agency volume in 2012, which shifted more
costs to Treasury.

Payment Services
The Reserve Banks work closely with Treasury’s Fiscal Service and other government agencies to process
payments to individuals and companies. For example,
the Banks process federal payroll payments, Social
Security and veterans’ benefits, income tax refunds,
vendor payments, and other types of payments.
Reserve Bank operating expenses for paymentsrelated activity totaled $141.5 million in 2012, compared with $125.2 million in 2011. The significant
increase in expenses is largely due to expanded Treasury requirements for the Go Direct, Do Not Pay (for-

merly known as the GoVerify program), and the
Invoice Processing Platform (IPP) programs.
The Go Direct initiative incurred additional costs as
Reserve Banks expanded operations to meet Treasury’s 2013 deadline to convert federal benefit check
payments to electronic channels. In 2012, expenses
for Go Direct increased 17.2 percent, to more than
$29.3 million, because of staff increases to support
higher Go Direct call-center volumes.
In support of Treasury’s Do Not Pay initiative, the
Reserve Banks have built a single point of access, or
portal, through which federal agencies can query
multiple data sources before making federal payments. The Reserve Banks implemented a number of
software releases, automated manual processes, and
added a number of new agency participants. In 2012,
expenses for Do Not Pay were $8.0 million, compared with $2.2 million in 2011.
The IPP is part of Treasury’s all-electronic initiative
and is an electronic invoicing and payment information system that allows vendors to enter invoice data
electronically, either through a web-based portal or
electronic submission. The IPP accepts, processes,
and presents data from agencies and supplier systems
related to all stages of transactions. During 2012, the
Reserve Banks’ IPP expenses increased 30.8 percent,
to $11.9 million. This increase is primarily driven by
IPP’s support of expanded agency outreach and support in response to Treasury’s initiative.
Treasury’s payments-related expenses were offset
somewhat by decreases in the Stored Value Card
(SVC) program. The program provides stored value
cards that military personnel can use to purchase
goods and services on military bases. In 2012, the
SVC program’s expenses decreased 20.2 percent, to
$14.5 million, because the military deferred replacing
SVC mobile kiosks and implementing software
projects.

Collection Services
The Reserve Banks also work closely with Treasury’s
Fiscal Service to collect funds owed the federal government, including various taxes, fees for goods and
services, and delinquent debts. In 2012, Reserve Bank
operating expenses related to collections services
increased 7.1 percent, largely as a result of ongoing
support for Treasury’s Collections and Cash Management Modernization initiative.

Federal Reserve Banks

The Reserve Banks also continued to operate
Pay.gov, an application supporting Treasury’s program that allows the public to use the Internet to
authorize and initiate payments to federal agencies.
During the year, the Pay.gov program expanded to
include 75 new agency programs, and it processed
more than 94 million online payments, a 22 percent
increase from 2011. This expansion resulted in
expenses’ increasing 11 percent, to $11.7 million.
The Reserve Banks continued to support the government’s centralized delinquent debt-collection program. Specifically, the Banks developed and maintained software that facilitates the collection of delinquent debts owed to federal agencies and states by
matching federal payments against delinquent debts,
including past-due child support payments owed to
custodial parents.

Treasury Cash-Management Services
The Reserve Banks maintain Treasury’s operating
cash account and provide collateral-management and
collateral-monitoring services for those Treasury programs that have collateral requirements. The Reserve
Banks also support Treasury’s efforts to modernize
its financial management processes by developing
software, operating help desks, and managing projects on behalf of the Fiscal Service.
In 2012, Reserve Bank operating expenses related to
Treasury cash-management services totaled
$59.0 million, compared with $53.8 million in 2011.
During 2012, the Reserve Banks continued to support Treasury’s efforts to improve centralized government accounting and reporting functions. In particular, the Reserve Banks collaborated with the Fiscal
Service on several ongoing software development
efforts, such as the Central Accounting Reporting
System (CARS), which is intended to provide Treasury with a modernized system for the collection and
dissemination of financial management and accounting information transmitted from and to federal program agencies. In 2012, expenses for CARS were
$22.1 million, compared with $16.5 million in 2011.

Services Provided to Other Entities
When permitted by federal statute or when required
by the Secretary of the Treasury, the Reserve Banks
provide fiscal agency and depository services to other
domestic and international entities.

97

Reserve Bank operating expenses for services provided to other entities were $34.6 million in 2012,
compared with $27.9 million in 2011, an increase of
23.9 percent. The expense increase in 2012 is attributable to the Reserve Banks’ ongoing effort to migrate
securities services from a mainframe system to a distributed computing environment.
Book-entry securities issuance and maintenance
activities account for a significant amount of the
work performed for other entities, with the majority
performed for the Federal Home Loan Mortgage
Association, the Federal National Mortgage Association, and the Government National Mortgage
Association.
The Reserve Banks continue to process postal money
orders primarily in image form, resulting in operational improvements, lower staffing levels, and lower
costs to the U.S. Postal Service. In 2012, expenses for
postal money orders were $4.0 million, compared
with $4.1 million in 2011.

Use of Federal Reserve
Intraday Credit
The Federal Reserve Board’s Payment System Risk
(PSR) policy governs the use of Federal Reserve
Bank intraday credit, also known as daylight overdrafts. A daylight overdraft occurs when an institution’s account activity creates a negative balance in
the institution’s Federal Reserve account at any time
in the operating day. Daylight overdrafts enable an
institution to send payments more freely throughout
the day than if it were limited strictly by its available
intraday funds balance. The PSR policy recognizes
explicitly the role of the central bank in providing
intraday balances and credit to healthy institutions;
under the policy the Reserve Banks provide collateralized intraday credit at no cost.
Before late 2008, overnight balances were much lower
and daylight overdrafts significantly higher than levels observed since late 2008. In 2007, for example,
institutions held on average less than $20 billion in
overnight balances, and total average daylight overdrafts were $60 billion. In contrast, institutions held
historically high levels of overnight balances (on average about $1.5 trillion) at the Reserve Banks in 2012,
while demand for daylight overdrafts on average
remained historically low.

98

99th Annual Report | 2012

Figure 1. Aggregate Daylight Overdrafts, 2007–2012

$ Billions

Peak daylight overdrafts

Average daylight overdrafts

Average daylight overdrafts across the System
increased to $2.1 billion in 2012 from $1.7 billion in
2011, an increase of about 20 percent (see figure 1).
Conversely, the average level of peak daylight overdrafts decreased to almost $20 billion in 2012 from
$30 billion in 2011, a decrease of about 35 percent.
Daylight overdraft fees are also at historically low
levels. In 2012, institutions paid less than $50,000 in
daylight overdraft fees, down from almost $1 million
in 2011. The decrease in fees is largely attributable to
the March 2011 PSR policy revision that eliminated
fees for collateralized daylight overdrafts.

FedLine Access
to Reserve Bank Services
The Reserve Banks provide depository institutions
with a variety of alternatives for electronically accessing the Banks’ payment and information services
through their FedLine Access Solutions. These FedLine channels are designed to meet the individual
connectivity and contingency requirements of
depository institution customers.
For the past few years, as a result of the declining
number of depository institutions, Reserve Bank
FedLine connections have decreased. At the same

time, the number of employees within depository
institutions who have credentials that establish them
as trusted users increased, reflecting in part the
expansion of electronic value-added services provided. Between 2007 and 2012, the total number of
depository institutions in the U.S. declined 15.4 percent. The number of depository institutions with
FedLine connections declined 5.9 percent, while the
number of trusted users increased 11.0 percent over
the same period.
In 2012, the Reserve Banks continued to expand
usage of new service package options launched in
2011. The number of depository institutions using
the FedComplete bundled payment services package
increased from 60 to 146 at year-end 2012. Fed
Transaction Analyzer, a risk-management tool to
facilitate the analysis of payment transactions and to
help automate risk and compliance-reporting
requirements, was used by 816 depository institutions
with 2,020 credentialed employees, increases of 571
and 1,457, respectively.

Information Technology
The Federal Reserve Banks continued to improve the
efficiency, effectiveness, and security of information
technology (IT) services and operations in 2012.

Federal Reserve Banks

To improve the efficiency and overall quality of
operations, major multiyear initiatives continue to
consolidate the management and function of the
Federal Reserve’s IT operations and networking services. Substantial progress has been made, and the
centralization of the remaining enterprise IT functions will be completed within the next two years.
In addition, Federal Reserve Information Technology
(FRIT) continued to lead the Reserve Banks’ transition to a more robust information security posture,
and FRIT’s chief information security officer (CISO)
continued in his role maintaining System awareness
of information security (IS) risk and coordinating IS
activities among the Federal Reserve Banks.11 Under
the direction of the CISO, management of the Federal Reserve’s information security risk has matured.
In addition to the implementation of the first phase
of a program to implement a number of robust security measures across the System, the ongoing transition to the Federal Reserve System’s IS framework,
which is based on guidance from the National Institute of Science and Technology and adapted to the
Federal Reserve's environment, continues to
progress.12

Examinations of the
Federal Reserve Banks
The Reserve Banks and the consolidated variable
interest entities (VIEs) are subject to several levels of
audit and review.13 The combined financial statements of the Reserve Banks (see “Federal Reserve
Banks Combined Financial Statements” in the “Federal Reserve System Audits” section of this report) as
well as the financial statements of each of the 12
Banks and those of the consolidated VIEs are
audited annually by an independent public accountant retained by the Board of Governors.14 In addition, the Reserve Banks, including the consolidated
VIEs, are subject to oversight by the Board of Governors, which performs its own reviews.
11

12

13

14

FRIT supplies national infrastructure and business line technology services to the Federal Reserve Banks and provides thought
leadership regarding the System’s information technology architecture and business use of technology.
The National Institute of Science and Technology is a nonregulatory federal agency within the U.S. Department of Commerce.
The New York Reserve Bank is considered to be the controlling
financial interest holder of each of the consolidated VIEs.
Each VIE reimburses the Board of Governors—from the entity’s available net assets—for the fees related to the audit of its
financial statements.

99

The Reserve Banks use the framework established by
the Committee of Sponsoring Organizations of the
Treadway Commission (COSO) to assess their internal controls over financial reporting, including the
safeguarding of assets. Within this framework, the
management of each Reserve Bank annually provides
an assertion letter to its board of directors that confirms adherence to COSO standards. Similarly, each
consolidated VIE annually provides an assertion letter to the board of directors of the New York
Reserve Bank.
The Federal Reserve Board engaged Deloitte & Touche LLP (D&T) to audit the 2012 combined and
individual financial statements of the Reserve Banks
and those of the consolidated VIEs.15
In 2012, D&T also conducted audits of internal controls over financial reporting for each of the Reserve
Banks, Maiden Lane LLC, Maiden Lane III LLC,
and TALF LLC. Fees for D&T’s services totaled
$7 million, of which $1 million was for the audits of
the consolidated VIEs. To ensure auditor independence, the Board requires that D&T be independent
in all matters relating to the audits. Specifically, D&T
may not perform services for the Reserve Banks or
others that would place it in a position of auditing its
own work, making management decisions on behalf
of the Reserve Banks, or in any other way impairing
its audit independence. In 2012, the Banks did not
engage D&T for any non-audit services. One Bank
leases office space to D&T.
The Board’s reviews of the Reserve Banks include a
wide range of off-site and on-site oversight activities,
conducted primarily by its Division of Reserve Bank
Operations and Payment Systems. Division personnel
monitor on an ongoing basis the activities of each
Reserve Bank and consolidated VIE, FRIT, and the
Office of Employee Benefits of the Federal Reserve
System (OEB), and they conduct a comprehensive
on-site review of each Reserve Bank, FRIT, and
OEB at least once every three years.
The comprehensive on-site reviews typically include
an assessment of the internal audit function’s effectiveness and its conformance to the Institute of
Internal Auditors’ (IIA) International Standards for
15

In addition, D&T audited the Office of Employee Benefits of
the Federal Reserve System (OEB), the Retirement Plan for
Employees of the Federal Reserve System (System Plan), and
the Thrift Plan for Employees of the Federal Reserve System
(Thrift Plan). The System Plan and the Thrift Plan provide
retirement benefits to employees of the Board, the Federal
Reserve Banks, and the OEB.

100

99th Annual Report | 2012

the Professional Practice of Internal Auditing, applicable policies and guidance, and the IIA’s code of
ethics.
The division also reviews the System Open Market
Account (SOMA) and foreign currency holdings to
determine whether the New York Reserve Bank,
while conducting the related transactions, complies
with the policies established by the Federal Open
Market Committee (FOMC) and to assess SOMArelated IT project management and application development, vendor management, and system resiliency
and contingency plans. In addition, D&T audits the
year-end schedule of participated asset and liability
accounts and the related schedule of participated
income accounts. The FOMC is provided with the
external audit reports and a report on the division’s
review.

Income and Expenses
Table 4 summarizes the income, expenses, and distributions of net earnings of the Reserve Banks for
2012 and 2011. Income in 2012 was $81,586 million,
compared with $85,241 million in 2011.
Expenses totaled $9,397 million: $3,781 million in
operating expenses; $3,875 million in interest paid to
depository institutions on reserve balances and term
deposits; $142 million in interest expense on securities sold under agreements to repurchase; $490 million in assessments for Board of Governors expenditure; $722 million for new currency costs; $387 million for Consumer Financial Protection Bureau costs
and Office of Financial Research costs. Net additions
to current net income totaled $18,380 million, which
includes $13,496 million in realized gains on Treasury
securities and federal agency and governmentsponsored enterprise mortgage-backed securities
(GSE MBS); $6,038 million in net income associated
with consolidated VIEs; $38 million in other deductions; and $1,116 million in unrealized losses on foreign currency denominated assets revalued to reflect
current market exchange rates. Dividends paid to
member banks, set at 6 percent of paid-in capital by
section 7(1) of the Federal Reserve Act, totaled
$1,637 million.
Comprehensive net income before interest on Federal
Reserve notes expense remitted to Treasury totaled
$90,516 million in 2012 (net income of $90,569 million, reduced by other comprehensive loss of
$53 million). Distributions to Treasury in the form of

interest on Federal Reserve notes totaled $88,418 million in 2012. The distribution equals comprehensive
income after the deduction of dividends paid and the
amount necessary to equate the Reserve Banks’ surplus to paid-in capital.
The “Statistical Tables” section of this report provides more detailed information on the Reserve
Banks and the VIEs. Table 9 is a statement of condition for each Reserve Bank; table 10 details the
income and expenses of each Reserve Bank for 2012;
table 11 shows a condensed statement for each
Reserve Bank for the years 1914 through 2012; and
table 13 gives the number and annual salaries of officers and employees for each Reserve Bank. A
detailed account of the assessments and expenditures
of the Board of Governors appears in the Board of
Governors Financial Statements (see “Federal
Reserve System Audits”).

SOMA Holdings and Loans
The Reserve Banks’ average net daily holdings of
securities and loans during 2012 amounted to
$2,715,976 million, an increase of $139,094 million
from 2011 (see table 5).

SOMA Securities Holdings
The average daily holdings of Treasury securities
increased by $216,165 million, to an average daily
amount of $1,774,043 million. The average daily
holdings of GSE debt securities decreased by
$31,450 million, to an average daily amount of
$94,248 million. The average daily holdings of federal agency and GSE MBS decreased by $45,188 million, to an average daily amount of $872,819 million.
The increases in average daily holdings of Treasury
securities and federal agency and GSE MBS are due
to the purchases through a large-scale asset purchase
program and reinvestment of principal payments
from other SOMA holdings in federal agency and
GSE MBS. The average daily holdings of GSE debt
securities decreased as a result of principal payments
received.
There were no significant holdings of securities purchased under agreements to resell in 2012 or 2011.
Average daily holdings of foreign currency denominated assets in 2012 were $25,488 million, compared
with $26,566 million in 2011. The average daily balance of central bank liquidity swap drawings was

Federal Reserve Banks

101

Table 4. Income, Expenses, and Distribution of Net Earnings of the Federal Reserve Banks, 2012 and 2011
Millions of dollars
Item

2012

2011

Current income
SOMA interest income
Loan interest income
Other current income1
Current expenses
Operating expenses2
Interest paid on depository institutions deposits and term deposits
Interest expense on securities sold under agreements to repurchase
Current net income
Net additions to (deductions from) current net income
Profit on sales of Treasury securities
Profit on sales of federal agency and government-sponsored enterprise mortgage-backed securities
Profit (loss) on foreign exchange transactions
Net income (loss) from consolidated VIEs
Other additions3
Assessments by the Board of Governors
For Board expenditures
For currency costs
For Consumer Financial Protection Bureau costs4
For Office of Financial Research costs4
Net income before interest on Federal Reserve notes expense remitted to Treasury
Interest on Federal Reserve notes expense remitted to Treasury
Net income
Other comprehensive loss
Comprehensive income

81,586
80,860
81
645
7,798
3,781
3,875
142
73,788
18,380
13,255
241
-1,116
6,038
-38
1,599
490
722
385
2
90,569
88,418
2,151
-53
2,098

85,241
83,874
674
693
7,316
3,499
3,773
44
77,925
2,016
2,258
10
152
-356
-48
1,403
472
649
242
40
78,538
75,424
3,114
-1,162
1,952

Total distribution of net income
Dividends on capital stock
Transfer to surplus and change in accumulated other comprehensive income
Interest on Federal Reserve notes expense remitted to Treasury

90,516
1,637
461
88,418

77,376
1,577
375
75,424

1
2
3
4

Includes income from priced services, compensation received for services provided, and securities lending fees.
Includes a net periodic pension expense of $641 million in 2012 and $525 million in 2011.
Includes dividends on preferred interests and unrealized loss on Term Asset-Backed Securities Loan Facility loans.
The Board of Governors assesses the Reserve Banks to fund the operations of the Consumer Financial Protection Bureau and, for a two-year period beginning July 21, 2010,
the Office of Financial Research.

$38,737 million in 2012 and $5,368 million in 2011.
The average daily balance of securities sold under
agreements to repurchase was $91,785 million, an
increase of $19,626 million from 2011.
The average rates of interest earned on the Reserve
Banks’ holdings of Treasury securities decreased to
2.62 percent and the average rates on GSE debt securities increased to 2.79 percent in 2012. The average
rate of interest earned on federal agency and GSE
MBS decreased to 3.60 percent in 2012. The average
interest rates for securities sold under agreements to
repurchase increased to 0.15 percent in 2012. The
average rate of interest earned on foreign currency
denominated assets decreased to 0.55 percent while
the average rate of interest earned on central bank
liquidity swaps decreased to 0.62 percent in 2012.

Lending
In 2012, the average daily primary, secondary, and
seasonal credit extended by the Reserve Banks to
depository institutions increased by $10 million, to
$72 million. The average rate of interest earned on
primary, secondary, and seasonal credit decreased to
0.38 percent in 2012, from 0.43 percent in 2011. The
average daily balance of Term Asset-Backed Securities Loan Facility (TALF) loans in 2012 was
$4,497 million, which earned interest at an average
rate of 1.78 percent.
On January 14, 2011, all outstanding draws under the
American International Group, Inc. (AIG) revolving
line of credit and the related accrued interest, capitalized interest, and capitalized commitment fees were

102

99th Annual Report | 2012

Table 5. System Open Market Account (SOMA) Holdings and Loans of the Federal Reserve Banks, 2012 and 2011
Millions of dollars, except as noted
Average daily assets (+)/liabilities (–)

Current income (+)/expense (–)

Average interest rate (percent)

Item
2012
U.S. Treasury securities1
Government-sponsored enterprise debt securities1
Federal agency and government-sponsored enterprise
mortgage-backed securities2
Foreign currency denominated assets3
Central bank liquidity swaps4
Other SOMA assets5
Total SOMA assets
Securities sold under agreements to repurchase
Other SOMA liabilities6
Total SOMA liabilities
Total SOMA holdings
Primary, secondary. and seasonal credit
Total loans to depository institutions
Credit extended to American International Group, Inc.
(AIG), net7, 8
Term Asset-Backed Securities Loan Facility (TALF)9
Total loans to others
Total loans
Total SOMA holding and loans

2011

2012

2011

2012

2011

1,774,043
94,248

1,557,878
125,698

46,416
2,626

42,257
3,053

2.62
2.79

2.71
2.43

872,819
25,488
38,737
66
2,805,401
-91,785
-2,209
-93,994
2,711,407
72
72

918,007
26,566
5,368
8
2,633,525
-72,159
-56
-72,215
2,561,310
62
62

31,429
139
241
9
80,860
-142
…
-142
80,718
*
*

38,281
249
34
*
83,874
-44
…
-44
83,830
*
*

3.60
0.55
0.62
…
2.88
0.15
…
0.15
2.98
0.38
0.38

4.17
0.94
0.63
…
3.18
0.06
…
0.06
3.27
0.43
0.43

…
4,497
4,497
4,569
2,715,976

711
14,799
15,510
15,572
2,576,882

…
80
80
80
80,798

409
265
674
674
84,504

…
1.78
1.78
1.75
2.97

3.94
1.79
4.35
4.33
3.28

1

Face value, net of unamortized premiums and discounts.
Face value, which is the remaining principal balance of the securities, net of unamortized premiums and discounts. Does not include unsettled transactions.
3
Includes accrued interest. Foreign currency denominated assets are revalued daily at market exchange rates.
4
Dollar value of foreign currency held under these agreements valued at the exchange rate to be used when the foreign currency is returned to the foreign central bank. This
exchange rate equals the market exchange rate used when the foreign currency was acquired from the foreign central bank.
5
Cash and short-term investments related to the federal agency and government-sponsored enterprise mortgage-backed securities portfolio.
6
Represents the obligation to return cash margin posted by counterparties as collateral under commitments to purchase and sell federal agency and GSE MBS, as well as
obligations that arise from the failure of a seller to deliver securities on the settlement date.
7
Average daily balance includes outstanding principal and capitalized interest net of unamortized deferred commitment fees and allowance for loan restructuring, and
excludes undrawn amounts and credit extended to consolidated limited liability companies.
8
As a result of the closing of the AIG recapitalization plan, $381 million of deferred commitment fees and allowances were recognized as interest income. The average interest
rate calculation for 2011 excludes these items.
9
Represents the remaining principal balance.
* Less than $500 thousand.
… Not applicable.
2

repaid in full as a result of the closing of the AIG
recapitalization plan.

Investments of the Consolidated VIEs
Additional lending facilities established during 2008
and 2009, under authority of section 13(3) of the
Federal Reserve Act, involved creating and lending to
the consolidated VIEs (see table 6). Consistent with
generally accepted accounting principles, the assets
and liabilities of these VIEs have been consolidated
with the assets and liabilities of the New York
Reserve Bank in the preparation of the statements of
condition included in this report. The proceeds at the
maturity or the liquidation of the consolidated VIEs’
assets are used to repay the loans extended by the
New York Reserve Bank.

Net portfolio assets of the consolidated VIEs
decreased from $35,693 million to $2,750 million.
The sale of portfolio assets held by Maiden Lane
LLC, Maiden Lane II LLC, and Maiden Lane III
LLC during 2012 enabled the repayment in full,
including accrued interest, of loans extended to those
VIEs by the FRBNY. Funds advanced to those VIEs
by other beneficial interests were also repaid in full.

Federal Reserve Bank Premises
Several Reserve Banks took action in 2012 to maintain and renovate their facilities. The multiyear renovation programs at the New York, St. Louis, and San
Francisco Reserve Banks’ headquarters buildings
continued. The Dallas Reserve Bank completed

Federal Reserve Banks

103

Table 6. Key Financial Data for Consolidated Variable Interest Entities (VIEs), 2012 and 2011
Millions of dollars
TALF LLC

Maiden Lane LLC

Maiden Lane II LLC

Maiden Lane III LLC

2012

2012

Total VIEs

Item
2012

2011

2012

2011

2011

2011

Net portfolio assets of the consolidated VIEs and the net position of the New York Reserve Bank (FRBNY) and subordinated interest holders
856
811
1,811
7,805
61
9,257
22
17,820
Net portfolio assets1
Liabilities of consolidated VIEs
0
0
-415
-684
0
-3
0
-3
Net portfolio assets available2
856
811
1,396
7,121
61
9,254
22
17,817
Loans extended to the consolidated
0
0
0
4,859
0
6,792
0
9,826
VIEs by the FRBNY3
Other beneficial interests3, 4
113
109
0
1,385
0
1,106
0
5,542
Total loans and other beneficial
interests
113
109
0
6,244
0
7,898
0
15,368
Cumulative change in net assets since the inception of the program5
Allocated to FRBNY
71
32
1,396
877
51
1,130
15
1,641
Allocated to other beneficial interests
672
669
0
0
10
226
7
808
Cumulative change in net assets
743
701
1,396
877
61
1,356
22
2,449
Summary of consolidated VIE net income, including a reconciliation of total consolidated VIE net income to the consolidated VIE net income
Portfolio interest income6
1
0
34
808
52
609
1,023
2,012
Interest expense on loans extended by
7
FRBNY
0
0
-10
-138
-11
-117
-46
-146
Interest expense–other
-3
-4
-45
-70
-7
-36
-98
-175
Portfolio holdings gains (losses)
0
0
552
434
1,393
-991
5,506
-3,363
Professional fees
-1
0
-12
-43
-1
-8
-11
-20
Net income (loss) of consolidated VIEs
-3
-4
519
991
1,426
-543
6,374
-1,692
Less: Net income (loss) allocated to
other beneficial interests
4
44
0
114
238
-91
2,103
-558
Net income (loss) allocated to FRBNY
-7
-48
519
877
1,188
-452
4,271
-1,134
Add: Interest expense on loans
extended by FRBNY, eliminated in
consolidation7
0
0
10
138
11
117
46
146
-488
529
1,015
1,199
-335
4,317
-988
Net income (loss) recorded by FRBNY
-78
Balances of loans extended to the consolidated VIEs by the FRBNY
Balance at beginning of the year
0
0
4,859
25,845
6,792
13,485
9,826
14,071
Accrued and capitalized interest
0
0
10
138
11
117
46
146
Repayments
0
0
-4,869
-21,124
-6,803
-6,810
-9,872
-4,391
Balance at end of the year
0
0
0
4,859
0
6,792
0
9,826
1

2
3
4
5

6
7

8

2012

2011

2,750
-415
2,335

35,693
-690
35,003

0
113

21,477
8,142

113

29,619

1,533
689
2,222

3,680
1,703
5,383

1,110

3,429

-67
-153
7,451
-25
8,316

-401
-285
-3,920
-71
-1,248

2,345
5,971

-491
-757

67
6,038

401
-356

21,477
67
-21,544
0

53,401
401
-32,325
21,477

TALF, Maiden Lane, Maiden Lane II, and Maiden Lane III holdings are recorded at fair value. Fair value reflects an estimate of the price that would be received upon selling an
asset if the transaction were to be conducted in an orderly market on the measurement date.
Represents the net assets available for distribution to FRBNY and “other beneficiaries” of the consolidated VIEs.
Book value. Includes accrued interest.
The other beneficial interest holders are the U.S. Treasury for TALF LLC, JPMorgan Chase for Maiden Lane LLC, and AIG for Maiden Lane II LLC and Maiden Lane III LLC.
Represents the allocation of the change in net assets and liabilities of the consolidated VIEs that are available for distribution to FRBNY and the other beneficiaries of the
consolidated VIEs. The differences between the fair value of the net assets available and the book value of the loans (including accrued interest) are indicative of gains or
losses that would be incurred by the beneficiaries if the assets had been fully liquidated at prices equal to the fair value.
Interest income is recorded when earned and includes amortization of premiums, accretion of discounts, and paydown gains and losses.
Interest expense recorded by each consolidated VIE on the loans extended by FRBNY is eliminated when the VIEs are consolidated in FRBNY's financial statements and, as a
result, the consolidated VIEs’ net income (loss) recorded by FRBNY is increased by this amount.
In addition to the net income attributable to TALF LLC, FRBNY earned $46 million on TALF loans during the year ended December 31, 2012 (interest income of $80 million
and a loss on the valuation of loans of $34 million). FRBNY earned $181 million on TALF loans during the year ended December 31, 2011 (interest income of $265 million
and loss on the valuation of loans of $84 million).

security-enhancement projects at its headquarters
building that included improvements to its mainentrance lobby and construction of a remote vehiclescreening facility.
The New York Reserve Bank completed the purchase
of the 33 Maiden Lane property. The San Francisco
Reserve Bank disposed of the building formerly used

to house its Seattle Branch operations, and the
Atlanta Reserve Bank initiated efforts to sell its
Nashville Branch building. Additionally, the Cleveland and Dallas Reserve Banks consolidated certain
operations performed at their Pittsburgh and San
Antonio Branches, respectively, into other Reserve
Bank offices. As a result, these Reserve Banks will
maintain smaller Branch staffs. The Cleveland

104

99th Annual Report | 2012

Reserve Bank secured leased office space for its Pittsburgh Branch and is moving forward with plans to
sell the former building, and the Dallas Reserve Bank
is in the process of obtaining leased office space for
its San Antonio Branch and will pursue the sale of
the former building during 2013. The Chicago and
Cleveland Reserve Banks secured leased space for
their contingency requirements.

For more information on the acquisition costs and
net book value of the Federal Reserve Banks and
Branches, see table 14 in the “Statistical Tables” section of this report.

Federal Reserve Banks

Pro Forma Financial Statements for Federal Reserve Priced Services
Table 7: Pro Forma Balance Sheet for Federal Reserve Priced Services, December 31, 2012 and 2011
Millions of dollars
Item
Short-term assets (Note 2)
Imputed reserve requirements on clearing balances
Imputed investments
Receivables
Materials and supplies
Prepaid expenses
Items in process of collection
Total short-term assets
Long-term assets (Note 3)
Premises
Furniture and equipment
Leases, leasehold improvements, and long-term prepayments
Prepaid pension costs
Prepaid FDIC asset
Deferred tax asset
Total long-term assets
Total assets
Short-term liabilities
Clearing balances
Deferred-availability items
Short-term debt
Short-term payables
Total short-term liabilities
Long-term liabilities
Long-term debt
Accrued benefit costs
Total long-term liabilities
Total liabilities
Equity (including accumulated other comprehensive loss of $643.0 million
and $288.9 million at December 31, 2012 and 2011, respectively)
Total liabilities and equity (Note 4)

2012

2011

510.9
35.6
0.9
9.4
216.0

262.3
2,805.3
38.7
1.4
7.7
275.4
772.8

171.2
33.8
78.6
20.3
287.5

3,390.9
180.8
38.2
74.6
321.9
21.7
138.5

591.4
1,364.1
703.6
35.4

775.7
4,166.6
2,622.5
910.3
44.1

738.9
549.8

3,576.9
381.3

549.8
1,288.7

381.3
3,958.2

75.4
1,364.1

208.3
4,166.6

Note: Components may not sum to totals because of rounding. The accompanying notes are an integral part of these pro forma priced services financial statements.

105

106

99th Annual Report | 2012

Table 8: Pro Forma Income Statement for Federal Reserve Priced Services, 2012 and 2011
Millions of dollars
Item

2012

Revenue from services provided to depository institutions (Note 5)
Operating expenses (Note 6)
Income from operations
Imputed costs (Note 7)
Interest on float
Interest on debt
Sales taxes
FDIC Insurance
Income from operations after imputed costs
Other income and expenses (Note 8)
Investment income
Earnings credits
Income before income taxes
Imputed income taxes (Note 7)
Net income
Memo: Targeted return on equity (Note 7)

2011
449.3
406.1
43.2

(1.1)
4.6
1.4

477.4
421.3
56.1
-1.3
4.8
3.2

4.9
38.3

1.0
-0.5

6.8
49.3

2.5
-1.4

0.5
38.8
12.0
26.8
8.9

1.2
50.5
16.3
34.1
16.8

Note: Components may not sum to totals because of rounding. The accompanying notes are an integral part of these pro forma priced services financial statements.

Table 9: Pro Forma Income Statement for Federal Reserve Priced Services, by Service, 2012
Millions of dollars
Item
Revenue from services (Note 5)
Operating expenses (Note 6)
Income from operations
Imputed costs (Note 7)
Income from operations after imputed costs
Other income and expenses, net (Note 8)
Income before income taxes
Imputed income taxes (Note 7)
Net income
Memo: Targeted return on equity (Note 7)
Cost recovery (percent) (Note 9)

Total

Commercial check
collection

Commercial ACH

Fedwire funds

Fedwire securities

449.3
406.1
43.2
4.9
38.3
0.5
38.8
12.0
26.8
8.9
104.1

220.0
186.7
33.3
1.9
31.4
0.3
31.7
9.8
21.9
4.1
108.8

114.8
108.4
6.4
1.4
5.0
0.1
5.2
1.6
3.6
2.4
101.0

90.5
88.1
2.4
1.3
1.1
0.1
1.2
0.4
0.8
1.9
98.8

24.1
22.9
1.1
0.3
0.8
0.0
0.8
0.3
0.6
0.5
100.3

Note: Components may not sum to totals because of rounding. The accompanying notes are an integral part of these pro forma priced services financial statements.

Federal Reserve Banks

Notes to Pro Forma Financial Statements for Priced Services
(1) Discontinuation of Clearing Balance Program
Effective July 2012, the Board discontinued the contractual clearing balance program in connection with its simplification of reserve requirements. Clearing balances were a primary component of the pro forma balance sheet used to compute
the imputed costs in the private sector adjustment factor (PSAF). The elimination
of clearing balances reduced the size of the pro forma balance sheet substantially
as well as the associated imputed expenses and investment income.
(2) Short-Term Assets
The imputed reserve requirement on clearing balances held at Reserve Banks by
depository institutions reflects a treatment comparable to that of compensating
balances held at correspondent banks by respondent institutions. The reserve
requirement imposed on respondent balances must be held as vault cash or as balances maintained; thus, a portion of priced services clearing balances held with the
Federal Reserve is shown as required reserves on the asset side of the balance
sheet. Another portion of the clearing balances is used to finance short- and longterm assets. The remainder of clearing balances and deposit balances arising from
float are assumed to be invested in a portfolio of investments, shown as imputed
investments. As a result of the discontinuation of the clearing balance program in
July 2012 there were no clearing balances or related reserve requirement balances
on December 31, 2012. (See note 1)
Receivables are composed of fees due the Reserve Banks for providing priced services and the share of suspense- and difference-account balances related to priced
services.
Items in process of collection are gross Federal Reserve cash items in process of
collection (CIPC), stated on a basis comparable to that of a commercial bank.
They reflect adjustments for intra-Reserve Bank items that would otherwise be
double-counted on the combined Federal Reserve balance sheet and adjustments
for items associated with nonpriced items (such as those collected for government
agencies). Among the costs to be recovered under the Monetary Control Act is the
cost of float, or net CIPC during the period (the difference between gross CIPC
and deferred-availability items, which is the portion of gross CIPC that involves a
financing cost), valued at the federal funds rate.
(3) Long-Term Assets
Long-term assets consist of long-term assets used solely in priced services and the
priced-service portion of long-term assets shared with nonpriced services, including the net pension asset and deferred tax asset related to the priced services pension and postretirement benefits obligation.
Long-term assets also consist of an estimate of the assets of the Board of Governors used in the development of priced services and an imputed prepaid Federal
Deposit Insurance Corporation (FDIC) asset.
(4) Liabilities and Equity
Under the matched-book capital structure for assets, short-term assets are
financed with short-term payables, clearing balances, and imputed short-term
debt, if needed. Long-term assets are financed with long-term liabilities, core
clearing balances, imputed equity, and imputed long-term debt, if needed. Equity

107

108

99th Annual Report | 2012

is imputed at 10 percent of total risk-weighted assets to satisfy the FDIC requirements for a well-capitalized institution. No short- or long-term debt was imputed
for 2012 or 2011.
Effective December 31, 2006, the Reserve Banks implemented the Financial
Accounting Standard Board’s (FASB) Statement of Financial Accounting Standards (SFAS) No. 158, Employers’ Accounting for Defined Benefit Pension and
Other Postretirement Plans (codified in FASB Accounting Standards Codification
(ASC) Topic 715 (ASC 715), Compensation–Retirement Benefits), which requires
an employer to record the funded status of its pension and other benefit plans on
its balance sheet. In order to reflect the funded status of its benefit plans, the
Reserve Banks recognized the deferred items related to these plans, which include
prior service costs and actuarial gains or losses, on the balance sheet. This resulted
in an adjustment to the pension and other benefit plans related to priced services
and the recognition of an associated deferred tax asset with an offsetting adjustment, net of tax, to accumulated other comprehensive income (AOCI), which is
included in equity.
The Reserve Bank priced services recognized a pension liability in accrued benefit
costs in 2012 and a net pension asset in 2011. The pension liability and net pension
asset were $103.6 million and $321.9 million in 2012 and 2011, respectively. The
change in the funded status of the pension and other benefit plans resulted in a
corresponding increase in accumulated other comprehensive loss of $354.1 million
in 2012.
The method for estimating the priced services portion of the SFAS 158/ASC715
adjustments to the pension and other benefit liabilities, AOCI, and deferred tax
asset was refined in 2012 and incorporates AOCI component changes from yearto-year since the adoption of SFAS 158 in 2006. This estimation change does not
directly affect the income statement or cost recovery.
(5) Revenue
Revenue represents fees charged to depository institutions for priced services, and
is realized from each institution through one of two methods: direct charges to an
institution’s account or charges against its accumulated earnings credits (see
note 7).
(6) Operating Expenses
Operating expenses consist of the direct, indirect, and other general administrative
expenses of the Reserve Banks for priced services plus the expenses of the Board
of Governors related to the development of priced services. Board expenses were
$4.1 million in 2012 and $5.2 million in 2011.
In accordance with SFAS No. 87, Employers’ Accounting for Pensions (codified in
ASC 715), the Reserve Bank priced services recognized qualified pension-plan
operating expenses of $49.1 million in 2012 and $45.2 million in 2011. Operating
expenses also include the nonqualified pension expense of $0.3 million in 2012 and
$3.1 million in 2011. The implementation of SFAS No. 158 (ASC 715) does not
change the systematic approach required by generally accepted accounting principles to recognize the expenses associated with the Reserve Banks’ benefit plans in
the income statement. As a result, these expenses do not include amounts related
to changes in the funded status of the Reserve Banks’ benefit plans, which are
reflected in AOCI (see note 4).

Federal Reserve Banks

The income statement by service reflects revenue, operating expenses, imputed
costs, other income and expenses, and cost recovery.
(7) Imputed Costs
Imputed costs consist of income taxes, return on equity, interest on debt, sales
taxes, an FDIC assessment, and interest on float. Many imputed costs are derived
from the PSAF model. The cost of debt and the effective tax rate are derived from
bank holding company data, which serve as the proxy for the financial data of a
representative private-sector firm, and are used to impute debt and income taxes in
the PSAF model. The after-tax rate of return on equity is based on the returns of
the equity market as a whole and is applied to the equity on the balance sheet to
impute the profit that would have been earned had the services been provided by a
private-sector firm. Beginning in 2009, given the uncertain long-term effect that
payment of interest on reserve balances would have on the level of clearing balances, the equity used to determine the imputed profit has been adjusted to reflect
the actual clearing balance levels maintained; previously, projections of clearing
balance levels were used.
Interest is imputed on the debt assumed necessary to finance priced-service assets;
there was no need to impute debt in 2012 or 2011. The imputed FDIC assessment
reflects rate and assessment methodology changes in 2011.
Interest on float is derived from the value of float to be recovered, either explicitly
or through per-item fees, during the period. Float costs include costs for the check,
Fedwire Funds, ACH, and Fedwire Securities services.
Float cost or income is based on the actual float incurred for each priced service.
Other imputed costs are allocated among priced services according to the ratio of
operating expenses, less shipping expenses, for each service to the total expenses,
less the total shipping expenses, for all services.
The following shows the daily average recovery of actual float by the Reserve
Banks for 2012, in millions of dollars:
Total float
Unrecovered float
Float subject to recovery
Sources of recovery of float
Direct charges
Per-item fees

(767.1)
10.8
(777.9)
1.1
(779.0)

Unrecovered float includes float generated by services to government agencies and
by other central bank services. Float that is created by account adjustments due to
transaction errors and the observance of nonstandard holidays by some depository institutions was recovered from the depository institutions through charging
institutions directly. Float subject to recovery is valued at the federal funds rate.
Certain check products are designed to generate credit float and therefore have
lower per-item fees; this float has been subtracted from the cost base subject to
recovery in 2012 and 2011.
(8) Other Income and Expenses
Other income and expenses consist of investment and interest income on the
imputed investment of clearing balances and the cost of earnings credits or income
from expired earnings credits. Investment income on clearing balances for 2012

109

110

99th Annual Report | 2012

and 2011 represents the average coupon-equivalent yield on three-month Treasury
bills. The investment return is applied to the required portion of the clearing balance. Other income also includes imputed interest on the portion of clearing balances set aside as required reserves. Expenses for earnings credits granted to
depository institutions on their clearing balances are based on a discounted average coupon-equivalent yield on three-month Treasury bills. Earnings credits expire
52 weeks after they are granted.
(9) Cost Recovery
Annual cost recovery is the ratio of revenue, including other income, to the sum of
operating expenses, imputed costs, imputed income taxes, and targeted return on
equity.

111

Other Federal Reserve Operations

Regulatory Developments:
Dodd-Frank Act Implementation
The Dodd-Frank Wall Street Reform and Consumer
Protection Act (Dodd-Frank Act) (Pub. L. No. 111203) is one of the most significant pieces of legislation affecting the U.S. financial regulatory framework
in many years. Enacted on July 21, 2010, the DoddFrank Act seeks to address critical gaps and weaknesses in the U.S. regulatory framework that were
revealed by the financial crisis. The act gives the Federal Reserve important responsibilities to issue rules
and supervise financial companies to enhance financial stability and preserve the safety and soundness of
the banking system.
Throughout 2012, the Federal Reserve continued to
work diligently to implement the many regulatory
changes required under the Dodd-Frank Act. As of
December 31, 2012, the Board had issued 27 final
rules required by the act and had proposed an additional 15 rules for public comment.1 The Board also
continued to implement various international frameworks developed under the auspices of the Basel
Committee on Banking Supervision (BCBS).
The following is a summary of key regulatory developments announced by the Federal Reserve during
2012 in connection with the implementation of the
Dodd-Frank Act and BCBS international
frameworks.

Enhanced Prudential Standards for
Financial Firms
Enhanced Prudential Standards for Foreign
Banking Organizations
The act requires the Board to establish heightened
prudential standards for nonbank financial companies supervised by the Board and for bank holding
1

These figures include Board actions since the enactment of the
act on July 21, 2010.

companies (BHCs) with total consolidated assets of
$50 billion or more (collectively, covered companies).
These standards must be more stringent than the
standards that apply to other nonbank financial
companies and BHCs that do not pose similar risks
to the financial system. Foreign banking organizations that are or are treated as BHCs for purposes of
the Bank Holding Company Act and that meet the
$50 billion asset threshold are also subject to the
heightened prudential standards.
On December 14, 2012, the Board invited comment
on a proposal to establish enhanced prudential standards for foreign banking organizations with global
consolidated assets of $50 billion or more and with a
U.S. banking presence (foreign proposal). The proposed standards for foreign banking organizations
are broadly consistent with the standards that the
Board proposed for U.S. covered companies in
December 2011. Differences between the standards
proposed for foreign banking organizations and U.S.
covered companies reflect the different regulatory
framework and structure under which foreign banking organizations operate.
The foreign proposal would require a foreign banking
organization with $50 billion or more in global consolidated assets and $10 billion or more in total nonbranch U.S. assets to organize its U.S. subsidiaries
under a single U.S. intermediate holding company
(IHC). IHCs of foreign banking organizations would
be subject to the same risk-based and leverage capital
standards applicable to U.S. BHCs, and IHCs with
$50 billion or more in consolidated assets would be
subject to the Board’s capital plan rule. In addition,
the U.S. operations of a foreign banking organization
with combined U.S. assets of $50 billion or more
would be required to meet enhanced liquidity riskmanagement standards, conduct liquidity stress tests,
and hold a 30-day buffer of highly liquid assets. The
proposal also imposes capital stress test, singlecounterparty credit limit, overall risk-management,
and early remediation requirements on U.S. operations of foreign banking organizations.

112

99th Annual Report | 2012

Annual Stress Tests
The act requires the Board to conduct supervisory
stress tests of covered companies and requires financial companies with more than $10 billion in total
consolidated assets to conduct annual stress tests.
Covered companies are also required to conduct
semiannual company-run stress tests.
On October 9, 2012, the Board published two final
rules implementing these stress testing regimes. One
rule implemented the supervisory stress test and
semiannual company-run stress test requirements for
covered companies, while one rule implemented the
annual company-run stress test requirements for
BHCs with total consolidated assets of more than
$10 billion but less than $50 billion, and for state
member banks and savings and loan holding companies (SLHCs) with total consolidated assets of more
than $10 billion.
The Board began conducting supervisory stress tests
in the fall of 2012 for 18 BHCs that participated in
the 2009 Supervisory Capital Assessment Program
and subsequent Comprehensive Capital Analysis and
Reviews. These companies and their state-member
bank subsidiaries also conducted their own
company-run stress tests in the fall of 2012. Other
companies subject to the Board’s final rules for
Dodd-Frank Act stress testing will be required to
comply with the final rule beginning in October 2013.
Companies with between $10 billion and $50 billion
in total assets that begin conducting their first
company-run stress test in in the fall of 2013 will not
have to publicly disclose the results of that first stress
test.

Changes to Banking Regulation
and Supervision
Regulatory Capital Framework
On June 12, 2012, the Board and other federal banking agencies approved a final rule to implement
changes to the market risk capital rule, which
requires institutions with significant trading activities
to adjust their capital ratios to better account for the
market risks of those activities.2 The final market risk
capital rule implements certain revisions made by the
BCBS to its market risk framework. The final rule is
intended to enhance sensitivity to risks arising from
2

The market risk capital rule applies to a BHC or bank with
aggregate trading assets and liabilities equal to 10 percent of
total assets, or $1 billion or more. Separately, the Board proposed to apply the market risk capital rule to SLHCs that meet
the thresholds described in the rule.

trading activities, reduce procyclicality in the market
risk capital requirements, and increase transparency
through enhanced disclosures. Consistent with section 939A of the Dodd-Frank Act, which requires all
federal agencies to remove from their regulations references to and requirements of reliance on credit ratings, the final rule does not include those aspects of
the BCBS market risk framework that rely on credit
ratings. Instead, the final rule includes alternative
standards of creditworthiness for determining specific risk capital requirements for certain debt and
securitization positions.
Also on June 12, 2012, the Board and other federal
banking agencies invited comment on three notices
of proposed rulemakings that would implement in
the United States the Basel III regulatory capital
reforms adopted by the BCBS and make other revisions to the agencies’ regulatory capital requirements.
The proposals would establish an integrated regulatory capital framework to address shortcomings in
regulatory capital requirements that became apparent
during the financial crisis. The proposed rules would
be consistent with section 171 of the Dodd-Frank
Act, which directs the Board to establish minimum
risk-based and leverage capital requirements for
BHCs and SLHCs that are not less than the “generally applicable” capital requirements for insured
depository institutions and not “quantitatively lower
than” the “generally applicable” capital requirements
in effect for insured depository institutions when the
Dodd-Frank Act was enacted.
The first notice of proposed rulemaking (Basel III
NPR) is focused primarily on reforms that would
improve the overall quality and quantity of capital
held by all depository institutions, BHCs with total
consolidated assets of $500 million or more, and all
SLHCs (collectively, banking organizations). Consistent with the international Basel framework, the
Basel III NPR would establish a new minimum common equity tier 1 ratio and common equity tier 1
capital conservation buffer; raise the minimum tier 1
capital ratio; revise the definition of capital to ensure
that regulatory capital instruments can absorb losses;
establish limitations on capital distributions and certain discretionary bonus payments if common equity
tier 1 capital buffers are not met; and introduce a
supplementary leverage ratio for banking organizations that are subject to the advanced approaches
risk-based capital rules. The proposal includes transition provisions designed to provide sufficient time for
banking organizations to meet the new capital standards while supporting lending to the economy.

Other Federal Reserve Operations

The second notice of proposed rulemaking (Standardized Approach NPR) would revise the Board’s
rules for calculating risk-weighted assets to enhance
their risk sensitivity and address weaknesses identified over recent years. Specifically, it would incorporate aspects of the BCBS’s Basel II standardized
framework (known as the International Convergence
of Capital Measurement and Capital Standards),
Basel III, and alternatives to credit ratings for the
treatment of certain exposures, consistent with section 939A of the Dodd-Frank Act. The Standardized
Approach NPR would apply to all banking
organizations.
The third notice of proposed rulemaking (Advanced
Approaches and Market Risk NPR) would revise the
advanced approaches risk-based capital rule in a
manner consistent with sections 171 and 939A of the
Dodd-Frank Act and incorporate certain aspects of
Basel III that the Board would apply only to
advanced approaches banking organizations (generally, the largest, most complex banking organizations). In particular, the Advanced Approaches and
Market Risk NPR would enhance the risk sensitivity
of the current rules to better address counterparty
credit risk and interconnectedness among financial
institutions. The proposal also would codify the
Board’s market risk capital rule and, as described
above, would apply consolidated capital requirements
to SLHCs.
Registration of Securities Holding Companies
(SHCs)
Section 618 of the Dodd-Frank Act permits a company that one or more securities broker or dealer registered with the Securities and Exchange Commission
(SEC), and that is required by a foreign regulator or
provision of foreign law to be subject to comprehensive consolidated supervision, to register with the
Board as an SHC and become subject to supervision
and regulation by the Board. An SHC that registers
with the Board under section 618 is subject to the full
examination, supervision, and enforcement regime
applicable to a registered BHC, including capital
requirements (although the statute allows the Board
to modify its capital rules to account for differences
in activities and structure of SHCs).
On May 30, 2012, the Board adopted a final rule to
implement section 618 of the act. The final rule,
which became effective July 20, 2012, specifies the
information that an SHC must provide to the Board
as part of registration, including information relating
to organizational structure, capital, and financial

113

condition. Under the final rule, an SHC’s registration
becomes effective no later than 45 days from the date
the Board receives all required information. Consistent with the act, the restrictions on nonbanking
activities in section 4 of the Bank Holding Company
Act would not apply to a supervised SHC.
Bank Secrecy Act (BSA) Regulations
On November 29, 2012, the Board and the Financial
Crimes Enforcement Network, a bureau of the U.S.
Department of Treasury, proposed a rule to amend
the definitions of “funds transfer” and “transmittal
of funds” under regulations implementing the BSA.
The proposed amendments would maintain the current scope of funds transfers and transmittals subject
to the BSA in light of an ambiguity caused by
amendments to the Electronic Fund Transfer Act
made by the Dodd-Frank Act.

Financial Market Utilities (FMUs)
and Payment, Clearing, and Settlement
Activities
Title VIII of the act establishes a new supervisory
framework for systemically important FMUs and
systemically important payment, clearing, and settlement activities conducted between financial institutions. Under the framework, the Board is authorized
to prescribe risk-management standards governing
the operations of FMUs that are designated as systemically important by the Financial Stability Oversight Council (FSOC) (other than a designated FMU
that is registered with the Commodity Futures Trading Commission as a derivatives clearing organization (DCO) or registered with the SEC as a clearing
agency) as well as the conduct of payment, clearing,
and settlement activities by financial institutions if
such activities have been designated as systemically
important by the FSOC. On July 18, 2012, the FSOC
voted unanimously to designate eight FMUs as systemically important under the act.
On July 30, 2012, the Federal Reserve announced the
approval of a final rule (Regulation HH) to implement certain provisions of title VIII of the act. The
final rule creates risk-management standards governing the operations related to the payment, clearing,
and settlement activities of FMUs designated as systemically important by the FSOC (other than registered DCOs or clearing agencies). The riskmanagement standards are based on the recognized
international standards developed by the Committee
on Payment and Settlement Systems and the Technical Committee of the International Organization of

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99th Annual Report | 2012

Securities Commissions that were incorporated previously into the Board’s Policy on Payment System
Risk.
Regulation HH also establishes requirements for
advance notice of proposed material changes to the
rules, procedures, or operations of a designated
FMU for which the Board is the supervisory agency
as specified in title VIII of the act. The advance
notice requirements set the threshold above which a
proposed change would be considered material and
thus require an advance notice to the Board, and also
include provisions on the length of the review period.

required, in light of changes in the types of fraud
and available methods of fraud prevention.
The final rule retains and clarifies the requirement
that an issuer that meets these standards and wishes
to receive the adjustment must annually notify the
payment card networks in which it participates of its
eligibility to receive the adjustment. In addition, the
final rule explicitly prohibits an issuer from receiving
or charging a fraud-prevention adjustment if the
issuer is substantially noncompliant with the Board’s
fraud-prevention standards and sets forth a timeframe within which such an issuer must stop receiving or charging a fraud-prevention adjustment.

Debit Interchange
Section 1075 of the act restricts the interchange fees
that issuers may receive for electronic debit card
transactions. Specifically, the interchange fee an
issuer receives for a particular transaction must be
reasonable and proportional to the cost incurred by
the issuer with respect to the transaction. The
Board’s Regulation II, adopted in 2011, sets standards for determining whether an interchange fee is
reasonable and proportional to the issuer’s cost. In
addition, the Board concurrently promulgated an
interim final rule to permit an issuer to receive a
fraud-prevention adjustment to the issuer’s interchange fee.
On July 27, 2012, the Board announced the approval
of a final rule that permits a debit card issuer subject
to the interchange fee standards of Regulation II to
receive a fraud-prevention adjustment. Under the
fraud-prevention adjustment final rule, an issuer is
eligible for an adjustment of no more than 1 cent per
transaction (unchanged from the previous interim
final rule) if it develops and implements policies and
procedures that are reasonably designed to take effective steps to reduce the occurrence of, and costs to all
parties from, fraudulent debit card transactions. The
final rule simplifies the elements required to be
included in an issuer’s fraud-prevention policies and
procedures. To receive an adjustment, an issuer is
required to review its fraud-prevention policies and
procedures, and their implementation, at least annually. An issuer also is required to update its policies
and procedures as necessary in light of their effectiveness and cost-effectiveness and, as previously

Consumer Financial Protection
On August 15, 2012, the Board—jointly with the
Consumer Financial Protection Bureau, the Federal
Deposit Insurance Corporation, the Federal Housing
Finance Agency, the National Credit Union Administration, and the Office of the Comptroller of the
Currency—proposed a rule to implement section 129H of the Truth in Lending Act (TILA),
added by the Dodd-Frank Act, which requires a
creditor to obtain an appraisal before issuing a
“higher-risk mortgage.” Under the act, mortgage
loans are higher-risk if they are secured by a consumer’s home and have interest rates above a certain
threshold.
For higher-risk mortgage loans, the proposed rule
would require creditors to use a licensed or certified
appraiser who prepares a written appraisal report
based on a physical inspection of the interior of the
property. The proposed rule also would require creditors to disclose to applicants information about the
purpose of the appraisal and provide consumers with
a free copy of any appraisal report. Creditors would
have to obtain an additional appraisal at no cost to
the consumer for a home-purchase higher-risk mortgage loan if the seller acquired the property for a
lower price during the past six months. This requirement would address fraudulent property flipping by
seeking to ensure that the value of the property being
used as collateral for the loan legitimately increased.

Other Federal Reserve Operations

The Board of Governors and the
Government Performance and
Results Act
Overview
The Government Performance and Results Act
(GPRA) of 1993 requires that federal agencies, in
consultation with Congress and outside stakeholders,
prepare a strategic plan covering a multiyear period
and submit an annual performance plan and performance report. The GPRA Modernization Act of
2010 refines those requirements to include quarterly
performance reporting. Although the Board is not
covered by GPRA, the Board follows the spirit of the
act and, like federal agencies, prepares a performance
plan and performance report.

Strategic Plan, Performance Plan, and
Performance Report
The Board’s 2012–2015 strategic plan articulates the
Board’s mission in the context of what it would take

115

to meet Dodd-Frank Act mandates, close any crossdisciplinary knowledge gaps, develop appropriate
policy, and continue effectively addressing the recovery of a fragile global economy. The plan sets forth
major goals, outlines strategies for achieving those
goals, identifies key quantitative measures of performance and discusses the evaluation of performance.
The performance plan includes specific targets for
some of the performance measures identified in the
strategic plan and describes the operational processes
and resources needed to meet those targets. The performance report discusses the Board’s performance
against the strategic goals.
The strategic plan, performance plan, and performance report are available on the Board’s website at
www.federalreserve.gov/publications/gpra/
default.htm.

117

Record of Policy Actions
of the Board of Governors

Policy actions of the Board of Governors are presented pursuant to section 10 of the Federal Reserve
Act. That section provides that the Board shall keep
a record of all questions of policy determined by the
Board and shall include in its annual report to Congress a full account of such actions. This chapter provides a summary of policy actions in 2012, as implemented through (1) rules and regulations, (2) policy
statements and other actions, and (3) discount rates
for depository institutions. Policy actions were
approved on the date stated by all Board members in
office, unless indicated otherwise.1 More information
on the actions is available from the “Reading
Rooms” on the Board’s Freedom of Information
(FOI) Act web page or on request from the Board’s
FOI Office.

Banks.2 The amendments to Regulation D create a
common two-week maintenance period for all
depository institutions, establish a penalty-free band
around reserve balance requirements in place of carryover and routine penalty waivers, discontinue certain as-of adjustments and replace others, and eliminate the contractual clearing balance program. Regulation J was amended to remove references to as-of
adjustments and clarify other matters, including the
handling of checks sent to Federal Reserve Banks.
The Regulation D amendments related to the elimination of contractual clearing balances and as-of
adjustments are effective July 12, 2012; the other
Regulation D amendments are effective January 24,
2013. The Regulation J amendments are effective
July 12, 2012.

For information on Federal Open Market Committee
policy actions relating to open market operations, see
“Minutes of Federal Open Market Committee
Meetings” on page 123.

Voting for this action: Chairman Bernanke, Vice
Chair Yellen, and Governors Duke, Tarullo, and
Raskin.

Rules and Regulations
Regulation D (Reserve Requirements of
Depository Institutions) and Regulation J
(Collection of Checks and Other Items by
Federal Reserve Banks and Funds
Transfers through Fedwire)
On April 4, 2012, the Board approved final rules
(Docket Nos. R-1433 and R-1434) to simplify the
administration of reserve requirements; reduce
administrative and operational costs for depository
institutions, the Board, and Federal Reserve Banks;
and clarify certain matters related to the Reserve

1

Governor Powell joined the Board on May 25, and Governor
Stein joined the Board on May 30, 2012.

On October 25, 2012, the Board approved a final rule
(Docket No. R-1433) to delay the effective date of
certain Regulation D amendments to simplify the
administration of reserve requirements, which were
to take effect on January 24, 2013 (specifically, the
creation of a common two-week maintenance period
and the establishment of a penalty-free band around
reserve balance requirements).3 The delay will allow
time for further development and testing of automated systems to ensure a smooth transition for
affected institutions. The new effective date is
June 27, 2013.

2

3

See Federal Register notices at www.gpo.gov/fdsys/pkg/FR2012-04-12/html/2012-8562.htm and www.gpo.gov/fdsys/pkg/
FR-2012-04-12/html/2012-8563.htm.
See Federal Register notice at www.gpo.gov/fdsys/pkg/FR-201211-05/html/2012-26731.htm.

118

99th Annual Report | 2012

Voting for this action: Chairman Bernanke, Vice
Chair Yellen, and Governors Duke, Tarullo,
Stein, and Powell. Abstaining: Governor Raskin.

Regulation H (Membership of State
Banking Institutions in the Federal
Reserve System) and Regulation Y
(Bank Holding Companies and
Change in Bank Control)
On June 7, 2012, the Board approved a final rule
(Docket No. R-1401) to revise its market risk capital
rule, which requires banking organizations with significant trading activities to adjust their capital
requirements to reflect the market risk of those
activities.4 The Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency also implemented the revised rule for the institutions they supervise.
The rule implements certain revisions the Basel Committee on Banking Supervision made to the international framework for market risk capital standards
between 2005 and 2010. Among other provisions, the
final rule better captures positions for which the market risk capital rule is appropriate, reduces procyclicality in market risk capital requirements, enhances
the market risk rule’s sensitivity to risks that were not
adequately captured in the previous version of the
rule, and increases transparency through enhanced
disclosures. The final rule also replaces credit ratings
with alternative standards of creditworthiness, as
required by the Dodd-Frank Act Wall Street Reform
and Consumer Protection Act (the Dodd-Frank
Act). The final rule is effective January 1, 2013.
Voting for this action: Chairman Bernanke, Vice
Chair Yellen, and Governors Duke, Tarullo,
Raskin, Stein, and Powell.

Regulation M (Consumer Leasing) and
Regulation Z (Truth in Lending)
On October 25, 2012, the Board approved final rules
(Docket Nos. R-1449 and R-1450) to increase the
dollar threshold for exempt consumer credit and
lease transactions from $51,800 to $53,000, in accordance with the Dodd-Frank Act.5 The final rules
were published jointly with the Consumer Financial
4

5

See Federal Register notice at www.gpo.gov/fdsys/pkg/FR-201208-30/html/2012-16759.htm.
See Federal Register notices at www.gpo.gov/fdsys/pkg/FR2012-11-21/html/2012-27996.htm and www.gpo.gov/fdsys/pkg/
FR-2012-11-21/html/2012-27993.htm.

Protection Bureau (CFPB). The dollar threshold is
adjusted annually to reflect the annual percentage
increase in the consumer price index. Transactions at
or below the threshold are subject to the protections
of the regulations. Although the Dodd-Frank Act
generally transferred rulemaking authority under the
Consumer Leasing Act and the Truth in Lending Act
to the CFPB, the Board retains authority to issue
rules for certain motor vehicle dealers. The final rules
are effective January 1, 2013.
Voting for this action: Chairman Bernanke, Vice
Chair Yellen, and Governors Duke, Tarullo,
Raskin, Stein, and Powell.

Regulation HH (Designated Financial
Market Utilities)
On July 26, 2012, the Board approved a final rule
(Docket No. R-1412) to establish risk-management
standards for certain financial market utilities
(FMUs) designated as systemically important by the
Financial Stability Oversight Council.6 The final rule
implements provisions of the Dodd-Frank Act that
require the Board to establish such standards, as well
as standards for determining when an FMU supervised by the Board must provide advance notice to
the Board of proposed material changes to its rules,
procedures, or operations. FMUs, such as payment
systems, central securities depositories, and central
counterparties, provide the infrastructure to clear
and settle payments and other financial transactions.
The final rule is effective September 14, 2012.
Voting for this action: Chairman Bernanke, Vice
Chair Yellen, and Governors Duke, Tarullo,
Raskin, Stein, and Powell.

Regulation II (Debit Card Interchange Fees
and Routing)
On July 26, 2012, the Board approved a final rule
(Docket No. R-1404) amending the provisions in
Regulation II that govern adjustments to the debit
card interchange fee standards to make an allowance
for fraud-prevention costs incurred by debit card
issuers subject to those standards.7 Under the amendments, an issuer is eligible for an adjustment of no
more than 1 cent per transaction (unchanged from
the interim final rule), in addition to the interchange
6

7

See Federal Register notice at www.gpo.gov/fdsys/pkg/FR-201208-02/html/2012-18762.htm.
See Federal Register notice at www.gpo.gov/fdsys/pkg/FR-201208-03/html/2012-18726.htm

Record of Policy Actions of the Board of Governors

transaction fee permitted by Regulation II, if that
issuer develops and implements policies and procedures that are reasonably designed to take effective
steps to reduce the occurrence of, and costs to all parties from, fraudulent debit card transactions. The
final rule simplifies the elements required to be
included in an issuer’s fraud-prevention policies and
procedures. The amendments also require an issuer
that receives a fraud-prevention allowance to
(1) review its fraud-prevention policies and procedures and their implementation at least annually and
(2) update them as necessary in light of their effectiveness, their cost-effectiveness, and changes in the
types of fraud and available methods of fraud prevention. The final rule also includes provisions relating to an issuer’s notification of its eligibility for a
fraud-prevention adjustment and prohibiting adjustments for issuers that are in substantial noncompliance with the Board’s fraud-prevention standards.
The final rule, which revises provisions already in
effect under an interim final rule, is effective October 1, 2012.
Voting for this action: Chairman Bernanke, Vice
Chair Yellen, and Governors Duke, Tarullo,
Raskin, Stein, and Powell.

Regulation OO (Securities Holding
Companies)
On May 25, 2012, the Board approved a final rule
(Docket No. R-1430) to implement a provision of the
Dodd-Frank Act that permits nonbank companies
that own at least one registered securities broker or
dealer (securities holding companies, or SHCs) and
that are required by a foreign regulator or provision
of foreign law to be subject to comprehensive consolidated supervision, but are not currently subject to
such supervision, to register with the Board and subject themselves to supervision by the Board (covered
SHCs).8 The final rule outlines the requirements that
covered SHCs must satisfy to make an effective election for Board supervision. Upon registration, these
companies would be supervised as if they were bank
holding companies; however, the restrictions on nonbanking activities in section 4 of the Bank Holding
Company Act would not apply to them. The final
rule is effective July 20, 2012.

Voting for this action: Chairman Bernanke, Vice
Chair Yellen, and Governors Duke, Tarullo, and
Raskin.

Regulation YY (Enhanced Prudential
Standards)
On October 4, 2012, the Board approved final rules
(Docket No. R-1438) to implement the Dodd-Frank
Act’s stress testing requirements for bank holding
companies, state member banks, savings and loan
holding companies (SLHCs), and nonbank financial
companies designated for Board supervision by the
Financial Stability Oversight Council.9
The act requires that the Board conduct supervisory
stress tests of bank holding companies with total
consolidated assets of $50 billion or more and nonbank financial companies supervised by the Board
and also requires that these companies conduct semiannual company-run stress tests. In addition, the act
requires that other financial companies that are regulated by a primary federal financial regulatory agency
and have total consolidated assets of more than
$10 billion conduct annual company-run stress tests.
The final rules are effective November 15, 2012.
The Board began conducting supervisory stress tests
under the final rules in the fall of 2012 for 18 bank
holding companies that participated in the 2009
Supervisory Capital Assessment Program and subsequent Comprehensive Capital Analysis and Reviews.
Also, these companies and their state member bank
subsidiaries began conducting their own DoddFrank Act company-run stress tests in the fall of
2012. Other BHCs, state member banks, and SLHCs
subject to the stress testing rules are required to comply with the rules beginning in October 2013. Companies with total consolidated assets between $10 billion and $50 billion that begin conducting their first
company-run stress test in the fall of 2013 will not
have to publicly disclose the results of that first stress
test.
Voting for this action: Chairman Bernanke, Vice
Chair Yellen, and Governors Duke, Tarullo,
Raskin, Stein, and Powell.

9
8

See Federal Register notice at www.gpo.gov/fdsys/pkg/FR-201206-04/html/2012-13311.htm

119

See Federal Register notices at www.gpo.gov/fdsys/pkg/FR2012-10-12/html/2012-24987.htm and www.gpo.gov/fdsys/pkg/
FR-2012-10-12/html/2012-24988.htm.

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99th Annual Report | 2012

Rules of Practice for Hearings
On November 5, 2012, the Board approved an
amendment (Docket No. R-1451) to adjust the maximum amount of each statutory civil money penalty
within its jurisdiction to account for inflation, as
required under the Federal Civil Penalties Inflation
Adjustment Act as amended by the Debt Collection
Improvement Act.10 The amendment is effective
November 16, 2012.
Voting for this action: Chairman Bernanke, Vice
Chair Yellen, and Governors Duke, Tarullo,
Raskin, Stein, and Powell.

Policy Statements and Other Actions
Joint Guidance on the Effective Date
of Section 716 of the Dodd-Frank Act
On March 28, 2012, the Board, acting with the Federal Deposit Insurance Corporation and the Office of
the Comptroller of the Currency, approved joint
guidance to clarify that the effective date of section 716 of the Dodd-Frank Act is July 16, 2013.11
Section 716, the so-called swaps pushout provision,
generally prohibits certain types of federal assistance
to any entity defined to be a swaps entity with respect
to any swap, security-based swap, or other activity of
the swaps entity. Under section 716, “federal assistance” includes discount window lending or deposit
insurance.
Voting for this action: Chairman Bernanke, Vice
Chair Yellen, and Governors Duke, Tarullo, and
Raskin.

Policy on Payment System Risk
On April 9, 2012, the Board approved technical
changes to its Policy on Payment System Risk
(Docket No. OP-1440) to conform with procedural
changes made by the Department of the Treasury
(Treasury) to the redemption of separately sorted
savings bonds and to eliminate a reference to the contractual clearing balance program.12 The Board’s
recent amendments to Regulation D eliminated this
10

11

12

See Federal Register notice at www.gpo.gov/fdsys/pkg/FR-201211-16/html/2012-27857.htm.
See Federal Register notice at www.gpo.gov/fdsys/pkg/FR-201205-10/html/2012-11326.htm.
See Federal Register notice at www.gpo.gov/fdsys/pkg/FR-201204-17/html/2012-9211.htm.

program. The policy revisions concerning separately
sorted savings bond redemptions are effective
April 11, 2012, and those related to the elimination of
the contractual clearing balance program are effective
July 12, 2012.
Voting for this action: Chairman Bernanke, Vice
Chair Yellen, and Governors Duke, Tarullo, and
Raskin.

Clarification of Volcker Rule
Conformance Period
On April 16, 2012, the Board approved guidance
(Docket No. OP-1441) clarifying that an entity covered by section 619 of the Dodd-Frank Act (the
so-called Volcker Rule) has the full two-year period
provided by statute, until July 21, 2014, to fully conform its activities and investments to the requirements of section 619 and any final implementing
regulations, unless that period is extended by the
Board.13 The conformance period is intended to give
markets and firms an opportunity to adjust to the
prohibitions and restrictions on proprietary trading
and on hedge fund and private equity fund activities
imposed under section 619. (The Board, Office of the
Comptroller of the Currency, Federal Deposit Insurance Corporation, Securities and Exchange Commission, and Commodity Futures Trading Commission
had previously invited public comments on their proposal to implement the Volcker Rule.)
Voting for this action: Chairman Bernanke, Vice
Chair Yellen, and Governors Duke, Tarullo, and
Raskin.

Guidance on Stress Testing for Banking
Organizations with Assets over $10 Billion
On May 9, 2012, the Board approved supervisory
guidance (Docket No. OP-1421) outlining general
principles for stress testing practices of banking organizations with total consolidated assets of more than
$10 billion.14 The guidance was issued jointly with
the Federal Deposit Insurance Corporation and the
Office of the Comptroller of the Currency.
The guidance highlights the importance of stress
testing at banking organizations as an ongoing riskmanagement practice that supports a banking orga13

14

See Federal Register notice at www.gpo.gov/fdsys/pkg/FR-201206-08/html/2012-13937.htm.
See Federal Register notice at www.gpo.gov/fdsys/pkg/FR-201205-17/html/2012-11989.htm.

Record of Policy Actions of the Board of Governors

nization’s forward-looking assessment of its risks
and better equips it to address a range of adverse
outcomes. The guidance outlines general principles
for a satisfactory stress testing framework and
describes various stress testing approaches and how
stress testing should be used at various levels within
an organization. The guidance also discusses the
importance of stress testing in capital and liquidity
planning and the importance of strong internal governance and controls as part of an effective stress
testing framework.
The Board approved final rules in October 2012 to
implement the Dodd-Frank Act’s stress testing
requirements. (See Regulation YY on page 119.)
Banking organizations are expected to follow the
principles set forth in the guidance when conducting
stress testing pursuant to the Dodd-Frank Act rules
or other statutory or regulatory requirements. The
guidance is effective July 23, 2012.
Voting for this action: Chairman Bernanke, Vice
Chair Yellen, and Governors Duke, Tarullo, and
Raskin.

Term Asset-Backed Securities
Loan Facility
On June 27, 2012, the Board approved a reduction
from $4.3 billion to $1.4 billion in the credit protection provided by Treasury, through its Troubled Asset
Relief Program, for the Term Asset-Backed Securities
Loan Facility (TALF).15 The TALF program closed
on June 30, 2010, with $43 billion in loans outstanding. Most TALF loans have been repaid or have
matured, and the program has experienced no losses
to date.
Voting for this action: Chairman Bernanke, Vice
Chair Yellen, and Governors Duke, Tarullo,
Raskin, Stein, and Powell.
Note: On January 15, 2013, the Board approved
eliminating Treasury’s credit protection for the TALF
program. The Board and Treasury agreed that the
credit protection was unnecessary because the accumulated fees collected through the program exceeded
the amount of TALF loans outstanding, which had
declined by then to $556 million.16
15

16

See press release at www.federalreserve.gov/newsevents/press/
monetary/20120628a.htm.
See press release at www.federalreserve.gov/newsevents/press/
monetary/20130115b.htm.

121

Revised Methodology for the
Private Sector Adjustment Factor
On October 25, 2012, the Board approved modifications (Docket No. OP-1447) to the methodology for
calculating the private sector adjustment factor
(PSAF), which is used in setting fees for certain payment services provided to depository institutions.17
The PSAF is an allowance for income taxes and
other imputed expenses that would have been paid
and profits that would have been earned if the
Reserve Banks’ priced services were provided by a
private business. The Monetary Control Act requires
that the Federal Reserve establish fees to recover the
costs of providing payment services, including the
PSAF, over the long run, to promote competition
between the Reserve Banks and private-sector providers of payment services.
Beginning in 2013, the Board will estimate income
tax and other imputed costs from the U.S. publicly
traded firm market. Previously, the estimated income
tax and other imputed costs were derived from top
bank holding companies under the correspondent
bank model, which relied on clearing balances held at
Reserve Banks as a primary component. The Board
eliminated the contractual clearing balance program
earlier in 2012. (See Regulation D on page 117).
Voting for this action: Chairman Bernanke, Vice
Chair Yellen, and Governors Duke, Tarullo,
Raskin, Stein, and Powell.

Discount Rates for Depository
Institutions in 2012
Under the Federal Reserve Act, the boards of directors of the Federal Reserve Banks must establish
rates on discount window loans to depository institutions at least every 14 days, subject to review and
determination by the Board of Governors.

Primary, Secondary, and Seasonal Credit
Primary credit, the Federal Reserve’s main lending
program for depository institutions, is extended at
the primary credit rate, which is set above the usual
level of short-term market interest rates. It is made
available, with minimal administration and for very
short terms, as a backup source of liquidity to
17

See Federal Register notice at www.gpo.gov/fdsys/pkg/FR-201211-08/html/2012-26918.htm.

122

99th Annual Report | 2012

depository institutions that, in the judgment of the
lending Federal Reserve Bank, are in generally sound
financial condition. Throughout 2012, the primary
credit rate was ¾ percent.
Secondary credit is available in appropriate circumstances to depository institutions that do not qualify
for primary credit. The secondary credit rate is set at
a spread above the primary credit rate. Throughout
2012, the spread was set at 50 basis points; therefore,
the secondary credit rate was 1¼ percent. Seasonal
credit is available to smaller depository institutions to
meet liquidity needs that arise from regular swings in
their loans and deposits. The rate on seasonal credit
is calculated every two weeks as an average of

selected money-market yields, typically resulting in a
rate close to the federal funds rate target. At yearend, the seasonal credit rate was 0.20 percent.18

Votes on Changes to Discount Rates for
Depository Institutions
About every two weeks during 2012, the Board
approved proposals by the 12 Reserve Banks to
maintain the formulas for computing the secondary
and seasonal credit rates. In 2012, the Board did not
approve any changes in the primary credit rate.
18

For current and historical discount rates, see www
.frbdiscountwindow.org/.

123

Minutes of Federal Open Market
Committee Meetings

The policy actions of the Federal Open Market Committee, contained in the minutes of its meetings, are
presented in the Annual Report of the Board of Governors pursuant to the requirements of section 10 of
the Federal Reserve Act. That section provides that
the Board shall keep a complete record of the actions
taken by the Board and by the Federal Open Market
Committee on all questions of policy relating to open
market operations, that it shall record therein the
votes taken in connection with the determination of
open market policies and the reasons underlying each
policy action, and that it shall include in its annual
report to Congress a full account of such actions.
The minutes of the meetings contain the votes on the
policy decisions made at those meetings, as well as a
summary of the information and discussions that led
to the decisions. In addition, four times a year, starting with the October 2007 Committee meeting, a
Summary of Economic Projections (SEP) is published as an addendum to the minutes.1 The descriptions of economic and financial conditions in the
minutes and the Summary of Economic Projections
are based solely on the information that was available
to the Committee at the time of the meetings.
Members of the Committee voting for a particular
action may differ among themselves as to the reasons
for their votes; in such cases, the range of their views
1

In 2012, there were five SEPs due to a transition in the schedule.

is noted in the minutes. When members dissent from
a decision, they are identified in the minutes and a
summary of the reasons for their dissent is provided.
Policy directives of the Federal Open Market Committee are issued to the Federal Reserve Bank of New
York as the Bank selected by the Committee to
execute transactions for the System Open Market
Account. In the area of domestic open market operations, the Federal Reserve Bank of New York operates under instructions from the Federal Open Market Committee that take the form of an Authorization for Domestic Open Market Operations and a
Domestic Policy Directive. (A new Domestic Policy
Directive is adopted at each regularly scheduled
meeting.) In the foreign currency area, the Federal
Reserve Bank of New York operates under an Authorization for Foreign Currency Operations, a Foreign
Currency Directive, and Procedural Instructions with
Respect to Foreign Currency Operations. Changes in
the instruments during the year are reported in the
minutes for the individual meetings.2
2

As of January 1, 2012, the Federal Reserve Bank of New York
was operating under the Domestic Policy Directive approved at
the December 13, 2011, Committee meeting. The other policy
instruments (the Authorization for Domestic Open Market
Operations, the Authorization for Foreign Currency Operations,
the Foreign Currency Directive, and Procedural Instructions
with Respect to Foreign Currency Operations) in effect as of
January 1, 2012, were approved at the January 25–26, 2011,
meeting.

124

99th Annual Report | 2012

Meeting Held on January 24–25, 2012

Steven B. Kamin
Economist

A meeting of the Federal Open Market Committee
was held in the offices of the Board of Governors in
Washington, D.C., on Tuesday, January 24, 2012, at
10:00 a.m., and continued on Wednesday, January 25,
2012, at 8:30 a.m.

David W. Wilcox
Economist

Present
Ben Bernanke
Chairman
William C. Dudley
Vice Chairman
Elizabeth Duke
Jeffrey M. Lacker
Dennis P. Lockhart
Sandra Pianalto
Sarah Bloom Raskin
Daniel K. Tarullo
John C. Williams
Janet L. Yellen
James Bullard, Christine Cumming,
Charles L. Evans, Esther L. George, and
Eric Rosengren
Alternate Members of the Federal Open Market
Committee
Richard W. Fisher, Narayana Kocherlakota, and
Charles I. Plosser
Presidents of the Federal Reserve Banks of Dallas,
Minneapolis, and Philadelphia, respectively
William B. English
Secretary and Economist
Deborah J. Danker
Deputy Secretary
Matthew M. Luecke
Assistant Secretary
David W. Skidmore
Assistant Secretary
Michelle A. Smith
Assistant Secretary
Scott G. Alvarez
General Counsel
Thomas C. Baxter
Deputy General Counsel

David Altig, Thomas A. Connors,
Michael P. Leahy, William Nelson,
Simon Potter, David Reifschneider,
Glenn D. Rudebusch, and William Wascher
Associate Economists
Brian Sack
Manager, System Open Market Account
Michael S. Gibson
Director, Division of Banking Supervision and
Regulation, Board of Governors
Nellie Liang
Director, Office of Financial Stability Policy and
Research, Board of Governors
Jon W. Faust and Andrew T. Levin
Special Advisors to the Board, Office of Board
Members, Board of Governors
James A. Clouse
Deputy Director, Division of Monetary Affairs,
Board of Governors
Linda Robertson
Assistant to the Board, Office of Board Members,
Board of Governors
Daniel E. Sichel
Senior Associate Director, Division of Research and
Statistics, Board of Governors
Ellen E. Meade, Stephen A. Meyer, and
Joyce K. Zickler
Senior Advisers, Division of Monetary Affairs,
Board of Governors
Lawrence Slifman
Senior Adviser, Division of Research and Statistics,
Board of Governors
Eric M. Engen1 and Daniel M. Covitz
Associate Directors, Division of Research and
Statistics, Board of Governors
Trevor A. Reeve
Associate Director, Division of International Finance,
Board of Governors
Joshua Gallin1
Deputy Associate Director, Division of Research and
Statistics, Board of Governors
1

Attended Tuesday’s session only.

Minutes of Federal Open Market Committee Meetings | January

David H. Small
Project Manager, Division of Monetary Affairs,
Board of Governors
Chiara Scotti
Senior Economist, Division of International Finance,
Board of Governors
Louise Sheiner
Senior Economist, Division of Research and
Statistics, Board of Governors
Lyle Kumasaka
Senior Financial Analyst, Division of Monetary
Affairs, Board of Governors
Kurt F. Lewis
Economist, Division of Monetary Affairs,
Board of Governors
Randall A. Williams
Records Management Analyst, Division of Monetary
Affairs, Board of Governors
Kenneth C. Montgomery
First Vice President, Federal Reserve Bank of Boston
Jeff Fuhrer, Loretta J. Mester,
Harvey Rosenblum, and Daniel G. Sullivan
Executive Vice Presidents, Federal Reserve Banks of
Boston, Philadelphia, Dallas, and Chicago,
respectively
Craig S. Hakkio, Mark E. Schweitzer,
Christopher J. Waller, and Kei-Mu Yi
Senior Vice Presidents, Federal Reserve Banks of
Kansas City, Cleveland, St. Louis, and Minneapolis,
respectively
John Duca2 and Andrew Haughwout2
Vice Presidents, Federal Reserve Banks of Dallas and
New York, respectively
Julie Ann Remache
Assistant Vice President, Federal Reserve Bank of
New York
Robert L. Hetzel
Senior Economist, Federal Reserve Bank of
Richmond
Daniel Cooper2
Economist, Federal Reserve Bank of Boston

125

Role of Financial Conditions in Economic
Recovery: Lending and Leverage
Staff summarized research projects being conducted
across the Federal Reserve System on the effects of
changes in lending practices and household leverage
on consumer spending in recent years. These projects
provided a range of views regarding the size and
importance of such effects. An analysis employing
aggregate time-series data indicated that changes in
income, household assets and liabilities, and credit
availability can largely account for the movements in
aggregate consumption seen since the mid-1990s; this
finding suggests that changes in credit conditions
may have been an important factor driving changes
in the saving rate in recent years. A second analysis
used data on borrowing, debt repayments, and other
credit factors for individual borrowers; this study
found that movements in leverage—resulting from
voluntary loan repayments and from loan chargeoffs—have had a substantial effect on the cash flow
of many households over time, and thus presumably
on their spending. However, a third study, which
employed household-level data, suggested that movements in consumption before, during, and after the
recession were driven primarily by employment,
income, and net worth, leaving little variation to be
explained by changes in leverage and credit
availability.
In their discussion following the staff presentation,
several meeting participants considered possible reasons for the differing results of the various analyses;
participants also noted contrasts between these findings and those reported in some academic research.
Several possible explanations for the varying conclusions were discussed, including differences across
studies in model specification and data, as well as differences in the definition of deleveraging. In addition, it was noted that data limitations make it difficult to reach firm conclusions on this issue, at least at
this time. Participants also considered the possible
influence on aggregate consumer spending of
changes in real interest rates and the distribution of
income, the potential for policy actions to affect the
fundamental factors driving household saving, and
whether households’ spending behavior is being
affected by concerns about the future of Social
Security.

Annual Organizational Matters
2

Attended the discussion of the role of financial
conditions in economic recovery.

In the agenda for this meeting, it was reported that
advices of the election of the following members and

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99th Annual Report | 2012

alternate members of the Federal Open Market Committee for a term beginning January 24, 2012, had
been received and that these individuals had executed
their oaths of office.

Deborah J. Danker
Deputy Secretary

The elected members and alternate members were as
follows:

David W. Skidmore
Assistant Secretary

William C. Dudley
President of the Federal Reserve Bank of New York,
with

Michelle A. Smith
Assistant Secretary

Christine Cumming
First Vice President of the Federal Reserve Bank of
New York, as alternate.
Jeffrey M. Lacker
President of the Federal Reserve Bank of Richmond,
with
Eric Rosengren
President of the Federal Reserve Bank of Boston, as
alternate.
Sandra Pianalto
President of the Federal Reserve Bank of Cleveland,
with
Charles L. Evans
President of the Federal Reserve Bank of Chicago, as
alternate.
Dennis P. Lockhart
President of the Federal Reserve Bank of Atlanta,
with
James Bullard
President of the Federal Reserve Bank of St. Louis,
as alternate.
John C. Williams
President of the Federal Reserve Bank of
San Francisco, with
Esther L. George
President of the Federal Reserve Bank of Kansas
City, as alternate.
By unanimous vote, the following officers of the Federal Open Market Committee were selected to serve
until the selection of their successors at the first regularly scheduled meeting of the Committee in 2013:
Ben Bernanke
Chairman
William C. Dudley
Vice Chairman
William B. English
Secretary and Economist

Matthew M. Luecke
Assistant Secretary

Scott G. Alvarez
General Counsel
Thomas Baxter
Deputy General Counsel
Richard M. Ashton
Assistant General Counsel
Steven B. Kamin
Economist
David W. Wilcox
Economist
David Altig
Thomas A. Connors
Michael P. Leahy
William Nelson
Simon Potter
David Reifschneider
Glenn D. Rudebusch
Mark S. Sniderman
William Wascher
John A. Weinberg
Associate Economists
By unanimous vote, the Federal Reserve Bank of
New York was selected to execute transactions for
the System Open Market Account.
By unanimous vote, Brian Sack was selected to serve
at the pleasure of the Committee as Manager, System
Open Market Account, on the understanding that his
selection was subject to being satisfactory to the Federal Reserve Bank of New York.
Secretary’s note: Advice subsequently was
received that the selection of Mr. Sack as Manager
was satisfactory to the Board of Directors of the
Federal Reserve Bank of New York.
By unanimous vote, the Authorization for Domestic
Open Market Operations was amended to allow lend-

Minutes of Federal Open Market Committee Meetings | January

ing of securities on longer than an overnight basis to
accommodate weekend, holiday, and similar trading
conventions. The Guidelines for the Conduct of
System Open Market Operations in Federal-Agency
Issues remained suspended.

Authorization for Domestic Open Market
Operations (Amended January 24, 2012)
1. The Federal Open Market Committee authorizes
and directs the Federal Reserve Bank of New
York, to the extent necessary to carry out the
most recent domestic policy directive adopted at
a meeting of the Committee:
A. To buy or sell U.S. Government securities,
including securities of the Federal Financing
Bank, and securities that are direct obligations of, or fully guaranteed as to principal
and interest by, any agency of the United
States in the open market, from or to securities dealers and foreign and international
accounts maintained at the Federal Reserve
Bank of New York, on a cash, regular, or
deferred delivery basis, for the System Open
Market Account at market prices, and, for
such Account, to exchange maturing U.S.
Government and Federal agency securities
with the Treasury or the individual agencies
or to allow them to mature without
replacement;
B. To buy or sell in the open market U.S. Government securities, and securities that are
direct obligations of, or fully guaranteed as to
principal and interest by, any agency of the
United States, for the System Open Market
Account under agreements to resell or repurchase such securities or obligations (including
such transactions as are commonly referred
to as repo and reverse repo transactions) in
65 business days or less, at rates that, unless
otherwise expressly authorized by the Committee, shall be determined by competitive
bidding, after applying reasonable limitations
on the volume of agreements with individual
counterparties.
2. In order to ensure the effective conduct of open
market operations, the Federal Open Market
Committee authorizes the Federal Reserve Bank
of New York to use agents in agency MBS-related
transactions.

127

3. In order to ensure the effective conduct of open
market operations, the Federal Open Market
Committee authorizes the Federal Reserve Bank
of New York to lend on an overnight basis U.S.
Government securities and securities that are
direct obligations of any agency of the United
States, held in the System Open Market Account,
to dealers at rates that shall be determined by
competitive bidding. The Federal Reserve Bank
of New York shall set a minimum lending fee
consistent with the objectives of the program and
apply reasonable limitations on the total amount
of a specific issue that may be auctioned and on
the amount of securities that each dealer may
borrow. The Federal Reserve Bank of New York
may reject bids which could facilitate a dealer’s
ability to control a single issue as determined
solely by the Federal Reserve Bank of New York.
The Federal Reserve Bank of New York may lend
securities on longer than an overnight basis to
accommodate weekend, holiday, and similar trading conventions.
4. In order to ensure the effective conduct of open
market operations, while assisting in the provision
of short-term investments for foreign and international accounts maintained at the Federal
Reserve Bank of New York and accounts maintained at the Federal Reserve Bank of New York
as fiscal agent of the United States pursuant to
Section 15 of the Federal Reserve Act, the Federal Open Market Committee authorizes and
directs the Federal Reserve Bank of New York:
A. for System Open Market Account, to sell
U.S. Government securities, and securities
that are direct obligations of, or fully guaranteed as to principal and interest by, any
agency of the United States, to such accounts
on the bases set forth in paragraph 1.A under
agreements providing for the resale by such
accounts of those securities in 65 business
days or less on terms comparable to those
available on such transactions in the market; and
B. for New York Bank account, when appropriate, to undertake with dealers, subject to the
conditions imposed on purchases and sales of
securities in paragraph l.B, repurchase agreements in U.S. Government securities, and
securities that are direct obligations of, or
fully guaranteed as to principal and interest
by, any agency of the United States, and to

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99th Annual Report | 2012

arrange corresponding sale and repurchase
agreements between its own account and
such foreign, international, and fiscal agency
accounts maintained at the Bank.
Transactions undertaken with such accounts
under the provisions of this paragraph may provide for a service fee when appropriate.
5. In the execution of the Committee’s decision
regarding policy during any intermeeting period,
the Committee authorizes and directs the Federal
Reserve Bank of New York, upon the instruction
of the Chairman of the Committee, to adjust
somewhat in exceptional circumstances the degree
of pressure on reserve positions and hence the
intended federal funds rate and to take actions
that result in material changes in the composition
and size of the assets in the System Open Market
Account other than those anticipated by the
Committee at its most recent meeting. Any such
adjustment shall be made in the context of the
Committee’s discussion and decision at its most
recent meeting and the Committee’s long-run
objectives for price stability and sustainable economic growth, and shall be based on economic,
financial, and monetary developments during the
intermeeting period. Consistent with Committee
practice, the Chairman, if feasible, will consult
with the Committee before making any
adjustment.
The Committee voted to reaffirm the Authorization for Foreign Currency Operations, the Foreign Currency Directive, and the Procedural
Instructions with Respect to Foreign Currency
Operations as shown below. The votes to reaffirm these documents included approval of the
System’s warehousing agreement with the U.S.
Treasury. Mr. Lacker dissented in the votes on
the Authorization for Foreign Currency Operations and the Foreign Currency Directive to
indicate his opposition to foreign currency intervention by the Federal Reserve. In his view, such
intervention would be ineffective if it did not
also signal a shift in domestic monetary policy;
and if it did signal such a shift, it could potentially compromise the Federal Reserve’s monetary policy independence.

Authorization for Foreign Currency
Operations (Reaffirmed January 24, 2012)
1. The Federal Open Market Committee authorizes
and directs the Federal Reserve Bank of New
York, for System Open Market Account, to the
extent necessary to carry out the Committee’s foreign currency directive and express authorizations
by the Committee pursuant thereto, and in conformity with such procedural instructions as the
Committee may issue from time to time:
A. To purchase and sell the following foreign
currencies in the form of cable transfers
through spot or forward transactions on the
open market at home and abroad, including
transactions with the U.S. Treasury, with the
U.S. Exchange Stabilization Fund established
by Section 10 of the Gold Reserve Act of
1934, with foreign monetary authorities, with
the Bank for International Settlements, and
with other international financial institutions:
Australian dollars
Brazilian reais
Canadian dollars
Danish kroner
euro
Japanese yen
Korean won
Mexican pesos
New Zealand dollars
Norwegian kroner
Pounds sterling
Singapore dollars
Swedish kronor
Swiss francs
B. To hold balances of, and to have outstanding
forward contracts to receive or to deliver, the
foreign currencies listed in paragraph A
above.
C. To draw foreign currencies and to permit foreign banks to draw dollars under the reciprocal currency arrangements listed in paragraph
2 below, provided that drawings by either
party to any such arrangement shall be fully

Minutes of Federal Open Market Committee Meetings | January

liquidated within 12 months after any
amount outstanding at that time was first
drawn, unless the Committee, because of
exceptional circumstances, specifically authorizes a delay.
D. To maintain an overall open position in all
foreign currencies not exceeding $25.0 billion.
For this purpose, the overall open position in
all foreign currencies is defined as the sum
(disregarding signs) of net positions in individual currencies, excluding changes in dollar
value due to foreign exchange rate movements and interest accruals. The net position
in a single foreign currency is defined as
holdings of balances in that currency, plus
outstanding contracts for future receipt,
minus outstanding contracts for future delivery of that currency, i.e., as the sum of these
elements with due regard to sign.
2. The Federal Open Market Committee directs the
Federal Reserve Bank of New York to maintain
reciprocal currency arrangements (“swap”
arrangements) for the System Open Market
Account for periods up to a maximum of
12 months with the following foreign banks,
which are among those designated by the Board
of Governors of the Federal Reserve System
under Section 214.5 of Regulation N, Relations
with Foreign Banks and Bankers, and with the
approval of the Committee to renew such
arrangements on maturity:
Foreign bank
Bank of Canada
Bank of Mexico

Amount of arrangement
(millions of dollars equivalent)
2,000
3,000

Any changes in the terms of existing swap
arrangements, and the proposed terms of any
new arrangements that may be authorized, shall
be referred for review and approval to the
Committee.
3. All transactions in foreign currencies undertaken
under paragraph 1.A. above shall, unless otherwise expressly authorized by the Committee, be at
prevailing market rates. For the purpose of providing an investment return on System holdings
of foreign currencies or for the purpose of adjusting interest rates paid or received in connection
with swap drawings, transactions with foreign

129

central banks may be undertaken at non-market
exchange rates.
4. It shall be the normal practice to arrange with
foreign central banks for the coordination of foreign currency transactions. In making operating
arrangements with foreign central banks on
System holdings of foreign currencies, the Federal
Reserve Bank of New York shall not commit
itself to maintain any specific balance, unless
authorized by the Federal Open Market Committee. Any agreements or understandings concerning the administration of the accounts maintained by the Federal Reserve Bank of New York
with the foreign banks designated by the Board of
Governors under Section 214.5 of Regulation N
shall be referred for review and approval to the
Committee.
5. Foreign currency holdings shall be invested to
ensure that adequate liquidity is maintained to
meet anticipated needs and so that each currency
portfolio shall generally have an average duration
of no more than 18 months (calculated as
Macaulay duration). Such investments may
include buying or selling outright obligations of,
or fully guaranteed as to principal and interest by,
a foreign government or agency thereof; buying
such securities under agreements for repurchase
of such securities; selling such securities under
agreements for the resale of such securities; and
holding various time and other deposit accounts
at foreign institutions. In addition, when appropriate in connection with arrangements to provide investment facilities for foreign currency
holdings, U.S. Government securities may be purchased from foreign central banks under agreements for repurchase of such securities within 30
calendar days.
6. All operations undertaken pursuant to the preceding paragraphs shall be reported promptly to
the Foreign Currency Subcommittee and the
Committee. The Foreign Currency Subcommittee
consists of the Chairman and Vice Chairman of
the Committee, the Vice Chairman of the Board
of Governors, and such other member of the
Board as the Chairman may designate (or in the
absence of members of the Board serving on the
Subcommittee, other Board members designated
by the Chairman as alternates, and in the absence
of the Vice Chairman of the Committee, the Vice
Chairman’s alternate). Meetings of the Subcommittee shall be called at the request of any mem-

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99th Annual Report | 2012

ber, or at the request of the Manager, System
Open Market Account (“Manager”), for the purposes of reviewing recent or contemplated operations and of consulting with the Manager on
other matters relating to the Manager’s responsibilities. At the request of any member of the Subcommittee, questions arising from such reviews
and consultations shall be referred for determination to the Federal Open Market Committee.
7. The Chairman is authorized:
A. With the approval of the Committee, to enter
into any needed agreement or understanding
with the Secretary of the Treasury about the
division of responsibility for foreign currency
operations between the System and the
Treasury;
B. To keep the Secretary of the Treasury fully
advised concerning System foreign currency
operations, and to consult with the Secretary
on policy matters relating to foreign currency
operations;
C. From time to time, to transmit appropriate
reports and information to the National
Advisory Council on International Monetary
and Financial Policies.
8. Staff officers of the Committee are authorized to
transmit pertinent information on System foreign
currency operations to appropriate officials of the
Treasury Department.
9. All Federal Reserve Banks shall participate in the
foreign currency operations for System Account
in accordance with paragraph 3G(1) of the Board
of Governors’ Statement of Procedure with
Respect to Foreign Relationships of Federal
Reserve Banks dated January 1, 1944.

Foreign Currency Directive (Reaffirmed
January 24, 2012)
1. System operations in foreign currencies shall generally be directed at countering disorderly market
conditions, provided that market exchange rates
for the U.S. dollar reflect actions and behavior
consistent with IMF Article IV, Section 1.
2. To achieve this end the System shall:

A. Undertake spot and forward purchases and
sales of foreign exchange.
B. Maintain reciprocal currency (“swap”)
arrangements with selected foreign central
banks.
C. Cooperate in other respects with central
banks of other countries and with international monetary institutions.
3. Transactions may also be undertaken:
A. To adjust System balances in light of probable future needs for currencies.
B. To provide means for meeting System and
Treasury commitments in particular currencies, and to facilitate operations of the
Exchange Stabilization Fund.
C. For such other purposes as may be expressly
authorized by the Committee.
4. System foreign currency operations shall be
conducted:
A. In close and continuous consultation and
cooperation with the United States Treasury;
B. In cooperation, as appropriate, with foreign
monetary authorities; and
C. In a manner consistent with the obligations
of the United States in the International
Monetary Fund regarding exchange arrangements under IMF Article IV.

Procedural Instructions with Respect to
Foreign Currency Operations (Reaffirmed
January 24, 2012)
In conducting operations pursuant to the authorization and direction of the Federal Open Market Committee as set forth in the Authorization for Foreign
Currency Operations and the Foreign Currency
Directive, the Federal Reserve Bank of New York,
through the Manager, System Open Market Account
(“Manager”), shall be guided by the following procedural understandings with respect to consultations
and clearances with the Committee, the Foreign Currency Subcommittee, and the Chairman of the Committee, unless otherwise directed by the Committee.

Minutes of Federal Open Market Committee Meetings | January

131

All operations undertaken pursuant to such clearances shall be reported promptly to the Committee.

By unanimous vote, the Committee reaffirmed its
Program for Security of FOMC Information.

1. The Manager shall clear with the Subcommittee
(or with the Chairman, if the Chairman believes
that consultation with the Subcommittee is not
feasible in the time available):

Statement on Longer-Run Goals and Monetary
Policy Strategy
Following the Committee’s disposition of organizational matters, participants considered a revised draft
of a statement of principles regarding the FOMC’s
longer-run goals and monetary policy strategy. The
revisions reflected discussion of an earlier draft during the Committee’s December meeting as well as
comments received over the intermeeting period. The
Chairman noted that the proposed statement did not
represent a change in the Committee’s policy
approach. Instead, the statement was intended to
help enhance the transparency, accountability, and
effectiveness of monetary policy.

A. Any operation that would result in a change
in the System’s overall open position in foreign currencies exceeding $300 million on any
day or $600 million since the most recent
regular meeting of the Committee.
B. Any operation that would result in a change
on any day in the System’s net position in a
single foreign currency exceeding $150 million, or $300 million when the operation is
associated with repayment of swap drawings.
C. Any operation that might generate a substantial volume of trading in a particular currency by the System, even though the change
in the System’s net position in that currency
might be less than the limits specified in 1.B.
D. Any swap drawing proposed by a foreign
bank not exceeding the larger of (i) $200 million or (ii) 15 percent of the size of the swap
arrangement.
2. The Manager shall clear with the Committee (or
with the Subcommittee, if the Subcommittee
believes that consultation with the full Committee
is not feasible in the time available, or with the
Chairman, if the Chairman believes that consultation with the Subcommittee is not feasible in
the time available):
A. Any operation that would result in a change
in the System’s overall open position in foreign currencies exceeding $1.5 billion since
the most recent regular meeting of the
Committee.
B. Any swap drawing proposed by a foreign
bank exceeding the larger of (i) $200 million
or (ii) 15 percent of the size of the swap
arrangement.
3. The Manager shall also consult with the Subcommittee or the Chairman about proposed swap
drawings by the System and about any operations
that are not of a routine character.

In presenting the draft statement on behalf of the
subcommittee on communications, Governor Yellen
pointed out several key elements. First, the statement
expresses the FOMC’s commitment to explain its
policy decisions as clearly as possible. Second, the
statement specifies a numerical inflation goal in a
context that firmly underscores the Federal Reserve’s
commitment to fostering both parts of its dual mandate. Third, the statement is intended to serve as an
overarching set of principles that would be reaffirmed during the Committee’s organizational meeting each year, and the bar for amending the statement would be high.
All participants but one supported adopting the
revised statement of principles regarding longer-run
goals and monetary policy strategy, which is reproduced below.
“Following careful deliberations at its recent
meetings, the Federal Open Market Committee
(FOMC) has reached broad agreement on the
following principles regarding its longer-run
goals and monetary policy strategy. The Committee intends to reaffirm these principles and to
make adjustments as appropriate at its annual
organizational meeting each January.
The FOMC is firmly committed to fulfilling its
statutory mandate from the Congress of promoting maximum employment, stable prices,
and moderate long-term interest rates. The
Committee seeks to explain its monetary policy
decisions to the public as clearly as possible.
Such clarity facilitates well-informed decisionmaking by households and businesses, reduces

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99th Annual Report | 2012

economic and financial uncertainty, increases
the effectiveness of monetary policy, and
enhances transparency and accountability,
which are essential in a democratic society.
Inflation, employment, and long-term interest
rates fluctuate over time in response to economic
and financial disturbances. Moreover, monetary
policy actions tend to influence economic activity and prices with a lag.
Therefore, the Committee’s policy decisions
reflect its longer-run goals, its medium-term outlook, and its assessments of the balance of risks,
including risks to the financial system that could
impede the attainment of the Committee’s goals.
The inflation rate over the longer run is primarily determined by monetary policy, and hence
the Committee has the ability to specify a
longer-run goal for inflation. The Committee
judges that inflation at the rate of 2 percent, as
measured by the annual change in the price
index for personal consumption expenditures, is
most consistent over the longer run with the
Federal Reserve’s statutory mandate. Communicating this inflation goal clearly to the public
helps keep longer-term inflation expectations
firmly anchored, thereby fostering price stability
and moderate long-term interest rates and
enhancing the Committee’s ability to promote
maximum employment in the face of significant
economic disturbances.
The maximum level of employment is largely
determined by nonmonetary factors that affect
the structure and dynamics of the labor market.
These factors may change over time and may
not be directly measurable. Consequently, it
would not be appropriate to specify a fixed goal
for employment; rather, the Committee’s policy
decisions must be informed by assessments of
the maximum level of employment, recognizing
that such assessments are necessarily uncertain
and subject to revision. The Committee considers a wide range of indicators in making these
assessments. Information about Committee participants’ estimates of the longer-run normal
rates of output growth and unemployment is
published four times per year in the FOMC’s
Summary of Economic Projections. For
example, in the most recent projections, FOMC
participants’ estimates of the longer-run normal
rate of unemployment had a central tendency of

5.2 percent to 6.0 percent, roughly unchanged
from last January but substantially higher than
the corresponding interval several years earlier.
In setting monetary policy, the Committee seeks
to mitigate deviations of inflation from its
longer-run goal and deviations of employment
from the Committee’s assessments of its maximum level. These objectives are generally
complementary. However, under circumstances
in which the Committee judges that the objectives are not complementary, it follows a balanced approach in promoting them, taking into
account the magnitude of the deviations and the
potentially different time horizons over which
employment and inflation are projected to
return to levels judged consistent with its
mandate.”
All FOMC members voted to adopt this statement
except Mr. Tarullo, who abstained because he questioned the ultimate usefulness of the statement in
promoting better communication of the Committee’s
policy strategy.
Developments in Financial Markets and the
Federal Reserve’s Balance Sheet
The Manager of the System Open Market Account
(SOMA) reported on developments in domestic and
foreign financial markets during the period since the
Federal Open Market Committee (FOMC) met on
December 13, 2011. He also reported on System
open market operations, including the ongoing reinvestment into agency-guaranteed mortgage-backed
securities (MBS) of principal payments received on
SOMA holdings of agency debt and agencyguaranteed MBS as well as the operations related to
the maturity extension program authorized at the
September 20–21 FOMC meeting. By unanimous
vote, the Committee ratified the Desk’s domestic
transactions over the intermeeting period. There were
no intervention operations in foreign currencies for
the System’s account over the intermeeting period.
Staff Review of the Economic Situation
The information reviewed at the January 24–25 meeting indicated that U.S. economic activity continued
to expand moderately, while global growth appeared
to be slowing. Overall conditions in the labor market
improved further, although the unemployment rate
remained elevated. Consumer price inflation was subdued, and measures of long-run inflation expectations remained stable.

Minutes of Federal Open Market Committee Meetings | January

The unemployment rate declined to 8.5 percent in
December; however, both long-duration unemployment and the share of workers employed part time
for economic reasons were still quite high. Private
nonfarm employment continued to expand moderately, while state and local government employment
decreased at a slower pace than earlier in 2011. Some
indicators of firms’ hiring plans improved. Initial
claims for unemployment insurance edged lower, on
balance, since the middle of December but remained
at a level consistent with only modest employment
growth.
Industrial production expanded in November and
December, on net, and the rate of manufacturing
capacity utilization moved up. Motor vehicle assemblies were scheduled to increase, on balance, in the
first quarter of 2012, and broader indicators of
manufacturing activity, such as the diffusion indexes
of new orders from the national and regional manufacturing surveys, were at levels that suggested moderate growth in production in the near term.
Real personal consumption expenditures continued
to rise moderately in November, boosted by spending
for motor vehicles and other durables, although
households’ real disposable income edged down. In
December, however, nominal retail sales excluding
purchases at motor vehicle and parts outlets
declined, and sales of motor vehicles also dropped
slightly. Consumer sentiment improved further in
early January but was still at a low level.
Activity in the housing market improved a bit in
recent months but continued to be held down by the
large overhang of foreclosed and distressed properties, uncertainty about future home prices, and tight
underwriting standards for mortgage loans. Starts
and permits for new single-family homes rose in
November and December but remained only a little
above the depressed levels seen earlier in 2011. Sales
of new and existing homes also firmed somewhat in
recent months, but home prices continued to trend
lower.
Real business expenditures on equipment and software appeared to have decelerated in the fourth quarter. Nominal orders and shipments of nondefense
capital goods excluding aircraft declined in November for a second month. Forward-looking indicators
of firms’ equipment spending were mixed: Some survey measures of business conditions and capital
spending plans improved, but corporate bond
spreads continued to be elevated and analysts’ earn-

133

ings expectations for producers of capital goods
remained muted. Nominal business spending for
nonresidential construction was unchanged in
November and continued to be held back by high
vacancy rates and tight credit conditions for construction loans. Inventories in most industries looked
to be well aligned with sales, though motor vehicle
stocks remained lean.
Monthly data for federal government spending
pointed to a significant decline in real defense purchases in the fourth quarter. Real state and local government purchases seemed to be decreasing at a
slower rate than during earlier quarters, as the pace
of reductions in payrolls eased and construction
spending leveled off in recent months.
The U.S. international trade deficit widened in
November as exports fell and imports rose. Exports
declined in most major categories, with the exception
of consumer goods. Exports of industrial supplies
and materials were especially weak, though the weakness was concentrated in a few particularly volatile
categories and reflected, in part, declines in prices.
The rise in imports largely reflected higher imports of
petroleum products and automotive products, which
more than offset decreases in most other broad categories of imports.
Overall U.S. consumer prices as measured by the
price index for personal consumption expenditures
were unchanged in November; as measured by the
consumer price index, they were flat in December as
well. Consumer energy prices decreased in recent
months, while increases in consumer food prices
slowed. Consumer prices excluding food and energy
rose modestly in the past two months. Near-term
inflation expectations from the Thomson Reuters/
University of Michigan Surveys of Consumers were
essentially unchanged in early January, and longerterm inflation expectations remained stable.
Available measures of labor compensation indicated
that wage gains continued to be modest. Average
hourly earnings for all employees posted a moderate
gain in December, and their rate of increase from
12 months earlier remained slow.
Recent indicators of foreign economic activity
pointed to a substantial deceleration in the fourth
quarter of 2011. In the euro area, retail sales and
industrial production were below their third-quarter
averages in both October and November. Economic
activity in much of Asia was disrupted by the effects

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of severe flooding in Thailand, which affected supply
chains in the region. Twelve-month inflation rates
receded in several advanced and emerging market
economies, and most central banks maintained
policy rates or eased further while continuing to provide significant liquidity support.
Staff Review of the Financial Situation
Developments in Europe continued to be a central
focus for investors over the intermeeting period as
concerns persisted about the prospects for a durable
solution to the European fiscal and financial difficulties. Nevertheless, market sentiment toward Europe
appeared to brighten a bit, and U.S. economic data
releases were somewhat better than investors
expected, leading to some improvement in conditions
in financial markets.
On balance over the period, the expected path for the
federal funds rate implied by money market futures
quotes was essentially unchanged. Yields on nominal
Treasury securities rose slightly at intermediate and
longer maturities. Indicators of inflation compensation derived from nominal and inflation-protected
Treasury securities edged up.
U.S. financial institutions reportedly retained ready
access to short-term funding markets; there were no
significant dislocations in those markets over yearend. Dollar funding pressures for European banks
eased slightly. While spreads of the London interbank offered rate (Libor) over overnight index swap
(OIS) rates of the same maturity remained elevated,
rates for unsecured overnight commercial paper (CP)
issued by some entities with European parents
declined substantially following the lowering of
charges on the central bank liquidity swap lines with
the Federal Reserve, the implementation by the European Central Bank (ECB) of its first three-year
longer-term refinancing operation (LTRO), and the
passage of year-end. In secured funding markets,
spreads of overnight asset-backed CP rates over overnight unsecured CP rates also declined, and the general collateral repurchase agreement, or repo, market
continued to function normally.
Indicators of financial stress eased somewhat over
the intermeeting period, although they generally continued to be elevated. Market-based measures of possible spillovers from troubles at particular financial
firms to the broader financial system were below
their levels in the fall but remained above their levels
prior to the financial crisis. Initial fourth-quarter
earnings reports for large bank holding companies

were mixed relative to market expectations, with poor
capital market revenues weighing on the profits of
institutions with significant trading operations.
Although credit default swap (CDS) spreads of most
large domestic bank holding companies remained
elevated, they moved lower over the intermeeting
period, and some institutions took advantage of easing credit conditions by issuing significant quantities
of new long-term debt. Equity prices of most large
domestic financial institutions outperformed the
broader market, on net, over the intermeeting period.
Nonetheless, the ratio of the market value of bank
equity to its book value remained low for some large
financial firms. Responses to the December Senior
Credit Officer Opinion Survey on Dealer Financing
Terms indicate that, since August, securities dealers
have devoted increased time and attention to the
management of concentrated credit exposures to
other financial intermediaries, pointing to increased
concern over counterparty risk.
Broad equity price indexes increased more than
6 percent, on net, over the intermeeting period, and
option-implied equity volatility declined notably.
Yields on investment-grade corporate bonds declined
a bit relative to those on comparable-maturity Treasury securities, while spreads of speculative-grade corporate bond yields over yields on Treasury securities
decreased noticeably. Indicators of the credit quality
of nonfinancial corporations continued to be solid.
Conditions in the secondary market for leveraged
loans were stable, with median bid prices about
unchanged. Financing conditions for large nonfinancial businesses generally remained favorable. Bond
issuance by investment-grade nonfinancial corporations was robust, though below its elevated November pace, while issuance by lower-rated firms slowed,
likely owing in part to seasonal factors. Issuance of
leveraged loans was relatively modest in the fourth
quarter compared with its rapid pace earlier in the
year. Share repurchases and cash-financed mergers
by nonfinancial firms maintained their recent
strength in the third quarter, leaving net equity issuance deeply negative.
Financing conditions for commercial real estate
(CRE) remained strained, and issuance of commercial mortgage-backed securities was very light in the
fourth quarter. Responses to the January Senior
Loan Officer Opinion Survey on Bank Lending Practices (SLOOS) indicated that bank CRE lending
standards continued to be extraordinarily tight, but
some banks reported having reduced the spreads of
loan rates over their cost of funds (compared with a

Minutes of Federal Open Market Committee Meetings | January

year ago) for the first time since 2007. Delinquency
rates on commercial mortgages remained elevated,
and CRE price indexes continued to fluctuate around
levels substantially lower than their 2007 peaks.
Conditions in residential mortgage markets remained
extremely tight. Although mortgage interest rates and
yields on current-coupon agency MBS edged down
to near their historical lows, mortgage refinancing
activity continued to be subdued amid tight underwriting standards and low levels of home equity.
Mortgage delinquency rates, while improving gradually, remained elevated relative to pre-crisis norms,
and house prices continued to move lower. The price
of subprime residential mortgage-backed securities
(RMBS), as measured by the ABX index, rose over
the intermeeting period, consistent with similar
changes for other higher-risk fixed-income securities.
RMBS prices were supported by reports of the sale
of a significant portion of the RMBS held in the
Maiden Lane II portfolio.
On the whole, conditions in consumer credit markets
showed signs of improvement. Consumer credit
increased in November, while delinquency rates on
credit card loans in securitized pools held steady in
November at historically low levels. Data on credit
card solicitations and from responses to the January
SLOOS suggested that lending standards on consumer loans continued to ease modestly.
Financing conditions for state and local governments
were mixed. Gross long-term issuance of municipal
bonds remained robust in December, with continued
strength in new issuance for capital projects. CDS
spreads for states inched down further over the intermeeting period, and yields on long-term general obligation municipal bonds fell notably. However, downgrades of municipal bonds continued to substantially
outpace upgrades in the third quarter.
In the fourth quarter, bank credit continued to
increase as banks accumulated agency MBS and
growth of total loans picked up. Core loans—the
sum of commercial and industrial (C&I) loans, real
estate loans, and consumer loans—expanded modestly. Growth of C&I loans at domestic banks was
robust but was partly offset by weakness at U.S.
branches and agencies of European banks. Noncore
loans rose sharply, on net, reflecting in part a surge in
such loans at the U.S. branches and agencies of
European institutions. Responses to the January
SLOOS indicated that, in the aggregate, loan demand

135

strengthened slightly and lending standards eased a
bit further in the fourth quarter.
M2 increased at an annual rate of 5¼ percent in
December, likely reflecting continued demand for
safe and liquid assets given investor concerns over
developments in Europe. In addition, demand deposits rose rapidly around year-end, reportedly because
lenders in short-term funding markets chose to leave
substantial balances with banks over the turn of the
year. The monetary base increased in December,
largely reflecting growth in currency. Reserve balances were roughly unchanged over the intermeeting
period.
International financial markets seemed somewhat
calmer over the intermeeting period than they had
been in previous months, and the funding conditions
faced by most European financial institutions and
sovereigns eased somewhat in the wake of the ECB’s
first three-year LTRO. Short-term euro interest rates
moved lower as euro-area institutions drew a substantial amount of three-year funds from the ECB,
and dollar funding costs for European banks also
appeared to decline. Spreads of yields on Italian and
Spanish government debt over those on German
bunds narrowed over the intermeeting period, with
spreads on shorter-term debt falling particularly
noticeably. The apparent improvement in market sentiment was not diminished by news late in the period
that Standard & Poor’s lowered its long-term sovereign bond ratings of nine euro-area countries and the
European Financial Stability Facility or by news that
negotiations over the terms of a voluntary privatesector debt exchange for Greece had not yet reached
a conclusion.
The staff’s broad index of the foreign exchange value
of the dollar declined slightly over the intermeeting
period. While the dollar fell against most other currencies, it appreciated against the euro. Foreign stock
markets generally ended the period higher, with headline equity indexes in Europe and the emerging market economies up substantially, although emerging
market equity and bond funds continued to experience outflows on net during the period.
Staff Economic Outlook
In the economic forecast prepared for the January
FOMC meeting, the staff’s projection for the growth
in real gross domestic product (GDP) in the near
term was revised down a bit. The revision reflected
the apparent decline in federal defense purchases and

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the somewhat shallower trajectory for consumer
spending in recent months; the recent data on the
labor market, production, and other spending categories were, on balance, roughly in line with the
staff’s expectations at the time of the previous forecast. The medium-term projection for real GDP
growth in the January forecast was little changed
from the one presented in December. Although the
developments in Europe were expected to continue to
weigh on the U.S. economy during the first half of
this year, the staff still projected that real GDP
growth would accelerate gradually in 2012 and 2013,
supported by accommodative monetary policy, further improvements in credit availability, and rising
consumer and business sentiment. The increase in
real GDP was expected to be sufficient to reduce the
slack in product and labor markets only slowly over
the projection period, and the unemployment rate
was anticipated to still be high at the end of 2013.
The staff’s forecast for inflation was essentially
unchanged from the projection prepared for the
December FOMC meeting. With stable long-run
inflation expectations and substantial slack in labor
and product markets anticipated to persist over the
forecast period, the staff continued to project that
inflation would remain subdued in 2012 and 2013.
Participants’ Views on Current Conditions and
the Economic Outlook
In conjunction with this FOMC meeting, all participants—the five members of the Board of Governors
and the presidents of the 12 Federal Reserve Banks—
provided projections of output growth, the unemployment rate, and inflation for each year from 2011
through 2014 and over the longer run. Longer-run
projections represent each participant’s assessment of
the rate to which each variable would be expected to
converge, over time, under appropriate monetary
policy and in the absence of further shocks to the
economy. Starting with this meeting, participants
also provided assessments of the path for the target
federal funds rate that they view as appropriate and
compatible with their individual economic projections. Participants’ economic projections and policy
assessments are described in more detail in the Summary of Economic Projections, which is attached as
an addendum to these minutes.
In their discussion of the economic situation and
outlook, meeting participants agreed that the information received since the Committee met in December suggested that the economy had been expanding
moderately, notwithstanding some slowing in growth

abroad. In general, labor market indicators pointed
to some further improvement in labor market conditions, but progress was gradual and the unemployment rate remained elevated. Household spending
had continued to advance at a moderate pace despite
still-sluggish growth in real disposable income, but
growth in business fixed investment had slowed. The
housing sector remained depressed, with very low
levels of activity; there were, however, signs of
improvement in some local housing markets. Many
participants observed that some indicators bearing
on the economy’s recent performance had shown
greater-than-expected improvement, but a number
also noted less favorable data; one noted that growth
in final sales appeared to have slowed in the fourth
quarter of last year even as output growth picked up.
Inflation had been subdued in recent months, there
was little evidence of wage or cost pressures, and
longer-term inflation expectations had remained
stable.
With respect to the economic outlook, participants
generally anticipated that economic growth over
coming quarters would be modest and, consequently,
expected that the unemployment rate would decline
only gradually. A number of factors were seen as
likely to restrain the pace of economic expansion,
including the slowdown in economic activity abroad,
fiscal tightening in the United States, the weak housing market, further household deleveraging, high levels of uncertainty among households and businesses,
and the possibility of increased volatility in financial
markets until the fiscal and banking issues in the euro
area are more fully addressed. Participants continued
to expect these headwinds to ease over time and so
anticipated that the recovery would gradually gain
strength. However, participants agreed that strains in
global financial markets continued to pose significant
downside risks to the economic outlook. With unemployment expected to remain elevated, and with
longer-term inflation expectations stable, almost all
participants expected inflation to remain subdued in
coming quarters—that is, to run at or below the
2 percent level that the Committee judges most consistent with its statutory mandate over the longer run.
In discussing the household sector, meeting participants noted that consumer spending had grown moderately in recent months. Consumer sentiment had
improved since last summer, though its level was still
quite low. Business contacts in the retail sector
reported generally satisfactory holiday sales, but
high-end retailers saw strong gains while lower-end

Minutes of Federal Open Market Committee Meetings | January

retailers saw mixed results. Contacts also reported
widespread discounting. Major express delivery companies indicated very high volumes at year-end and
into January. Several participants observed that consumer spending had outpaced growth in personal disposable income last year, and a few noted that households remained pessimistic about their income prospects and uncertain about the economic outlook.
These observations suggested that growth of consumer spending might slow. However, a few other
participants pointed to increasing job gains in recent
months as contributing to an improving trend in real
incomes and thus supporting continued moderate
growth in consumer spending.
Reports from business contacts indicated that activity
in the manufacturing, energy, and agricultural sectors
continued to advance in recent months. Businesses
generally reported that they remained cautious
regarding capital spending and hiring; some contacts
cited uncertainty about the economic outlook and
about fiscal and regulatory policy. Nonetheless, business contacts had become somewhat more optimistic,
with more contacts reporting plans to expand capacity and payrolls. Some companies indicated that they
planned to relocate some production from abroad to
the United States. A few participants noted that
national and District surveys of firms’ capital spending plans suggested that the recent slowing in business fixed investment was partly temporary. The
combination of high energy prices and availability of
new drilling technologies was promoting strong
growth in investment outlays in the energy sector.
Participants generally saw the housing sector as still
depressed. The level of activity remained quite weak,
house prices were continuing to decline in most areas,
and the overhang of foreclosed and distressed properties was still substantial. Nonetheless, there were
some small signs of improvement. The inventory of
unsold homes had declined, though in part because
the foreclosure process had slowed, and issuance of
permits for new single-family homes had risen from
its lows. One participant again noted reports from
some homebuilders suggesting that land prices were
edging up and that financing was available from nonbank sources. Another participant cited reports from
business contacts indicating that credit standards in
mortgage lending were becoming somewhat less
stringent. Yet another noted that recent changes to
the Home Affordable Refinance Program, which
were intended to streamline the refinancing of performing high-loan-to-value mortgages, were showing
some success.

137

Participants generally expected that growth of U.S.
exports was likely to be held back in the coming year
by slower global economic growth. In particular, fiscal austerity programs in Europe and stresses in the
European banking system seemed likely to restrain
economic growth there, perhaps with some spillover
to growth in Asia. One participant noted that shipping rates had declined of late, suggesting that a
slowdown in international trade might be under way.
Participants agreed that recent indicators showed
some further gradual improvement in overall labor
market conditions: Payroll employment had
increased somewhat more rapidly in recent months,
new claims for unemployment insurance had trended
lower, and the unemployment rate had declined.
Some business contacts indicated that they planned
to do more hiring this year than last. However,
unemployment—including longer-term unemployment—remained elevated, and the numbers of discouraged workers and people working part time
because they could not find full-time work were also
still quite high. Participants expressed a range of
views on the current extent of slack in the labor market. Very high long-duration unemployment might
indicate a mismatch between unemployed workers’
skills and employers’ needs, suggesting that a substantial part of the increase in unemployment since
the beginning of the recession reflected factors other
than a shortfall in aggregate demand. In contrast, the
quite modest increases in labor compensation of late,
and the large number of workers reporting that they
are working part time because their employers have
cut their hours, suggested that underutilization of
labor was still substantial. A few participants noted
that the recent decline in the unemployment rate
reflected declining labor force participation in large
part, and judged that the decline in the participation
rate was likely to be reversed, at least to some extent,
as the recovery continues and labor demand picks up.
Meeting participants observed that financial conditions improved and financial market stresses eased
somewhat during the intermeeting period: Equity
prices rose, volatility declined, and bank lending conditions appeared to improve. Participants noted that
the ECB’s three-year refinancing operation had
apparently contributed to improved conditions in
European sovereign debt markets. Nonetheless, participants expected that global financial markets
would remain focused on the evolving situation in
Europe and anticipated that continued policy efforts
would be necessary in Europe to fully address the
area’s fiscal and financial problems. U.S. banks

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99th Annual Report | 2012

reported increases in commercial lending as some
European lenders pulled back, and some banking
contacts indicated that creditworthy companies’
demand for credit had increased. A number of participants noted further improvement in the availability of loans to businesses, with a couple of them indicating that small business contacts had reported
increased availability of bank credit. However, a few
other participants commented that small businesses
in their Districts continued to face difficulty in
obtaining bank loans.
Participants observed that longer-run inflation expectations were still well anchored and also noted that
inflation had been subdued in recent months, partly
reflecting a decline in commodity prices and an easing of supply chain disruptions since mid-2011. In
addition, labor compensation had risen only slowly
and productivity continued to increase. One participant reported that a survey of business inflation
expectations indicated firms were anticipating
increases in unit costs on the order of 1¾ percent this
year, just a bit higher than last year. Looking farther
ahead, participants generally judged that the modest
expansion in economic activity that they were projecting would be consistent with a gradual reduction
in the current wide margins of slack in labor and
product markets and with subdued inflation going
forward. Some remained concerned that, with the
persistence of considerable resource slack, inflation
might continue to drift down and run below
mandate-consistent levels for some time. However, a
couple of participants were concerned that inflation
could rise as the recovery continued and argued that
providing additional monetary accommodation, or
even maintaining the current highly accommodative
stance of monetary policy over the medium run,
would erode the stability of inflation expectations
and risk higher inflation.
Committee participants discussed possible changes
to the forward guidance that has been included in the
Committee’s recent post-meeting statements. Many
participants thought it important to explore means
for better communicating policymakers’ thinking
about future monetary policy and its relationship to
evolving economic conditions. A couple of participants expressed concern that some press reports had
misinterpreted the Committee’s use of a date in its
forward guidance as a commitment about its future
policy decisions. Several participants thought it
would be helpful to provide more information about
the economic conditions that would be likely to warrant maintaining the current target range for the fed-

eral funds rate, perhaps by providing numerical
thresholds for the unemployment and inflation rates.
Different opinions were expressed regarding the
appropriate values of such thresholds, reflecting different assessments of the path for the federal funds
rate that would likely be appropriate to foster the
Committee’s longer-run goals. However, some participants worried that such thresholds would not
accurately or effectively convey the Committee’s
forward-looking approach to monetary policy and
thus would pose difficult communications issues, or
that movements in the unemployment rate, by themselves, would be an unreliable measure of progress
toward maximum employment. Several participants
proposed either dropping or greatly simplifying the
forward guidance in the Committee’s statement,
arguing that information about participants’ assessments of the appropriate future level of the federal
funds rate, which would henceforth be contained in
the Summary of Economic Projections (SEP), made
it unnecessary to include forward guidance in the
post-meeting statement. However, several other participants emphasized that the information regarding
the federal funds rate in the SEP could not substitute
for a formal decision of the members of the FOMC.
Participants agreed to continue exploring approaches
for providing the public with greater clarity about the
linkages between the economic outlook and the
Committee’s monetary policy decisions.

Committee Policy Action
Members viewed the information on U.S. economic
activity received over the intermeeting period as suggesting that the economy had been expanding moderately and generally agreed that the economic outlook
had not changed greatly since they met in December.
While overall labor market conditions had improved
somewhat further and unemployment had declined in
recent months, almost all members viewed the unemployment rate as still elevated relative to levels that
they saw as consistent with the Committee’s mandate
over the longer run. Available data indicated some
slowing in the pace of economic growth in Europe
and in some emerging market economies, pointing to
reduced growth of U.S. exports going forward. With
the economy facing continuing headwinds from the
recent financial crisis and with growth slowing in a
number of U.S. export markets, members generally
expected a modest pace of economic growth over
coming quarters, with the unemployment rate declining only gradually. Strains in global financial markets
continued to pose significant downside risks to economic activity. Inflation had been subdued in recent

Minutes of Federal Open Market Committee Meetings | January

months, and longer-term inflation expectations
remained stable. Members generally anticipated that
inflation over coming quarters would run at or below
the 2 percent level that the Committee judges most
consistent with its mandate.
In their discussion of monetary policy for the period
ahead, members agreed that it would be appropriate
to maintain the existing highly accommodative
stance of monetary policy. In particular, they agreed
to keep the target range for the federal funds rate at
0 to ¼ percent, to continue the program of extending
the average maturity of the Federal Reserve’s holdings of securities as announced in September, and to
retain the existing policies regarding the reinvestment
of principal payments from Federal Reserve holdings
of securities.
With respect to the statement to be released following
the meeting, members agreed that only relatively
small modifications to the first two paragraphs were
needed to reflect the incoming information and the
modest changes to the economic outlook implied by
the recent data. In light of the economic outlook,
almost all members agreed to indicate that the Committee expects to maintain a highly accommodative
stance for monetary policy and currently anticipates
that economic conditions—including low rates of
resource utilization and a subdued outlook for inflation over the medium run—are likely to warrant
exceptionally low levels for the federal funds rate at
least through late 2014, longer than had been indicated in recent FOMC statements. In particular, several members said they anticipated that unemployment would still be well above their estimates of its
longer-term normal rate, and inflation would be at or
below the Committee’s longer-run objective, in late
2014. It was noted that extending the horizon of the
Committee’s forward guidance would help provide
more accommodative financial conditions by shifting
downward investors’ expectations regarding the
future path of the target federal funds rate. Some
members underscored the conditional nature of the
Committee’s forward guidance and noted that it
would be subject to revision in response to significant
changes in the economic outlook.
The Committee also stated that it is prepared to
adjust the size and composition of its securities holdings as appropriate to promote a stronger economic
recovery in a context of price stability. A few members observed that, in their judgment, current and
prospective economic conditions—including elevated
unemployment and inflation at or below the Com-

139

mittee’s objective—could warrant the initiation of
additional securities purchases before long. Other
members indicated that such policy action could
become necessary if the economy lost momentum or
if inflation seemed likely to remain below its
mandate-consistent rate of 2 percent over the
medium run. In contrast, one member judged that
maintaining the current degree of policy accommodation beyond the near term would likely be inappropriate; that member anticipated that a preemptive
tightening of monetary policy would be necessary
before the end of 2014 to keep inflation close to
2 percent.
At the conclusion of the discussion, the Committee
voted to authorize and direct the Federal Reserve
Bank of New York, until it was instructed otherwise,
to execute transactions in the System Account in
accordance with the following domestic policy
directive:
“The Federal Open Market Committee seeks
monetary and financial conditions that will foster price stability and promote sustainable
growth in output. To further its long-run objectives, the Committee seeks conditions in reserve
markets consistent with federal funds trading in
a range from 0 to ¼ percent. The Committee
directs the Desk to continue the maturity extension program it began in September to purchase,
by the end of June 2012, Treasury securities with
remaining maturities of approximately 6 years to
30 years with a total face value of $400 billion,
and to sell Treasury securities with remaining
maturities of 3 years or less with a total face
value of $400 billion. The Committee also
directs the Desk to maintain its existing policies
of rolling over maturing Treasury securities into
new issues and of reinvesting principal payments
on all agency debt and agency mortgage-backed
securities in the System Open Market Account
in agency mortgage-backed securities in order to
maintain the total face value of domestic securities at approximately $2.6 trillion. The Committee directs the Desk to engage in dollar roll
transactions as necessary to facilitate settlement
of the Federal Reserve’s agency MBS transactions. The System Open Market Account Manager and the Secretary will keep the Committee
informed of ongoing developments regarding
the System’s balance sheet that could affect the
attainment over time of the Committee’s objectives of maximum employment and price
stability.”

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99th Annual Report | 2012

The vote encompassed approval of the statement
below to be released at 12:30 p.m.:
“Information received since the Federal Open
Market Committee met in December suggests
that the economy has been expanding moderately, notwithstanding some slowing in global
growth. While indicators point to some further
improvement in overall labor market conditions,
the unemployment rate remains elevated. Household spending has continued to advance, but
growth in business fixed investment has slowed,
and the housing sector remains depressed. Inflation has been subdued in recent months, and
longer-term inflation expectations have
remained stable.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment
and price stability. The Committee expects economic growth over coming quarters to be modest and consequently anticipates that the unemployment rate will decline only gradually toward
levels that the Committee judges to be consistent
with its dual mandate. Strains in global financial
markets continue to pose significant downside
risks to the economic outlook. The Committee
also anticipates that over coming quarters, inflation will run at levels at or below those consistent with the Committee’s dual mandate.

larly review the size and composition of its securities holdings and is prepared to adjust those
holdings as appropriate to promote a stronger
economic recovery in a context of price
stability.”
Voting for this action: Ben Bernanke, William C.
Dudley, Elizabeth Duke, Dennis P. Lockhart, Sandra
Pianalto, Sarah Bloom Raskin, Daniel K. Tarullo,
John C. Williams, and Janet L. Yellen.
Voting against this action: Jeffrey M. Lacker.
Mr. Lacker dissented because he preferred to omit
the description of the time period over which economic conditions were likely to warrant exceptionally
low levels of the federal funds rate. He expected that
a preemptive tightening of monetary policy would be
necessary to prevent an increase in inflation projections or inflation expectations prior to the end of
2014. More broadly, given the inclusion of FOMC
participants’ projections for the federal funds rate
target in the Summary of Economic Projections, he
saw no need to provide additional forward guidance
in the Committee statement.
It was agreed that the next meeting of the Committee
would be held on Tuesday, March 13, 2012. The
meeting adjourned at 11:30 a.m. on January 25, 2012.

Notation Vote
To support a stronger economic recovery and to
help ensure that inflation, over time, is at levels
consistent with the dual mandate, the Committee expects to maintain a highly accommodative
stance for monetary policy. In particular, the
Committee decided today to keep the target
range for the federal funds rate at 0 to ¼ percent
and currently anticipates that economic conditions—including low rates of resource utilization and a subdued outlook for inflation over
the medium run—are likely to warrant exceptionally low levels for the federal funds rate at
least through late 2014.
The Committee also decided to continue its program to extend the average maturity of its holdings of securities as announced in September.
The Committee is maintaining its existing policies of reinvesting principal payments from its
holdings of agency debt and agency mortgagebacked securities in agency mortgage-backed
securities and of rolling over maturing Treasury
securities at auction. The Committee will regu-

By notation vote completed on December 30, 2011,
the Committee unanimously approved the minutes of
the FOMC meeting held on December 13, 2011.
William B. English
Secretary

Addendum:
Summary of Economic Projections
In conjunction with the January 24–25, 2012, Federal
Open Market Committee (FOMC) meeting, the
members of the Board of Governors and the presidents of the Federal Reserve Banks, all of whom participate in the deliberations of the FOMC, submitted
projections for growth of real output, the unemployment rate, and inflation for the years 2012 to 2014
and over the longer run. The economic projections
were based on information available at the time of
the meeting and participants’ individual assumptions
about factors likely to affect economic outcomes,
including their assessments of appropriate monetary

Minutes of Federal Open Market Committee Meetings | January

policy. Starting with the January meeting, participants also submitted their assessments of the path for
the target federal funds rate that they viewed as
appropriate and compatible with their individual economic projections. Longer-run projections represent
each participant’s assessment of the rate to which
each variable would be expected to converge over
time under appropriate monetary policy and in the
absence of further shocks. “Appropriate monetary
policy” is defined as the future path of policy that
participants deem most likely to foster outcomes for
economic activity and inflation that best satisfy their
individual interpretation of the Federal Reserve’s
objectives of maximum employment and stable
prices.

141

mum employment and price stability. Participants
viewed the upward pressures on inflation in 2011
from factors such as supply chain disruptions and
rising commodity prices as having waned, and they
anticipated that inflation would fall back in 2012.
Over the projection period, most participants
expected inflation, as measured by the annual change
in the price index for personal consumption expenditures (PCE), to be at or below the FOMC’s objective
of 2 percent that was expressed in the Committee’s
statement of longer-run goals and policy strategy.
Core inflation was projected to run at about the same
rate as overall inflation.
As indicated in table 1, relative to their previous projections in November 2011, participants made small
downward revisions to their expectations for the rate
of increase in real GDP in 2012 and 2013, but they
did not materially alter their projections for a noticeably stronger pace of expansion by 2014. With the
unemployment rate having declined in recent months
by more than participants had anticipated in the previous Summary of Economic Projections (SEP), they
generally lowered their forecasts for the level of the
unemployment rate over the next two years. Participants’ expectations for both the longer-run rate of
increase in real GDP and the longer-run unemployment rate were little changed from November. They
did not significantly alter their forecasts for the rate
of inflation over the next three years. However, in
light of the 2 percent inflation that is the objective
included in the statement of longer-run goals and

As depicted in figure 1, FOMC participants projected continued economic expansion over the
2012–14 period, with real gross domestic product
(GDP) rising at a modest rate this year and then
strengthening further through 2014. Participants generally anticipated only a small decline in the unemployment rate this year. In 2013 and 2014, the pace of
the expansion was projected to exceed participants’
estimates of the longer-run sustainable rate of
increase in real GDP by enough to result in a gradual
further decline in the unemployment rate. However,
at the end of 2014, participants generally expected
that the unemployment rate would still be well above
their estimates of the longer-run normal unemployment rate that they currently view as consistent with
the FOMC’s statutory mandate for promoting maxi-

Table 1. Economic projections of Federal Reserve Board members and Federal Reserve Bank presidents, January 2012
Percent
Central tendency1

Range2

Variable
2012
Change in real GDP
November projection
Unemployment rate
November projection
PCE inflation
November projection
Core PCE inflation3
November projection

2013

2014

Longer run

2012

2013

2014

Longer run

2.2 to 2.7
2.5 to 2.9
8.2 to 8.5
8.5 to 8.7
1.4 to 1.8
1.4 to 2.0
1.5 to 1.8
1.5 to 2.0

2.8 to 3.2
3.0 to 3.5
7.4 to 8.1
7.8 to 8.2
1.4 to 2.0
1.5 to 2.0
1.5 to 2.0
1.4 to 1.9

3.3 to 4.0
3.0 to 3.9
6.7 to 7.6
6.8 to 7.7
1.6 to 2.0
1.5 to 2.0
1.6 to 2.0
1.5 to 2.0

2.3 to 2.6
2.4 to 2.7
5.2 to 6.0
5.2 to 6.0
2.0
1.7 to 2.0

2.1 to 3.0
2.3 to 3.5
7.8 to 8.6
8.1 to 8.9
1.3 to 2.5
1.4 to 2.8
1.3 to 2.0
1.3 to 2.1

2.4 to 3.8
2.7 to 4.0
7.0 to 8.2
7.5 to 8.4
1.4 to 2.3
1.4 to 2.5
1.4 to 2.0
1.4 to 2.1

2.8 to 4.3
2.7 to 4.5
6.3 to 7.7
6.5 to 8.0
1.5 to 2.1
1.5 to 2.4
1.4 to 2.0
1.4 to 2.2

2.2 to 3.0
2.2 to 3.0
5.0 to 6.0
5.0 to 6.0
2.0
1.5 to 2.0

Note: Projections of change in real gross domestic product (GDP) and projections for both measures of inflation are from the fourth quarter of the previous year to the fourth
quarter of the year indicated. PCE inflation and core PCE inflation are the percentage rates of change in, respectively, the price index for personal consumption expenditures
(PCE) and the price index for PCE excluding food and energy. Projections for the unemployment rate are for the average civilian unemployment rate in the fourth quarter of the
year indicated. Each participant’s projections are based on his or her assessment of appropriate monetary policy. Longer-run projections represent each participant’s
assessment of the rate to which each variable would be expected to converge under appropriate monetary policy and in the absence of further shocks to the economy. The
November projections were made in conjunction with the meeting of the Federal Open Market Committee on November 1–2, 2011.
1
The central tendency excludes the three highest and three lowest projections for each variable in each year.
2
The range for a variable in a given year includes all participants’ projections, from lowest to highest, for that variable in that year.
3
Longer-run projections for core PCE inflation are not collected.

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99th Annual Report | 2012

Figure 1. Central tendencies and ranges of economic projections, 2012–14 and over the longer run
Percent

Change in real GDP

4

Central tendency of projections
Range of projections

3
2
1
+
0
_
1

Actual

2
3

2007

2008

2009

2010

2011

2012

2013

2014

Longer
run
Percent

Unemployment rate
9
8
7
6
5

2007

2008

2009

2010

2011

2012

2013

2014

Longer
run
Percent

PCE inflation
3

2

1

2007

2008

2009

2010

2011

2012

2013

2014

Longer
run
Percent

Core PCE inflation
3

2

1

2007

2008

2009

2010

2011

2012

2013

2014

Note: Definitions of variables are in the notes to table 1. The data for the actual values of the variables are annual. The data for the change in real GDP, PCE inflation, and core
PCE inflation shown for 2011 incorporate the advance estimate of GDP for the fourth quarter of 2011, which the Bureau of Economic Analysis released on January 27, 2012.
This information was not available to FOMC meeting participants at the time of their meeting.

Minutes of Federal Open Market Committee Meetings | January

policy strategy adopted at the January meeting, the
range and central tendency of their projections of
longer-run inflation were all equal to 2 percent.
As shown in figure 2, most participants judged that
highly accommodative monetary policy was likely to
be warranted over coming years to promote a
stronger economic expansion in the context of price
stability. In particular, with the unemployment rate
projected to remain elevated over the projection
period and inflation expected to be subdued, six participants anticipated that, under appropriate monetary policy, the first increase in the target federal
funds rate would occur after 2014, and five expected
policy firming to commence during 2014 (the upper
panel). The remaining six participants judged that
raising the federal funds rate sooner would be
required to forestall inflationary pressures or avoid
distortions in the financial system. As indicated in
the lower panel, all of the individual assessments of
the appropriate target federal funds rate over the next
several years were below the longer-run level of the
federal funds rate, and 11 participants placed the target federal funds rate at 1 percent or lower at the end
of 2014. Most participants indicated that they
expected that the normalization of the Federal
Reserve’s balance sheet should occur in a way consistent with the principles agreed on at the June 2011
meeting of the FOMC, with the timing of adjustments dependent on the expected date of the first
policy tightening. A few participants judged that,
given their current assessments of the economic outlook, appropriate policy would include additional
asset purchases in 2012, and one assumed an early
ending of the maturity extension program.
A sizable majority of participants continued to judge
the level of uncertainty associated with their projections for real activity and the unemployment rate as
unusually high relative to historical norms. Many also
attached a greater-than-normal level of uncertainty
to their forecasts for inflation, but, compared with
the November SEP, two additional participants
viewed uncertainty as broadly similar to longer-run
norms. As in November, many participants saw
downside risks attending their forecasts of real GDP
growth and upside risks to their forecasts of the
unemployment rate; most participants viewed the
risks to their inflation projections as broadly
balanced.
The Outlook for Economic Activity
The central tendency of participants’ forecasts for the
change in real GDP in 2012 was 2.2 to 2.7 percent.
This forecast for 2012, while slightly lower than the
projection prepared in November, would represent a

143

pickup in output growth from 2011 to a rate close to
its longer-run trend. Participants stated that the economic information received since November showed
continued gradual improvement in the pace of economic activity during the second half of 2011, as the
influence of the temporary factors that damped
activity in the first half of the year subsided. Consumer spending increased at a moderate rate, exports
expanded solidly, and business investment rose further. Recently, consumers and businesses appeared to
become somewhat more optimistic about the outlook. Financial conditions for domestic nonfinancial
businesses were generally favorable, and conditions in
consumer credit markets showed signs of
improvement.
However, a number of factors suggested that the
pace of the expansion would continue to be
restrained. Although some indicators of activity in
the housing sector improved slightly at the end of
2011, new homebuilding and sales remained at
depressed levels, house prices were still falling, and
mortgage credit remained tight. Households’ real disposable income rose only modestly through late 2011.
In addition, federal spending contracted toward yearend, and the restraining effects of fiscal consolidation
appeared likely to be greater this year than anticipated at the time of the November projections. Participants also read the information on economic
activity abroad, particularly in Europe, as pointing to
weaker demand for U.S. exports in coming quarters
than had seemed likely when they prepared their
forecasts in November.
Participants anticipated that the pace of the economic expansion would strengthen over the 2013–14
period, reaching rates of increase in real GDP above
their estimates of the longer-run rates of output
growth. The central tendencies of participants’ forecasts for the change in real GDP were 2.8 to 3.2 percent in 2013 and 3.3 to 4.0 percent in 2014. Among
the considerations supporting their forecasts, participants cited their expectation that the expansion
would be supported by monetary policy accommodation, ongoing improvements in credit conditions, rising household and business confidence, and strengthening household balance sheets. Many participants
judged that U.S. fiscal policy would still be a drag on
economic activity in 2013, but many anticipated that
progress would be made in resolving the fiscal situation in Europe and that the foreign economic outlook would be more positive. Over time and in the
absence of shocks, participants expected that the rate
of increase of real GDP would converge to their estimates of its longer-run rate, with a central tendency

144

99th Annual Report | 2012

Figure 2. Overview of FOMC participants’ assessments of appropriate monetary policy

Appropriate Timing of Policy Firming

Number of Participants
10
9
8
7
6
5

5
4

3

4

3

3
2

2
1

2012

2013

2014

2015

0

2016

Appropriate Pace of Policy Firming

Percent
6

Target Federal Funds Rate at Year-End

5

4

3

2

1

2012

2013

2014

Longer run

0

Note: In the upper panel, the height of each bar denotes the number of FOMC participants who judge that, under appropriate monetary policy and in the absence of further
shocks to the economy, the first increase in the target federal funds rate from its current range of 0 to ¼ percent will occur in the specified calendar year. In the lower panel,
each shaded circle indicates the value (rounded to the nearest ¼ percent) of an individual participant’s judgment of the appropriate level of the target federal funds rate at the
end of the specified calendar year or over the longer run.

Minutes of Federal Open Market Committee Meetings | January

of 2.3 to 2.6 percent, little changed from their estimates in November.
The unemployment rate improved more in late 2011
than most participants had anticipated when they
prepared their November projections, falling from
9.1 to 8.7 percent between the third and fourth quarters. As a result, most participants adjusted down
their projections for the unemployment rate this year.
Nonetheless, with real GDP expected to increase at a
modest rate in 2012, the unemployment rate was projected to decline only a little this year, with the central tendency of participants’ forecasts at 8.2 to
8.5 percent at year-end. Thereafter, participants
expected that the pickup in the pace of the expansion
in 2013 and 2014 would be accompanied by a further
gradual improvement in labor market conditions. The
central tendency of participants’ forecasts for the
unemployment rate at the end of 2013 was 7.4 to
8.1 percent, and it was 6.7 to 7.6 percent at the end of
2014. The central tendency of participants’ estimates
of the longer-run normal rate of unemployment that
would prevail in the absence of further shocks was
5.2 to 6.0 percent. Most participants indicated that
they anticipated that five or six years would be
required to close the gap between the current unemployment rate and their estimates of the longer-run
rate, although some noted that more time would
likely be needed.
Figures 3.A and 3.B provide details on the diversity
of participants’ views regarding the likely outcomes
for real GDP growth and the unemployment rate
over the next three years and over the longer run.
The dispersion in these projections reflected differences in participants’ assessments of many factors,
including appropriate monetary policy and its effects
on economic activity, the underlying momentum in
economic activity, the effects of the European situation, the prospective path for U.S. fiscal policy, the
likely evolution of credit and financial market conditions, and the extent of structural dislocations in the
labor market. Compared with their November projections, the range of participants’ forecasts for the
change in real GDP in 2012 narrowed somewhat and
shifted slightly lower, as some participants reassessed
the outlook for global economic growth and for U.S.
fiscal policy. Many, however, made no material
change to their forecasts for growth of real GDP this
year. The dispersion of participants’ forecasts for
output growth in 2013 and 2014 remained relatively
wide. Having incorporated the data showing a lower
rate of unemployment at the end of 2011 than previously expected, the distribution of participants’ projections for the end of 2012 shifted noticeably down
relative to the November forecasts. The ranges for the

145

unemployment rate in 2013 and 2014 showed less
pronounced shifts toward lower rates and, as was the
case with the ranges for output growth, remained
wide. Participants made only modest adjustments to
their projections of the rates of output growth and
unemployment over the longer run, and, on net, the
dispersions of their projections for both were little
changed from those reported in November. The dispersion of estimates for the longer-run rate of output
growth is narrow, with only one participant’s estimate outside of a range of 2.2 to 2.7 percent. By
comparison, participants’ views about the level to
which the unemployment rate would converge in the
long run are more diverse, reflecting, among other
things, different views on the outlook for labor supply and on the extent of structural impediments in
the labor market.
The Outlook for Inflation
Participants generally viewed the outlook for inflation as very similar to that in November. Most indicated that, as they expected, the effects of the run-up
in prices of energy and other commodities and the
supply disruptions that occurred in the first half of
2011 had largely waned, and that inflation had been
subdued in recent months. Participants also noted
that inflation expectations had remained stable over
the past year despite the fluctuations in headline
inflation. Assuming no further supply shocks, most
participants anticipated that both headline and core
inflation would remain subdued over the 2012–14
period at rates at or below the FOMC’s longer-run
objective of 2 percent. Specifically, the central tendency of participants’ projections for the increase in
inflation, as measured by the PCE price index, in
2012 was 1.4 to 1.8 percent, and it edged up to a central tendency of 1.6 to 2.0 percent in 2014; the central
tendencies of the forecasts for core PCE inflation
were largely the same as those for the total measure.
Figures 3.C and 3.D provide information about the
diversity of participants’ views about the outlook for
inflation. Compared with their November projections, expectations for inflation in 2012 shifted down
a bit, with some participants noting that the slowing
in inflation at the end of 2011 had been greater than
they anticipated. Nonetheless, the range of participants’ forecasts for inflation in 2012 remained wide,
and the dispersion was only slightly narrower in
2013. By 2014, the range of inflation forecasts narrowed more noticeably, as participants expected that,
under appropriate monetary policy, inflation would
begin to converge to the Committee’s longer-run
objective. In general, the dispersion of views on the
outlook for inflation over the projection period represented differences in judgments regarding the

146

99th Annual Report | 2012

Figure 3.A. Distribution of participants’ projections for the change in real GDP, 2012–14 and over the longer run
Number of participants

2012

18

January projections
November projections

16
14
12
10
8
6
4
2

2.02.1

2.22.3

2.42.5

2.62.7

2.82.9

3.03.1

3.23.3

3.43.5

3.63.7

3.83.9

4.04.1

4.24.3

4.44.5

Percent range
Number of participants

2013

18
16
14
12
10
8
6
4
2

2.02.1

2.22.3

2.42.5

2.62.7

2.82.9

3.03.1

3.23.3

3.43.5

3.63.7

3.83.9

4.04.1

4.24.3

4.44.5

Percent range
Number of participants

2014

18
16
14
12
10
8
6
4
2

2.02.1

2.22.3

2.42.5

2.62.7

2.82.9

3.03.1

3.23.3

3.43.5

3.63.7

3.83.9

4.04.1

4.24.3

4.44.5

Percent range
Number of participants

Longer run

18
16
14
12
10
8
6
4
2

2.02.1

2.22.3

2.42.5

2.62.7

2.82.9

3.03.1

3.23.3

Percent range
Note: Definitions of variables are in the general note to table 1.

3.43.5

3.63.7

3.83.9

4.04.1

4.24.3

4.44.5

Minutes of Federal Open Market Committee Meetings | January

147

Figure 3.B. Distribution of participants’ projections for the unemployment rate, 2012–14 and over the longer run
Number of participants

2012

18

January projections
November projections

16
14
12
10
8
6
4
2

5.05.1

5.25.3

5.45.5

5.65.7

5.85.9

6.06.1

6.26.3

6.46.5

6.66.7

6.86.9

7.07.1

7.27.3

7.47.5

7.67.7

7.87.9

8.08.1

8.28.3

8.48.5

8.68.7

8.88.9

Percent range
Number of participants

2013

18
16
14
12
10
8
6
4
2

5.05.1

5.25.3

5.45.5

5.65.7

5.85.9

6.06.1

6.26.3

6.46.5

6.66.7

6.86.9

7.07.1

7.27.3

7.47.5

7.67.7

7.87.9

8.08.1

8.28.3

8.48.5

8.68.7

8.88.9

Percent range
Number of participants

2014

18
16
14
12
10
8
6
4
2

5.05.1

5.25.3

5.45.5

5.65.7

5.85.9

6.06.1

6.26.3

6.46.5

6.66.7

6.86.9

7.07.1

7.27.3

7.47.5

7.67.7

7.87.9

8.08.1

8.28.3

8.48.5

8.68.7

8.88.9

Percent range
Number of participants

Longer run

18
16
14
12
10
8
6
4
2

5.05.1

5.25.3

5.45.5

5.65.7

5.85.9

6.06.1

6.26.3

6.46.5

6.66.7

6.86.9

7.07.1

Percent range
Note: Definitions of variables are in the general note to table 1.

7.27.3

7.47.5

7.67.7

7.87.9

8.08.1

8.28.3

8.48.5

8.68.7

8.88.9

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99th Annual Report | 2012

Figure 3.C. Distribution of participants’ projections for PCE inflation, 2012–14 and over the longer run
Number of participants

2012

18

January projections
November projections

16
14
12
10
8
6
4
2

1.31.4

1.51.6

1.71.8

1.92.0

2.12.2

2.32.4

2.52.6

2.72.8

Percent range
Number of participants

2013

18
16
14
12
10
8
6
4
2
1.31.4

1.51.6

1.71.8

1.92.0

2.12.2

2.32.4

2.52.6

2.72.8

Percent range
Number of participants

2014

18
16
14
12
10
8
6
4
2
1.31.4

1.51.6

1.71.8

1.92.0

2.12.2

2.32.4

2.52.6

2.72.8

Percent range
Number of participants

Longer run

18
16
14
12
10
8
6
4
2

1.31.4

1.51.6

1.71.8

1.92.0

Percent range
Note: Definitions of variables are in the general note to table 1.

2.12.2

2.32.4

2.52.6

2.72.8

Minutes of Federal Open Market Committee Meetings | January

149

Figure 3.D. Distribution of participants’ projections for core PCE inflation, 2012–14
Number of participants

2012

18

January projections
November projections

16
14
12
10
8
6
4
2

1.31.4

1.51.6

1.71.8

1.92.0

2.12.2

Percent range
Number of participants

2013

18
16
14
12
10
8
6
4
2
1.31.4

1.51.6

1.71.8

1.92.0

2.12.2

Percent range
Number of participants

2014

18
16
14
12
10
8
6
4
2
1.31.4

1.51.6

1.71.8

Percent range
Note: Definitions of variables are in the general note to table 1.

1.92.0

2.12.2

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99th Annual Report | 2012

degree of slack in resource utilization and the extent
to which slack influences inflation and inflation
expectations. In addition, participants differed in
their estimates of how the stance of monetary policy
would influence inflation expectations.
Appropriate Monetary Policy
Most participants judged that the current outlook—
for a moderate pace of economic recovery with the
unemployment rate declining only gradually and
inflation subdued—warranted exceptionally low levels of the federal funds rate at least until late 2014. In
particular, five participants viewed appropriate policy
firming as commencing during 2014, while six others
judged that the first increase in the federal funds rate
would not be warranted until 2015 or 2016. As a
result, those 11 participants anticipated that the
appropriate federal funds rate at the end of 2014
would be 1 percent or lower. Those who saw the first
increase occurring in 2015 reported that they anticipated that the federal funds rate would be ½ percent
at the end of that year. For the two participants who
put the first increase in 2016, the appropriate target
federal funds rate at the end of that year was 1½ and
1¾ percent. In contrast, six participants expected
that an increase in the target federal funds rate would
be appropriate within the next two years, and those
participants anticipated that the target rate would
need to be increased to around 1½ to 2¾ percent at
the end of 2014.
Participants’ assessments of the appropriate path for
the federal funds rate reflected their judgments of the
policy that would best support progress in achieving
the Federal Reserve’s mandate for promoting maximum employment and stable prices. Among the key
factors informing participants’ expectations about
the appropriate setting for monetary policy were their
assessments of the maximum level of employment,
the Committee’s longer-run inflation goal, the extent
to which current conditions deviate from these
mandate-consistent levels, and their projections of
the likely time horizons required to return employment and inflation to such levels. Several participants
commented that their assessments took into account
the risks to the outlook for economic activity and
inflation, and a few pointed specifically to the relevance of financial stability in their policy judgments.
Participants also noted that because the appropriate
stance of monetary policy depends importantly on
the evolution of real activity and inflation over time,
their assessments of the appropriate future path of
the federal funds rate could change if economic conditions were to evolve in an unexpected manner.

All participants reported levels for the appropriate
target federal funds rate at the end of 2014 that were
well below their estimates of the level expected to
prevail in the longer run. The longer-run nominal levels were in a range from 3¾ to 4½ percent, reflecting
participants’ judgments about the longer-run equilibrium level of the real federal funds rate and the Committee’s inflation objective of 2 percent.
Participants also provided qualitative information on
their views regarding the appropriate path of the
Federal Reserve’s balance sheet. A few participants’
assessments of appropriate monetary policy incorporated additional purchases of longer-term securities
in 2012, and a number of participants indicated that
they remained open to a consideration of additional
asset purchases if the economic outlook deteriorated.
All but one of the participants continued to expect
that the Committee would carry out the normalization of the balance sheet according to the principles
approved at the June 2011 FOMC meeting. That is,
prior to the first increase in the federal funds rate, the
Committee would likely cease reinvesting some or all
payments on the securities holdings in the System
Open Market Account (SOMA), and it would likely
begin sales of agency securities from the SOMA
sometime after the first rate increase, aiming to eliminate the SOMA’s holdings of agency securities over a
period of three to five years. Indeed, most participants saw sales of agency securities starting no earlier
than 2015. However, those participants anticipating
an earlier increase in the federal funds rate also called
for earlier adjustments to the balance sheet, and one
participant assumed an early end of the maturity
extension program.
Figure 3.E details the distribution of participants’
judgments regarding the appropriate level of the target federal funds rate at the end of each calendar year
from 2012 to 2014 and over the longer run. Most
participants anticipated that economic conditions
would warrant maintaining the current low level of
the federal funds rate over the next two years. However, views on the appropriate level of the federal
funds rate at the end of 2014 were more widely dispersed, with two-thirds of participants seeing the
appropriate level of the federal funds rate as 1 percent or below and five seeing the appropriate rate as
2 percent or higher. Those participants who judged
that a longer period of exceptionally low levels of the
federal funds rate would be appropriate generally also
anticipated that the pace of the economic expansion
would be moderate and that the unemployment rate
would decline only gradually, remaining well above
its longer-run rate at the end of 2014. Almost all of
these participants expected that inflation would be

Minutes of Federal Open Market Committee Meetings | January

151

Figure 3.E. Distribution of participants’ projections for the target federal funds rate, 2012–14 and over the longer run
Number of participants

2012

18

January projections

16
14
12
10
8
6
4
2

0.000.37

0.380.62

0.630.87

0.881.12

1.131.37

1.381.62

1.631.87

1.882.12

2.132.37

2.382.62

2.632.87

2.883.12

3.133.37

3.383.62

3.633.87

3.884.12

4.134.37

4.384.62

4.634.87

Percent range
Number of participants

2013

18
16
14
12
10
8
6
4
2

0.000.37

0.380.62

0.630.87

0.881.12

1.131.37

1.381.62

1.631.87

1.882.12

2.132.37

2.382.62

2.632.87

2.883.12

3.133.37

3.383.62

3.633.87

3.884.12

4.134.37

4.384.62

4.634.87

Percent range
Number of participants

2014

18
16
14
12
10
8
6
4
2

0.000.37

0.380.62

0.630.87

0.881.12

1.131.37

1.381.62

1.631.87

1.882.12

2.132.37

2.382.62

2.632.87

2.883.12

3.133.37

3.383.62

3.633.87

3.884.12

4.134.37

4.384.62

4.634.87

Percent range
Number of participants

Longer run

18
16
14
12
10
8
6
4
2

0.000.37

0.380.62

0.630.87

0.881.12

1.131.37

1.381.62

1.631.87

1.882.12

2.132.37

2.382.62

2.632.87

2.883.12

3.133.37

3.383.62

Percent range
Note: The target funds rate is measured as the level of the target rate at the end of the calendar year or in the longer run.

3.633.87

3.884.12

4.134.37

4.384.62

4.634.87

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99th Annual Report | 2012

relatively stable at or below the FOMC’s longer-run
objective of 2 percent until the time of the first
increase in the federal funds rate. A number of them
also mentioned their assessment that a longer period
of low federal funds rates is appropriate when the
federal funds rate is constrained by its effective lower
bound. In contrast, the six participants who judged
that policy firming should begin in 2012 or 2013 indicated that the Committee would need to act decisively to keep inflation at mandate-consistent levels
and to limit the risk of undermining Federal Reserve
credibility and causing a rise in inflation expectations. Several were projecting a faster pickup in economic activity, and a few stressed the risk of distortions in the financial system from an extended period
of exceptionally low interest rates.
Uncertainty and Risks
Figure 4 shows that most participants continued to
share the view that their projections for real GDP
growth and the unemployment rate were subject to a
higher level of uncertainty than was the norm during
the previous 20 years.3 Many also judged the level of
uncertainty associated with their inflation forecasts
to be higher than the longer-run norm, but that
assessment was somewhat less prevalent among participants than was the case for uncertainty about real
activity. Participants identified a number of factors
that contributed to the elevated level of uncertainty
about the outlook. In particular, many participants
continued to cite risks related to ongoing developments in Europe. More broadly, they again noted difficulties in forecasting the path of economic recovery
from a deep recession that was the result of a severe
financial crisis and thus differed importantly from
the experience with recoveries over the past 60 years.
In that regard, participants continued to be uncertain
about the pace at which credit conditions would ease
and about prospects for a recovery in the housing
sector. In addition, participants generally saw the
outlook for fiscal and regulatory policies as still
highly uncertain. Regarding the unemployment rate,
several expressed uncertainty about how labor
demand and supply would evolve over the forecast
period. Among the sources of uncertainty about the
outlook for inflation were the difficulties in assessing
the current and prospective margins of slack in
resource markets and the effect of such slack on
prices.
3

Table 2 provides estimates of the forecast uncertainty for the
change in real GDP, the unemployment rate, and total consumer price inflation over the period from 1991 to 2010. At the
end of this summary, the box “Forecast Uncertainty” discusses
the sources and interpretation of uncertainty in the economic
forecasts and explains the approach used to assess the uncertainty and risks attending the participants’ projections.

Table 2. Average historical projection error ranges
Percentage points
Variable
Change in real GDP1
Unemployment rate1
Total consumer prices2

2012

2013

2014

±1.3
±0.7
±0.9

±1.7
±1.4
±1.0

±1.8
±1.8
±1.0

Note: Error ranges shown are measured as plus or minus the root mean squared
error of projections for 1991 through 2010 that were released in the winter by
various private and government forecasters. As described in the box “Forecast
Uncertainty,” under certain assumptions, there is about a 70 percent probability
that actual outcomes for real GDP, unemployment, and consumer prices will be in
ranges implied by the average size of projection errors made in the past. Further
information is in David Reifschneider and Peter Tulip (2007), “Gauging the
Uncertainty of the Economic Outlook from Historical Forecasting Errors,” Finance
and Economics Discussion Series 2007-60 (Washington: Board of Governors of
the Federal Reserve System, November).
1
For definitions, refer to general note in table 1.
2
Measure is the overall consumer price index, the price measure that has been
most widely used in government and private economic forecasts. Projection
is percent change, fourth quarter of the previous year to the fourth quarter of
the year indicated.

A majority of participants continued to report that
they saw the risks to their forecasts of real GDP
growth as weighted to the downside and, accordingly,
the risks to their projections for the unemployment
rate as skewed to the upside. All but one of the
remaining participants viewed the risks to both projections as broadly balanced, while one noted a risk
that the unemployment rate might continue to
decline more rapidly than expected. The most frequently cited downside risks to the projected pace of
the economic expansion were the possibility of
financial market and economic spillovers from the
fiscal and financial issues in the euro area and the
chance that some of the factors that have restrained
the recovery in recent years could persist and weigh
on economic activity to a greater extent than
assumed in participants’ baseline forecasts. In particular, some participants mentioned the downside
risks to consumer spending from still-weak household balance sheets and only modest gains in real
income, along with the possible effects of still-high
levels of uncertainty regarding fiscal and regulatory
policies that might damp businesses’ willingness to
invest and hire. A number of participants noted the
risk of another disruption in global oil markets that
could not only boost inflation but also reduce real
income and spending. The participants who judged
the risks to be broadly balanced also recognized a
number of these downside risks to the outlook but
saw them as counterbalanced by the possibility that
the resilience of economic activity in late 2011 and
the recent drop in the unemployment rate might signal greater underlying momentum in economic
activity.

Minutes of Federal Open Market Committee Meetings | January

Figure 4. Uncertainty and risks in economic projections
Number of participants

Uncertainty about GDP growth

Number of participants

18

January projections
November projections

16

Risks to GDP growth

18

January projections
November projections

16

14

10

8

8

6

6

4

4

2

Broadly
similar

12

10

Lower

14

12

2

Higher

Weighted to
downside

Broadly
balanced

Number of participants

Uncertainty about the unemployment rate

Weighted to
upside
Number of participants

18

Risks to the unemployment rate

18

16

12

10

10

8

8

6

6

4

4

2

Broadly
similar

14

12

Lower

16

14

2

Weighted to
downside

Higher

Broadly
balanced

Number of participants

Uncertainty about PCE inflation

Weighted to
upside
Number of participants

18

Risks to PCE inflation

18

16

12

10

10

8

8

6

6

4

4

2

Broadly
similar

14

12

Lower

16

14

2

Higher

Weighted to
downside

Broadly
balanced

Number of participants

Uncertainty about core PCE inflation

Weighted to
upside
Number of participants

18

Risks to core PCE inflation

18

16

10

8

8

6

6

4

4

2

Higher

12

10

Broadly
similar

14

12

Lower

16

14

2

Weighted to
downside

Broadly
balanced

Weighted to
upside

Note: For definitions of uncertainty and risks in economic projections, see the box “Forecast Uncertainty.” Definitions of variables are in the general note to table 1.

153

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99th Annual Report | 2012

In contrast to their outlook for economic activity,
most participants judged the risks to their projections
of inflation as broadly balanced. Participants generally viewed the recent decline in inflation as having
been in line with their earlier forecasts, and they
noted that inflation expectations remain stable. While
many of these participants saw the persistence of
substantial slack in resource utilization as likely to
keep inflation subdued over the projection period, a
few others noted the risk that elevated resource slack
might put more downward pressure on inflation than

expected. In contrast, some participants noted the
upside risks to inflation from developments in global
oil and commodity markets, and several indicated
that the current highly accommodative stance of
monetary policy and the substantial liquidity currently in the financial system risked a pickup in inflation to a level above the Committee’s objective. A few
also pointed to the risk that uncertainty about the
Committee’s ability to effectively remove policy
accommodation when appropriate could lead to a
rise in inflation expectations.

Minutes of Federal Open Market Committee Meetings | January

155

Forecast Uncertainty
The economic projections provided by the members
of the Board of Governors and the presidents of the
Federal Reserve Banks inform discussions of monetary policy among policymakers and can aid public
understanding of the basis for policy actions. Considerable uncertainty attends these projections, however. The economic and statistical models and relationships used to help produce economic forecasts
are necessarily imperfect descriptions of the real
world, and the future path of the economy can be
affected by myriad unforeseen developments and
events. Thus, in setting the stance of monetary
policy, participants consider not only what appears to
be the most likely economic outcome as embodied in
their projections, but also the range of alternative
possibilities, the likelihood of their occurring, and the
potential costs to the economy should they occur.
Table 2 summarizes the average historical accuracy
of a range of forecasts, including those reported in
past Monetary Policy Reports and those prepared by
the Federal Reserve Board’s staff in advance of
meetings of the Federal Open Market Committee.
The projection error ranges shown in the table illustrate the considerable uncertainty associated with
economic forecasts. For example, suppose a participant projects that real gross domestic product (GDP)
and total consumer prices will rise steadily at annual
rates of, respectively, 3 percent and 2 percent. If the
uncertainty attending those projections is similar to
that experienced in the past and the risks around the
projections are broadly balanced, the numbers
reported in table 2 would imply a probability of about
70 percent that actual GDP would expand within a
range of 1.7 to 4.3 percent in the current year, 1.3 to
4.7 percent in the second year, and 1.2 to 4.8 in the

third year. The corresponding 70 percent confidence
intervals for overall inflation would be 1.1 to 2.9 percent in the current year and 1.0 to 3.0 percent in the
second and third years.
Because current conditions may differ from those
that prevailed, on average, over history, participants
provide judgments as to whether the uncertainty
attached to their projections of each variable is
greater than, smaller than, or broadly similar to typical levels of forecast uncertainty in the past, as
shown in table 2. Participants also provide judgments
as to whether the risks to their projections are
weighted to the upside, are weighted to the downside, or are broadly balanced. That is, participants
judge whether each variable is more likely to be
above or below their projections of the most likely
outcome. These judgments about the uncertainty
and the risks attending each participant’s projections
are distinct from the diversity of participants’ views
about the most likely outcomes. Forecast uncertainty
is concerned with the risks associated with a particular projection rather than with divergences across a
number of different projections.
As with real activity and inflation, the outlook for the
future path of the federal funds rate is subject to considerable uncertainty. This uncertainty arises primarily
because each participant’s assessment of the appropriate stance of monetary policy depends importantly
on the evolution of real activity and inflation over
time. If economic conditions evolve in an unexpected
manner, then assessments of the appropriate setting
of the federal funds rate would change from that
point forward.

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99th Annual Report | 2012

Meeting Held on March 13, 2012

Steven B. Kamin
Economist

A meeting of the Federal Open Market Committee
was held in the offices of the Board of Governors of
the Federal Reserve System in Washington, D.C., on
Tuesday, March 13, 2012, at 8:30 a.m.

David W. Wilcox
Economist

Present
Ben Bernanke
Chairman
William C. Dudley
Vice Chairman
Elizabeth Duke
Jeffrey M. Lacker
Dennis P. Lockhart
Sandra Pianalto
Sarah Bloom Raskin
Daniel K. Tarullo
John C. Williams
Janet L. Yellen
James Bullard, Christine Cumming,
Charles L. Evans, Esther L. George, and
Eric Rosengren
Alternate Members of the Federal Open Market
Committee
Richard W. Fisher, Narayana Kocherlakota, and
Charles I. Plosser
Presidents of the Federal Reserve Banks of Dallas,
Minneapolis, and Philadelphia, respectively
William B. English
Secretary and Economist
Deborah J. Danker
Deputy Secretary
Matthew M. Luecke
Assistant Secretary
David W. Skidmore
Assistant Secretary
Michelle A. Smith
Assistant Secretary
Scott G. Alvarez
General Counsel
Thomas C. Baxter
Deputy General Counsel

David Altig, Thomas A. Connors, Michael P. Leahy,
David Reifschneider, Glenn D. Rudebusch,
William Wascher, and John A. Weinberg
Associate Economists
Brian Sack
Manager, System Open Market Account
Michael S. Gibson
Director, Division of Banking Supervision and
Regulation, Board of Governors
Nellie Liang
Director, Office of Financial Stability Policy and
Research, Board of Governors
Jon W. Faust and Andrew T. Levin
Special Advisors to the Board, Office of Board
Members, Board of Governors
James A. Clouse
Deputy Director, Division of Monetary Affairs,
Board of Governors
Linda Robertson
Assistant to the Board, Office of Board Members,
Board of Governors
Seth B. Carpenter
Senior Associate Director, Division of Monetary
Affairs, Board of Governors
Thomas Laubach
Senior Adviser, Division of Research and Statistics,
Board of Governors
Ellen E. Meade, Stephen A. Meyer, and
Joyce K. Zickler
Senior Advisers, Division of Monetary Affairs,
Board of Governors
Eric M. Engen, Michael T. Kiley, and
Michael G. Palumbo
Associate Directors, Division of Research and
Statistics, Board of Governors
Edward Nelson
Section Chief, Division of Monetary Affairs, Board
of Governors
Harvey Rosenblum and Daniel G. Sullivan
Executive Vice Presidents, Federal Reserve Banks of
Dallas and Chicago, respectively

Minutes of Federal Open Market Committee Meetings | March

Craig S. Hakkio, Geoffrey Tootell, and
Kei-Mu Yi
Senior Vice Presidents, Federal Reserve Banks of
Kansas City, Boston, and Minneapolis, respectively
Michael Dotsey, Joseph G. Haubrich,
Lorie K. Logan, and David C. Wheelock
Vice Presidents, Federal Reserve Banks of
Philadelphia, Cleveland, New York, and St. Louis,
respectively
Marc Giannoni
Senior Economist, Federal Reserve Bank of
New York

Developments in Financial Markets and
the Federal Reserve’s Balance Sheet
The Manager of the System Open Market Account
(SOMA) reported on developments in domestic and
foreign financial markets during the period since the
Federal Open Market Committee (FOMC) met on
January 24–25, 2012. He also reported on System
open market operations, including the ongoing reinvestment into agency-guaranteed mortgage-backed
securities (MBS) of principal payments received on
SOMA holdings of agency debt and agencyguaranteed MBS as well as the operations related to
the maturity extension program authorized at the
September 20–21, 2011, FOMC meeting. By unanimous vote, the Committee ratified the Desk’s domestic transactions over the intermeeting period. There
were no intervention operations in foreign currencies
for the System’s account over the intermeeting
period.

Staff Review of the Economic Situation
The information reviewed at the March 13 meeting
suggested that economic activity was expanding
moderately. Labor market conditions continued to
improve and the unemployment rate declined further,
although it remained elevated. Overall consumer
price inflation was relatively subdued in recent
months. More recently, prices of crude oil and gasoline increased substantially. Measures of long-run
inflation expectations remained stable.
Private nonfarm employment rose at an appreciably
faster average pace in January and February than in
the fourth quarter of last year, and declines in total
government employment slowed in recent months.
The unemployment rate decreased to 8.3 percent in
January and stayed at that level in February. Both the
rate of long-duration unemployment and the share of

157

workers employed part time for economic reasons
continued to be high. Initial claims for unemployment insurance trended lower over the intermeeting
period and were at a level consistent with further
moderate job gains.
Manufacturing production increased considerably in
January, and the rate of manufacturing capacity utilization stepped up. Factory output was boosted by a
sizable expansion in the production of motor
vehicles, but there also were solid and widespread
gains in other industries. In February, motor vehicle
assemblies remained near the strong pace recorded in
January; they were scheduled to edge up, on net,
through the second quarter. Broader indicators of
manufacturing activity, such as the diffusion indexes
of new orders from the national and regional manufacturing surveys, were at levels suggesting moderate
increases in factory production in the coming
months.
Households’ real disposable income increased, on
balance, in December and January as labor earnings
rose solidly. Moreover, households’ net worth grew in
the fourth quarter of last year and likely was boosted
further by gains in equity values thus far this year.
Nevertheless, real personal consumption expenditures
(PCE) were reported to have been flat in December
and January. Although households’ purchases of
motor vehicles rose briskly, spending for other consumer goods and services was weak. In February,
nominal retail sales excluding purchases at motor
vehicle and parts outlets increased moderately, while
motor vehicle sales continued to climb. Consumer
sentiment was little changed in February, and households remained downbeat about both the economic
outlook and their own income and finances.
Housing market activity improved somewhat in
recent months but continued to be restrained by the
substantial inventory of foreclosed and distressed
properties, tight credit conditions for mortgage loans,
and uncertainty about the economic outlook and
future home prices. After increasing in December,
starts of new single-family homes remained at that
higher level in January, likely boosted in part by
unseasonably warm weather; in both months, starts
ran above permit issuance. Sales of new and existing
homes stepped up further in recent months, though
they still remained at quite low levels. Home prices
were flat, on balance, in December and January.
Real business expenditures on equipment and software rose at a notably slower pace in the fourth quar-

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99th Annual Report | 2012

ter of last year than earlier in the year. Moreover,
nominal orders and shipments of nondefense capital
goods declined in January. However, a number of
forward-looking indicators of firms’ equipment
spending improved, including some survey measures
of business conditions and capital spending plans.
Nominal business spending for nonresidential construction firmed, on net, in December and January,
but the level of spending was still subdued, in part
reflecting high vacancy rates and tight credit conditions for construction loans. Inventories in most
industries looked to be reasonably well aligned with
sales in recent months, although stocks of motor
vehicles continued to be lean.
Data for federal government spending in January and
February indicated that real defense expenditures
continued to step down after decreasing significantly
in the fourth quarter. Real state and local government
purchases looked to be declining at a slower pace
than last year, as those governments’ payrolls edged
up in January and February and their nominal construction spending rose a little in January.
The U.S. international trade deficit widened in
December and January, as imports increased more
than exports. The expansion of imports was spread
across most categories, with petroleum products and
automotive products posting strong gains in January.
The rise in exports was supported by shipments of
capital goods and automotive products, while exports
of consumer goods and industrial supplies declined
on average. Data through December indicated that
net exports made a moderate negative contribution
to the rate of growth in real gross domestic product
(GDP) in the fourth quarter of last year.

Increases in compensation per hour in the nonfarm
business sector picked up somewhat over the four
quarters of 2011. However, the employment cost
index increased at a more modest pace than the compensation per hour measure over the past year, and
the 12-month change in average hourly earnings for
all employees remained muted in January and
February.
Recent indicators suggested some improvement in
foreign economic activity early this year after a significant slowing in the fourth quarter of last year.
Aggregate output in the euro area contracted in the
fourth quarter, but manufacturing purchasing managers indexes (PMIs) improved in January and February relative to their low fourth-quarter readings,
and consumer and business confidence edged up.
Floods caused steep production declines in the fourth
quarter in Thailand and also had negative effects on
output in other countries linked through Thai supply
chains. However, economic activity in Thailand
recovered sharply around year-end, and manufacturing PMIs moved up across Asia through February.
Higher prices for energy and food put upward pressure on headline inflation in foreign economies, but
measures of core inflation remained subdued.

Staff Review of the Financial Situation
On balance, U.S. financial conditions became somewhat more supportive of growth over the intermeeting period, and strains in global financial markets
eased, as domestic and foreign economic data were
generally better than market participants had
expected and investors appeared to see diminished
downside risks associated with the situation in
Europe.

Overall U.S. consumer prices, as measured by the
PCE price index, increased at a modest rate in
December and January. Consumer energy prices rose
in January after decreasing markedly in December,
and survey data indicated that gasoline prices moved
up considerably in February and early March. Meanwhile, increases in consumer food prices slowed in
recent months. Consumer prices excluding food and
energy also rose modestly in December and January.
Near-term inflation expectations from the Thomson
Reuters/University of Michigan Surveys of Consumers were unchanged in February, and longer-term
inflation expectations in the survey remained in their
recent range.

Measures of the expected path for the federal funds
rate derived from overnight index swap (OIS) rates
suggested that the near-term portion of the expected
policy rate path was about unchanged, on balance,
since the January FOMC meeting, but the path
beyond the middle of 2014 shifted down a bit,
reportedly reflecting in part the change in the forward rate guidance in the Committee’s January statement. On balance, yields on Treasury securities were
little changed over the intermeeting period. Indicators of inflation compensation over the next five
years edged up, while changes in measures of longerterm inflation compensation were mixed.

Measures of labor compensation generally indicated
that nominal wage gains continued to be subdued.

Conditions in unsecured short-term dollar funding
markets improved over the period, especially for

Minutes of Federal Open Market Committee Meetings | March

financial institutions with European parents. The
spread of the three-month London interbank offered
rate (LIBOR) over the OIS rate narrowed. In addition, spreads of rates on asset-backed commercial
paper over those on AA-rated nonfinancial paper
decreased significantly, and the amounts outstanding
from programs with European sponsors remained
stable. Moreover, the average maturity of unsecured
U.S. commercial paper issued by European banks
lengthened somewhat over the intermeeting period.
Responses to the March 2012 Senior Credit Officer
Opinion Survey on Dealer Financing Terms indicated little change, on balance, over the past three
months in credit terms for important classes of counterparties. Demand for securities financing was
reported to have risen somewhat across asset types,
but dealers indicated that the risk appetite of most
clients had changed relatively little over the previous
three months.
Broad U.S. equity price indexes rose significantly
over the intermeeting period; equity prices of large
banking organizations increased about in line with
the broader market. Aggregate earnings per share for
firms in the Standard & Poor’s 500 index declined in
the fourth quarter, but profit margins for large corporations remained wide by historical standards.
Reflecting a narrowing of spreads over yields on
comparable-maturity Treasury securities, yields on
investment- and speculative-grade corporate bonds
continued to decline over the period, moving toward
the low end of their historical ranges. Prices in the
secondary market for syndicated leveraged loans
moved up further, supported by continued strong
demand from institutional investors. The spreads of
yields on A2/P2-rated unsecured commercial paper
issued by nonfinancial firms over yields on A1/P1rated issues narrowed slightly on balance.
Bond issuance by financial firms was strong in January and February, likely reflecting in part the refinancing of maturing debt that had been issued during the financial crisis under the Federal Deposit
Insurance Corporation’s Temporary Liquidity Guarantee Program. The issuance of bonds by domestic
nonfinancial firms was solid in recent months, and
indicators of credit quality remained firm. Growth of
commercial and industrial (C&I) loans continued to
be substantial and was widespread across domestic
banks, though holdings of such loans at U.S.
branches and agencies of European banks decreased
further. Financing conditions in the commercial real
estate sector continued to be tight, and issuance of

159

commercial mortgage-backed securities remained low
in the fourth quarter of last year. Gross public equity
issuance by nonfinancial firms was still solid in January and February, boosted by continued strength in
initial public offerings. Share repurchases and cashfinanced mergers by nonfinancial firms maintained
their strength in the fourth quarter, leading to a
sharp decline in net equity issuance.
Although mortgage rates remained near their historical lows, conditions in residential mortgage markets
generally remained depressed. Consumer credit rose
in recent months, with the growth in nonrevolving
credit led by continued rapid expansion of
government-originated student loans. Issuance of
consumer credit asset-backed securities remained at
moderate levels in the fourth quarter of 2011 and in
early 2012.
Gross long-term issuance of municipal bonds was
subdued in the first two months of this year. Meanwhile, spreads on credit default swaps for debt issued
by states were roughly flat over the intermeeting
period.
Bank credit rose at a modest pace, on average, in
January and February, mainly reflecting strong
increases in securities holdings and C&I loans. Commercial real estate loans held by banks continued to
decline, while noncore loans—a category that
includes lending to nonbank financial institutions—
grew at a slower pace than in previous months. The
aggregate credit quality of loans on banks’ books
continued to improve across most asset classes in the
fourth quarter.
M2 advanced at a rapid pace in January, apparently
reflecting year-end effects, but its growth slowed in
February. The rise in M2 was mainly attributable to
continued strength in liquid deposits, reflecting investors’ preferences for safe and liquid assets as well as
very low yields on short-term instruments outside
M2. Currency expanded robustly, and the monetary
base also grew significantly over January and
February.
Foreign equity markets ended the period higher, particularly in Japan, and benchmark sovereign bond
yields declined. Spreads of yields on euro-area
peripheral sovereign debt over those on German
bunds generally continued to narrow, and foreign
corporate credit spreads also declined further. The
staff’s broad nominal index of the foreign exchange

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99th Annual Report | 2012

value of the dollar moved down modestly over the
intermeeting period.
Funding conditions for euro-area banks eased over
the period, as the European Central Bank (ECB)
conducted its second three-year refinancing operation and widened the pool of eligible collateral for
refinancing operations. Spreads of three-month euro
LIBOR over the OIS rate narrowed, on balance, and
European banks’ issuance of unsecured senior debt
and covered bonds increased. Dollar funding pressures continued to diminish, and the implied cost of
dollar funding through the foreign exchange swap
market fell moderately further. Reflecting the
improved conditions in funding markets, demand for
dollars at ECB lending operations declined and the
outstanding amounts drawn under the Federal
Reserve’s dollar liquidity swap lines with other foreign central banks remained small. Several other central banks in advanced and emerging market economies eased policy further. In particular, the Bank of
England increased the size of its existing gilt purchase program in February, and the Bank of Japan
scaled up its Asset Purchase Program. The Bank of
Japan also introduced a 1 percent inflation goal.

Staff Economic Outlook
In the economic projection prepared for the March
FOMC meeting, the staff revised up its near-term
forecast for real GDP growth a little. Although the
recent data on aggregate spending were, on balance,
about in line with the staff’s expectations at the time
of the previous forecast, indicators of labor market
conditions and production improved somewhat more
than the staff had anticipated. In addition, the
decline in the unemployment rate over the past year
was larger than what seemed consistent with the
modest reported rate of real GDP growth. Against
this backdrop, the staff reduced its estimate of the
level of potential output, yielding a measure of the
current output gap that was a little narrower and better aligned with the staff’s estimate of labor market
slack. In its March forecast, the staff’s projection for
real GDP growth over the medium term was somewhat higher than the one presented in January,
mostly reflecting an improved outlook for economic
activity abroad, a lower foreign exchange value for
the dollar, and a higher projected path of equity
prices. Nevertheless, the staff continued to forecast
that real GDP growth would pick up only gradually
in 2012 and 2013, supported by accommodative
monetary policy, easing credit conditions, and
improvements in consumer and business sentiment.

The wide margin of slack in product and labor markets was expected to decrease gradually over the projection period, but the unemployment rate was
expected to remain elevated at the end of 2013.
The staff also revised up its forecast for inflation a bit
compared with the projection prepared for the January FOMC meeting, reflecting recent data indicating
higher paths for the prices of oil, other commodities,
and imports, along with a somewhat narrower margin of economic slack in the March forecast. However, with energy prices expected to level out in the
second half of this year, substantial resource slack
persisting over the forecast period, and stable longrun inflation expectations, the staff continued to
project that inflation would be subdued in 2012 and
2013.

Participants’ Views on Current Conditions
and the Economic Outlook
In their discussion of the economic situation and
outlook, meeting participants agreed that the information received since the Committee’s previous
meeting, while mixed, had been positive, on balance,
and suggested that the economy had been expanding
moderately. Labor market conditions had improved
further: Payroll employment had continued to
expand, and the unemployment rate had declined
notably in recent months. Still, unemployment
remained elevated. Household spending and business
fixed investment had continued to advance. Despite
signs of improvement or stabilization in some local
housing markets, most participants agreed that the
housing sector remained depressed. Inflation had
been subdued in recent months, although prices of
crude oil and gasoline had increased of late. Longerterm inflation expectations had remained stable, and
most meeting participants saw little evidence of cost
pressures.
With respect to the economic outlook, participants
generally saw the intermeeting news as suggesting
that economic growth over coming quarters would
continue to be moderate and that the unemployment
rate would decline gradually toward levels that the
Committee judges to be consistent with its dual mandate. While a few participants indicated that their
expectations for real GDP growth for 2012 had risen
somewhat, most participants did not interpret the
recent economic and financial information as pointing to a material revision to the outlook for 2013 and
2014. Financial conditions had improved notably
since the January meeting: Equity prices were higher

Minutes of Federal Open Market Committee Meetings | March

and risk spreads had declined. Nonetheless, a number of factors continued to be seen as likely to
restrain the pace of economic expansion; these
included slower growth in some foreign economies,
prospective fiscal tightening in the United States, the
weak housing market, further household deleveraging, and high levels of uncertainty among households
and businesses. Participants continued to expect most
of the factors restraining economic expansion to ease
over time and so anticipated that the recovery would
gradually gain strength. In addition, participants
noted that recent policy actions in the euro area had
helped reduce financial stresses and lower downside
risks in the short term; however, increased volatility
in financial markets remained a possibility if measures to address the longer-term fiscal and banking
issues in the euro area were not put in place in a
timely fashion. Inflation had been subdued of late,
although the recent increase in crude oil and gasoline
prices would push up inflation temporarily. With
unemployment expected to remain elevated, and with
longer-term inflation expectations stable, most participants expected that inflation subsequently would
run at or below the 2 percent rate that the Committee
judges most consistent with its statutory mandate
over the longer run.
In discussing the household sector, meeting participants generally commented that consumer spending
had increased moderately of late. While a few participants suggested that recent improvements in labor
market conditions and the easing in financial conditions could help lay the groundwork for a strengthening in the pace of household spending, several other
participants pointed to factors that would likely
restrain consumption: Growth in real disposable
income was still sluggish, and consumer sentiment,
despite some improvement since last summer,
remained weak. A number of participants viewed the
recent run-up in petroleum prices as likely to limit
gains in consumer spending on non-energy items for
a time; a couple of participants noted, however, that
the unseasonably warm weather and the declining
price of natural gas had helped cushion the effect of
higher oil and gasoline prices on consumers’ overall
energy bills. Most participants agreed that, while
recent housing-sector data had shown some tentative
indications of upward movement, the level of activity
in that sector remained depressed and was likely to
recover only slowly over time. One participant, while
agreeing that the housing market had not yet turned
the corner, was more optimistic about the potential
for a stronger recovery in the market in light of signs

161

of reduced inventory overhang and stronger demand
in some regions.
Reports from business contacts indicated that activity
in the manufacturing, energy, and agriculture sectors
continued to advance in recent months. In the retail
sector, sales of new autos had strengthened, but
reports from other retailers were mixed. A number of
businesses had indicated that they were seeing some
improvement in demand and that they had become
somewhat more optimistic of late, with some reporting that they were adding to capacity. But most firms
reportedly remained fairly cautious—particularly on
hiring decisions—and continued to be uncertain
about the strength of the recovery.
Participants touched on the outlook for fiscal policy
and the export sector. Assessments of the outlook for
government revenues and expenditures were mixed.
State and local government spending had recently
shown modest growth, following a lengthy period of
contraction, and declines in public-sector employment appeared to have abated of late. However, it
was noted that if agreement was not reached on a
longer-term plan for the federal budget, an abrupt
and sharp fiscal tightening would occur at the start of
2013. A number of participants observed that
exports continued to be a positive factor for U.S.
growth, while noting risks to the export picture from
economic weakness in Europe or a greater-thanexpected slowdown in China and emerging Asia.
Participants generally observed the continued
improvement in labor market conditions since the
January meeting. A couple of participants stated that
the progress suggested by the payroll numbers was
also apparent in a broad array of labor market indicators, and others noted survey measures suggesting
further solid gains in employment going forward.
One participant pointed to inflation readings and a
high rate of long-duration unemployment as signs
that the current level of output may be much closer
to potential than had been thought, and a few others
cited a weaker path of potential output as a characteristic of the present expansion. However, a number
of participants judged that the labor market currently featured substantial slack. In support of that
view, various indicators were cited, including aggregate hours, which during the recession had exhibited
a decline that was particularly severe by historical
standards and remained well below the series’ prerecession peak; the high number of persons working
part time for economic reasons; and low ratios of job

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99th Annual Report | 2012

openings to unemployment and of employment to
population.
Most participants noted that the incoming information on components of final spending had exhibited
less strength than the indicators of employment and
production. Some participants expressed the view
that the recent increases in payrolls likely reflected, in
part, a reversal of the sharp cuts in employment during the recession, a scenario consistent with the weak
readings on productivity growth of late. In this view,
the recent pace of employment gains might not be
sustained if the growth rate of spending did not pick
up. Several participants noted that the unseasonably
warm weather of recent months added one more element of uncertainty to the interpretation of incoming data, and that this factor might account for a
portion of the recent improvement in indicators of
employment and housing. In a contrasting view, the
improvements registered in labor market indicators
could be seen as raising the likelihood that GDP data
for the recent period would undergo a significant
upward revision.
Many participants noted that strains in global financial markets had eased somewhat, and that financial
conditions were more supportive of economic growth
than at the time of the January meeting. Among the
evidence cited were higher equity prices and better
conditions in corporate credit markets, especially the
markets for high-yield bonds and leveraged loans.
Banking contacts were reporting steady, though
modest, growth in C&I loans. Many meeting participants believed that policy actions in the euro area,
notably the Greek debt swap and the ECB’s longerterm refinancing operations, had helped to ease
strains in financial markets and reduced the downside risks to the U.S. and global economic outlook.
Nonetheless, a number of participants noted that a
longer-term solution to the banking and fiscal problems in the euro area would require substantial further adjustment in the banking and public sectors.
Participants saw the possibility of disruptions in
global financial markets as continuing to pose a risk
to growth.
While the recent readings on consumer price inflation
had been subdued, participants agreed that inflation
in the near term would be pushed up by rising oil and
gasoline prices. A few participants noted that the
crude oil price increases in the latter half of 2010 and
the early part of 2011 had been part of a broadbased rise in commodity prices; in contrast, non-

energy commodity prices had been more stable of
late, which suggested that the recent upward pressure
on oil prices was principally due to geopolitical concerns rather than global economic growth. A couple
of participants noted that recent readings on unit
labor costs had shown a larger increase than earlier,
but other participants pointed to other measures of
labor compensation that continued to show modest
increases. With longer-run inflation expectations still
well anchored, most participants anticipated that
after the temporary effect of the rise in oil and gasoline prices had run its course, inflation would be at or
below the 2 percent rate that they judge most consistent with the Committee’s dual mandate. Indeed, a
few participants were concerned that, with the persistence of considerable resource slack, inflation might
be below the mandate-consistent rate for some time.
Other participants, however, were worried that inflation pressures could increase as the expansion continued; these participants argued that, particularly in
light of the recent rise in oil and gasoline prices,
maintaining the current highly accommodative
stance of monetary policy over the medium run
could erode the stability of inflation expectations and
risk higher inflation.

Committee Policy Action
Members viewed the information on U.S. economic
activity received over the intermeeting period as suggesting that the economy had been expanding moderately and generally agreed that the economic outlook,
while a bit stronger overall, was broadly similar to
that at the time of their January meeting. Labor market conditions had continued to improve and unemployment had declined in recent months, but almost
all members saw the unemployment rate as still
elevated relative to levels that they viewed as consistent with the Committee’s mandate over the longer
run. With the economy facing continuing headwinds,
members generally expected a moderate pace of economic growth over coming quarters, with gradual
further declines in the unemployment rate. Strains in
global financial markets, while having eased since
January, continued to pose significant downside risks
to economic activity. Recent monthly readings on
inflation had been subdued, and longer-term inflation expectations remained stable. Against that backdrop, members generally anticipated that the recent
increase in oil and gasoline prices would push up
inflation temporarily, but that subsequently inflation
would run at or below the rate that the Committee
judges most consistent with its mandate.

Minutes of Federal Open Market Committee Meetings | March

In their discussion of monetary policy for the period
ahead, members agreed that it would be appropriate
to maintain the existing highly accommodative
stance of monetary policy. In particular, they agreed
to keep the target range for the federal funds rate at
0 to ¼ percent, to continue the program of extending
the average maturity of the Federal Reserve’s holdings of securities as announced in September, and to
retain the existing policies regarding the reinvestment
of principal payments from Federal Reserve holdings
of securities.
With respect to the statement to be released following
the meeting, members agreed that only relatively
small modifications to the first two paragraphs were
needed to reflect the incoming economic data, the
improvement in financial conditions, and the modest
changes to the economic outlook. With the economic
outlook over the medium term not greatly changed,
almost all members again agreed to indicate that the
Committee expects to maintain a highly accommodative stance for monetary policy and currently anticipates that economic conditions—including low rates
of resource utilization and a subdued outlook for
inflation over the medium run—are likely to warrant
exceptionally low levels for the federal funds rate at
least through late 2014. Several members continued
to anticipate, as in January, that the unemployment
rate would still be well above their estimates of its
longer-term normal level, and inflation would be at
or below the Committee’s longer-run objective, in
late 2014. It was noted that the Committee’s forward
guidance is conditional on economic developments,
and members concurred that the date given in the
statement would be subject to revision in response to
significant changes in the economic outlook. While
recent employment data had been encouraging, a
number of members perceived a nonnegligible risk
that improvements in employment could diminish as
the year progressed, as had occurred in 2010 and
2011, and saw this risk as reinforcing the case for
leaving the forward guidance unchanged at this meeting. In contrast, one member judged that maintaining the current degree of policy accommodation
much beyond this year would likely be inappropriate;
that member anticipated that a tightening of monetary policy would be necessary well before the end
of 2014 in order to keep inflation close to the Committee’s 2 percent objective.
The Committee also stated that it is prepared to
adjust the size and composition of its securities holdings as appropriate to promote a stronger economic
recovery in a context of price stability. A couple of

163

members indicated that the initiation of additional
stimulus could become necessary if the economy lost
momentum or if inflation seemed likely to remain
below its mandate-consistent rate of 2 percent over
the medium run.
At the conclusion of the discussion, the Committee
voted to authorize and direct the Federal Reserve
Bank of New York, until it was instructed otherwise,
to execute transactions in the System Account in
accordance with the following domestic policy
directive:
“The Federal Open Market Committee seeks
monetary and financial conditions that will foster price stability and promote sustainable
growth in output. To further its long-run objectives, the Committee seeks conditions in reserve
markets consistent with federal funds trading in
a range from 0 to ¼ percent. The Committee
directs the Desk to continue the maturity extension program it began in September to purchase,
by the end of June 2012, Treasury securities with
remaining maturities of approximately 6 years to
30 years with a total face value of $400 billion,
and to sell Treasury securities with remaining
maturities of 3 years or less with a total face
value of $400 billion. The Committee also
directs the Desk to maintain its existing policies
of rolling over maturing Treasury securities into
new issues and of reinvesting principal payments
on all agency debt and agency mortgage-backed
securities in the System Open Market Account
in agency mortgage-backed securities in order to
maintain the total face value of domestic securities at approximately $2.6 trillion. The Committee directs the Desk to engage in dollar roll
transactions as necessary to facilitate settlement
of the Federal Reserve’s agency MBS transactions. The System Open Market Account Manager and the Secretary will keep the Committee
informed of ongoing developments regarding
the System’s balance sheet that could affect the
attainment over time of the Committee’s objectives of maximum employment and price
stability.”
The vote encompassed approval of the statement
below to be released at 2:15 p.m.:
“Information received since the Federal Open
Market Committee met in January suggests that
the economy has been expanding moderately.
Labor market conditions have improved further;

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99th Annual Report | 2012

the unemployment rate has declined notably in
recent months but remains elevated. Household
spending and business fixed investment have
continued to advance. The housing sector
remains depressed. Inflation has been subdued
in recent months, although prices of crude oil
and gasoline have increased lately. Longer-term
inflation expectations have remained stable.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment
and price stability. The Committee expects moderate economic growth over coming quarters
and consequently anticipates that the unemployment rate will decline gradually toward levels
that the Committee judges to be consistent with
its dual mandate. Strains in global financial markets have eased, though they continue to pose
significant downside risks to the economic outlook. The recent increase in oil and gasoline
prices will push up inflation temporarily, but the
Committee anticipates that subsequently inflation will run at or below the rate that it judges
most consistent with its dual mandate.
To support a stronger economic recovery and to
help ensure that inflation, over time, is at the
rate most consistent with its dual mandate, the
Committee expects to maintain a highly accommodative stance for monetary policy. In particular, the Committee decided today to keep the
target range for the federal funds rate at 0 to
¼ percent and currently anticipates that economic conditions—including low rates of
resource utilization and a subdued outlook for
inflation over the medium run—are likely to
warrant exceptionally low levels for the federal
funds rate at least through late 2014.
The Committee also decided to continue its program to extend the average maturity of its holdings of securities as announced in September.
The Committee is maintaining its existing policies of reinvesting principal payments from its
holdings of agency debt and agency mortgagebacked securities in agency mortgage-backed
securities and of rolling over maturing Treasury
securities at auction. The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those
holdings as appropriate to promote a stronger
economic recovery in a context of price
stability.”

Voting for this action: Ben Bernanke, William C.
Dudley, Elizabeth Duke, Dennis P. Lockhart, Sandra
Pianalto, Sarah Bloom Raskin, Daniel K. Tarullo,
John C. Williams, and Janet L. Yellen.
Voting against this action: Jeffrey M. Lacker.
Mr. Lacker dissented because he did not agree that
economic conditions were likely to warrant exceptionally low levels of the federal funds rate at least
through late 2014. In his view, with inflation close to
the Committee’s objective of 2 percent, the economy
expanding at a moderate pace, and downside risks
somewhat diminished, the federal funds rate will
most likely need to rise considerably sooner to prevent the emergence of inflationary pressures. Mr.
Lacker continues to prefer to provide forward guidance regarding future Committee policy actions
through the inclusion of FOMC participants’ projections of the federal funds rate in the Summary of
Economic Projections (SEP).

Monetary Policy Communications
As it noted in its statement of principles regarding
longer-run goals and monetary policy strategy
released in January, the Committee seeks to explain
its monetary policy decisions to the public as clearly
as possible. With that goal in mind, participants discussed a range of additional steps that the Committee might take to help the public better understand
the linkages between the evolving economic outlook
and the Federal Reserve’s monetary policy decisions,
and thus the conditionality in the Committee’s forward guidance. The purpose of the discussion was to
explore potentially promising approaches for further
enhancing FOMC communications; no decisions on
this topic were planned for this meeting and none
were taken.
Participants discussed ways in which the Committee
might include, in its postmeeting statements, additional qualitative or quantitative information that
could convey a sense of how the Committee might
adjust policy in response to changes in the economic
outlook. Participants also discussed whether modifications to the SEP that the Committee releases four
times per year could be helpful in clarifying the linkages between the economic outlook and the Committee’s monetary policy decisions. In addition, several
participants suggested that it could be helpful to discuss at a future meeting some alternative economic
scenarios and the monetary policy responses that

Minutes of Federal Open Market Committee Meetings | March

might be seen as appropriate under each one, in order
to clarify the Committee’s likely behavior in different
contingencies. Finally, participants observed that the
Committee introduced several important enhancements to its policy communications over the past
year or so; these included the Chairman’s postmeeting press conferences as well as changes to the
FOMC statement and the SEP. Against this backdrop, some participants noted that additional experience with the changes implemented to date could be
helpful in evaluating potential further enhancements.
It was agreed that the next meeting of the Committee
would be held on Tuesday–Wednesday, April 24–25,

165

2012. The meeting adjourned at 4:10 p.m. on
March 13, 2012.

Notation Vote
By notation vote completed on February 14, 2012,
the Committee unanimously approved the minutes of
the FOMC meeting held on January 24–25, 2012.
William B. English
Secretary

166

99th Annual Report | 2012

Meeting Held on April 24–25, 2012

Steven B. Kamin
Economist

A meeting of the Federal Open Market Committee
was held in the offices of the Board of Governors of
the Federal Reserve System in Washington, D.C., on
Tuesday, April 24, 2012, at 1:00 p.m., and continued
on Wednesday, April 25, 2012, at 8:30 a.m.

David W. Wilcox
Economist

Present

David Altig, Thomas A. Connors, Michael P. Leahy,
William Nelson, Simon Potter, David Reifschneider,
and William Wascher
Associate Economists

Ben Bernanke
Chairman

Brian Sack
Manager, System Open Market Account

William C. Dudley
Vice Chairman

Michael S. Gibson
Director, Division of Banking Supervision and
Regulation, Board of Governors

Elizabeth Duke
Jeffrey M. Lacker
Dennis P. Lockhart
Sandra Pianalto
Sarah Bloom Raskin
Daniel K. Tarullo
John C. Williams
Janet L. Yellen
James Bullard, Christine Cumming,
Charles L. Evans, Esther L. George, and
Eric Rosengren
Alternate Members of the Federal Open Market
Committee
Richard W. Fisher, Narayana Kocherlakota, and
Charles I. Plosser
Presidents of the Federal Reserve Banks of Dallas,
Minneapolis, and Philadelphia, respectively
William B. English
Secretary and Economist
Deborah J. Danker
Deputy Secretary
Matthew M. Luecke
Assistant Secretary
David W. Skidmore
Assistant Secretary
Michelle A. Smith
Assistant Secretary
Scott G. Alvarez
General Counsel
Thomas C. Baxter
Deputy General Counsel

Nellie Liang
Director, Office of Financial Stability Policy and
Research, Board of Governors
Jon W. Faust and Andrew T. Levin
Special Advisors to the Board, Office of Board
Members, Board of Governors
James A. Clouse
Deputy Director, Division of Monetary Affairs,
Board of Governors
Matthew J. Eichner
Deputy Director, Division of Research and Statistics,
Board of Governors
Linda Robertson
Assistant to the Board, Office of Board Members,
Board of Governors
Thomas Laubach
Senior Adviser, Division of Research and Statistics,
Board of Governors
Ellen E. Meade
Senior Adviser, Division of Monetary Affairs,
Board of Governors
Daniel M. Covitz and David E. Lebow
Associate Directors, Division of Research and
Statistics, Board of Governors
David Bowman
Deputy Associate Director, Division of International
Finance, Board of Governors
Gretchen C. Weinbach
Deputy Associate Director, Division of Monetary
Affairs, Board of Governors
Jane E. Ihrig
Assistant Director, Division of Monetary Affairs,
Board of Governors

Minutes of Federal Open Market Committee Meetings | April

David H. Small
Project Manager, Division of Monetary Affairs,
Board of Governors
Gregory L. Stefani
First Vice President, Federal Reserve Bank of
Cleveland
Jeff Fuhrer, Loretta J. Mester,
Harvey Rosenblum, and Daniel G. Sullivan
Executive Vice Presidents, Federal Reserve Banks of
Boston, Philadelphia, Dallas, and Chicago,
respectively
Troy Davig, Ron Feldman,
Mark E. Schweitzer, and Christopher J. Waller
Senior Vice Presidents, Federal Reserve Banks of
Kansas City, Minneapolis, Cleveland, and St. Louis,
respectively
John Fernald
Group Vice President, Federal Reserve Bank of
San Francisco
Andreas L. Hornstein and Lorie K. Logan
Vice Presidents, Federal Reserve Banks of Richmond
and New York, respectively

Monetary Policy under Alternative
Scenarios
A staff presentation provided an overview of an exercise that explored individual participants’ views on
appropriate monetary policy responses under alternative economic scenarios. Committee participants
discussed the potential value and drawbacks of this
type of exercise for both internal deliberations and
external communications about monetary policy.
Possible benefits include helping to clarify the factors
that individual participants judge most important in
forming their views about the economic outlook and
their assessments of appropriate monetary policy.
Two potential limitations of this approach are that
the scenario descriptions must by necessity be incomplete, and the practical range of scenarios that can be
examined may be insufficient to be informative, given
the degree of uncertainty surrounding possible outcomes. Some participants stated that exercises using
alternative scenarios, with appropriate adjustments,
could potentially be helpful for internal deliberations
and, thus, should be explored further. However, no
decision was made at this meeting regarding future
exercises along these lines.

167

Developments in Financial Markets and
the Federal Reserve’s Balance Sheet
The Manager of the System Open Market Account
(SOMA) reported on developments in domestic and
foreign financial markets during the period since the
Federal Open Market Committee (FOMC) met on
March 13, 2012. He also reported on System open
market operations, including the ongoing reinvestment into agency-guaranteed mortgage-backed securities (MBS) of principal payments received on
SOMA holdings of agency debt and agencyguaranteed MBS as well as the operations related to
the maturity extension program authorized at the
September 20–21, 2011, FOMC meeting. By unanimous vote, the Committee ratified the Desk’s domestic transactions over the intermeeting period. There
were no intervention operations in foreign currencies
for the System’s account over the intermeeting period.
With Mr. Lacker dissenting, the Committee agreed to
extend the reciprocal currency (swap) arrangements
with the Bank of Canada and the Banco de México
for an additional year beginning in midDecember 2012; these arrangements are associated
with the Federal Reserve’s participation in the North
American Framework Agreement of 1994. The
arrangement with the Bank of Canada allows for
cumulative drawings of up to $2 billion equivalent,
and the arrangement with the Banco de México
allows for cumulative drawings of up to $3 billion
equivalent. The vote to renew the System’s participation in these swap arrangements was taken at this
meeting because a provision in the Framework
Agreement requires each party to provide six
months’ prior notice of an intention to terminate its
participation. Mr. Lacker dissented because of his
opposition, as indicated at the January meeting, to
foreign exchange market intervention by the Federal
Reserve, which such swap arrangements might facilitate, and because of his opposition to direct lending
to foreign central banks.

Staff Review of the Economic Situation
The information reviewed at the April 24–25 meeting
suggested that economic activity was expanding
moderately. Payroll employment continued to move
up, and the unemployment rate, while still elevated,
declined a little further. Overall consumer price inflation increased somewhat, primarily reflecting higher

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99th Annual Report | 2012

prices of crude oil and gasoline, but measures of
long-run inflation expectations remained stable.
The unemployment rate declined to 8.2 percent in
March. The share of workers employed part time for
economic reasons also moved down, but the rate of
long-duration unemployment remained elevated. Private nonfarm employment rose at a slower pace in
March than in the preceding three months, while
total government employment was little changed in
recent months after declining last year. Some indicators of job openings and firms’ hiring plans
improved. After being roughly flat over most of the
intermeeting period, initial claims for unemployment
insurance rose moderately toward the end of the
period but remained at a level consistent with further
moderate job gains in the coming months.
Manufacturing production expanded, on net, in February and March, while the rate of manufacturing
capacity utilization was essentially unchanged. In
recent months, the production of motor vehicles continued to rise appreciably in response to both higher
vehicle sales and dealers’ additions to relatively low
levels of inventories; output gains in other industries
also were solid and widespread. Motor vehicle assemblies were scheduled to step up further in the second
quarter, and broader indicators of manufacturing
activity, such as the diffusion indexes of new orders
from the national and regional manufacturing surveys, were at levels consistent with moderate
increases in factory output in the second quarter.
Real personal consumption expenditures (PCE) rose
briskly in February, even though households’ real disposable incomes declined. In March, nominal retail
sales excluding purchases of motor vehicles increased
solidly, while motor vehicle sales fell off a little from
their brisk pace in the previous month. Consumer
sentiment was little changed, on balance, in March
and early April and remained subdued.
Some measures of home prices rose in January and
February, but activity in the housing market continued to be held down by the large inventory of foreclosed and distressed properties and by tight underwriting standards for mortgage loans. Starts of new
single-family homes fell back in February and March
to a level more in line with permit issuance; starts
were apparently boosted by unseasonably warm
weather in December and January. Moreover, sales of
new and existing homes edged down, on net, in
recent months.

Real business expenditures on equipment and software appeared to rise modestly in the first quarter.
Nominal shipments of nondefense capital goods
excluding aircraft increased in February and March
after declining in January; new orders for these capital goods increased, on balance, in February and
March, and they continued to run above the level of
shipments. The buildup of unfilled orders in recent
months, along with improvements in survey measures
of capital spending plans and some other forwardlooking indicators, pointed toward a pickup in the
pace of expenditures for business equipment. In contrast, nominal business spending for nonresidential
construction declined in January and February.
Inventories in most industries looked to be fairly well
aligned with sales in recent months, although motor
vehicle stocks were still relatively lean.
Data for federal government spending in recent
months indicated that real defense expenditures rose
modestly in the first quarter. Real state and local government purchases appeared to be about flat last
quarter, as the payrolls of these governments edged
up in the first quarter and their nominal construction
spending declined slightly, on net, in January and
February.
The U.S. international trade deficit narrowed in February as exports rose and imports fell. The export
gains were concentrated in services. Exports of goods
declined largely because of a decrease in exports of
automotive products. The drop in imports reflected
significant declines in imports of petroleum products,
automotive products, capital goods, and consumer
goods. Imports from China were especially weak,
which may in part reflect seasonal adjustment issues
related to the timing of the Chinese New Year.
Overall U.S. consumer prices, as measured by the
PCE price index, rose at a somewhat faster rate in
February than in the preceding six months. In
March, prices measured by the consumer price index
increased at that same faster pace. Consumer energy
prices climbed markedly in February and March,
although survey data indicated that gasoline prices
stepped down in the first half of April. Meanwhile,
increases in consumer food prices were relatively subdued in recent months. Consumer prices excluding
food and energy rose moderately in February and
March. Near-term inflation expectations from the
Thomson Reuters/University of Michigan Surveys of
Consumers increased in March but then fell back in

Minutes of Federal Open Market Committee Meetings | April

169

early April, while longer-term inflation expectations
in the survey remained stable.

reduction in Treasury bill issuance in April, but
ended the period roughly unchanged.

Available measures of labor compensation indicated
that nominal wage gains continued to be muted.
Average hourly earnings for all employees rose modestly in March, and their rate of increase from
12 months earlier remained low.

Broad U.S. stock price indexes followed the general
pattern observed across asset markets, rising early in
the period on increased investor optimism and then
falling later on, to end the period little changed on
net. Equity prices of financial institutions increased,
reportedly as investors interpreted the first-quarter
earnings of several large banking organizations and
the results of the CCAR as better than expected.
Yields and spreads on investment-grade corporate
bonds were about unchanged, but yields and spreads
on speculative-grade corporate bonds increased
somewhat.

Recent indicators suggested that foreign economic
activity improved on balance in the first quarter, but
there were important differences across economies. In
the euro area, economic indicators pointed to weakening activity as financial stresses worsened, whereas
in the emerging market economies, recent data were
consistent with continued expansion. Readings on
foreign inflation eased, although they were still relatively high in some Latin American countries.

Staff Review of the Financial Situation
Broad financial market conditions changed little, on
balance, since the March FOMC meeting. However,
asset prices fluctuated substantially over the period,
apparently in response to the evolving views on the
U.S. and global economic outlook and changing
expectations regarding the future course of monetary
policy.
Yields on nominal Treasury securities moved up early
in the period, reportedly as investors read incoming
information, including the March FOMC statement
and minutes along with the results of the Comprehensive Capital Analysis and Review (CCAR), as
suggesting a somewhat stronger economic outlook
than previously expected. Over subsequent weeks,
however, yields drifted lower in response to disappointing economic news and increased concerns
about the strains in Europe. On net, nominal Treasury yields finished the period slightly lower and
measures of the expected path for the federal funds
rate derived from overnight index swap (OIS) rates
moved down.
Conditions in unsecured short-term dollar funding
markets were stable over most of the intermeeting
period despite the increase in concerns about Europe
in the latter part of the period. In secured funding
markets, the overnight general collateral Treasury
repurchase agreement rate declined for a time late in
the period, reportedly in response to the seasonal

Businesses continued to raise substantial amounts of
funds in credit and capital markets over recent
months. Bond issuance by financial firms picked up
further in March from the strong pace recorded in
the previous two months. Domestic nonfinancial
firms’ bond issuance and growth in commercial and
industrial (C&I) loans were robust in the first quarter. Leveraged loan issuance was brisk over this
period as well, reportedly supported by investor
demand for newly issued collateralized loan obligations as well as by interest from pension funds and
other institutional investors. Gross public equity issuance by nonfinancial firms stayed strong in March.
In contrast, financial conditions in the commercial
real estate (CRE) sector remained strained amid
weak fundamentals and tight underwriting conditions, and issuance of commercial mortgage-backed
securities in the first quarter of 2012 was below that
of a year ago.
With respect to credit to households, developments
over the intermeeting period were mixed. Although
mortgage rates remained near their historical lows,
mortgage refinancing activity was subdued, and conditions in residential mortgage markets continued to
be weak. By contrast, consumer credit rose at a solid
pace, on balance, in recent months; nonrevolving
credit, particularly student loans, expanded. Issuance
of consumer asset-backed securities (ABS) edged up
in recent months, supported by auto-loan ABS issuance.
Gross issuance of long-term municipal bonds was
subdued in the first quarter. The ratio of general
obligation municipal bond yields to yields on

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99th Annual Report | 2012

comparable-maturity Treasury securities was little
changed over the intermeeting period, and the average spreads on credit default swaps for debt issued by
states declined on net.
Bank credit slowed in March but expanded at a solid
pace in the first quarter as a whole. The Senior Loan
Officer Opinion Survey on Bank Lending Practices
conducted in April indicated that, in the aggregate,
domestic banks eased slightly their lending standards
on core loans—C&I, real estate, and consumer
loans—and experienced somewhat stronger demand
for such loans in the first quarter of 2012. C&I loans
at domestic banks continued to expand in March,
with growth concentrated at large domestic banks.
Banks’ holdings of closed-end residential mortgage
loans expanded, while home equity loans and CRE
loans continued to decline. Consumer loans on
banks’ books rose modestly in March.
M2 expanded at a moderate pace in March, reflecting growth in liquid deposits and currency that was
only partially offset by declines in small time deposits
and in balances in retail money market funds.
Financial strains within the euro area increased over
the intermeeting period. Spreads of yields on sovereign Italian and Spanish debt over those on
comparable-maturity German bonds rose, amid official warnings that Spain would miss its fiscal target
for this year and would need to make further budget
cuts, as well as renewed concerns in the market about
the prospects for Spanish banks. Although the spread
of the three-month euro London interbank offered
rate over the comparable OIS rate narrowed on balance over the period, euro-area bank equity indexes
dropped sharply, driven by declines in the share
prices of Spanish and Italian banks. Five-year credit
default swap premiums rose for a broad range of
euro-area banks, especially Spanish banks.
Against the background of these increased stresses
within the euro area, foreign equity indexes declined
and corporate credit spreads widened. The staff’s
broad nominal index of the foreign exchange value of
the dollar was about unchanged over the intermeeting period as the dollar appreciated against most
emerging market currencies but depreciated moderately against the yen and sterling. Amid some volatility, yields on benchmark sovereign bonds for Germany and Japan ended the period somewhat lower.
Monetary policy abroad remained generally
accommodative.

The total outstanding amount on the Federal
Reserve’s dollar liquidity swap lines declined to
$32 billion, down from $65 billion at the time of the
March FOMC meeting; demand for dollars fell at the
lending operations of the European Central Bank,
the Bank of Japan, and the Swiss National Bank.

Staff Economic Outlook
In the economic forecast prepared for the April
FOMC meeting, the staff revised up slightly its nearterm projection for real gross domestic product
(GDP) growth, reflecting that the unemployment rate
was a little lower, the level of overall payroll employment a bit higher, and consumer spending noticeably
stronger than the staff had expected at the time of
the previous forecast. However, the staff’s mediumterm projection for real GDP growth in the April
forecast was little changed from the one presented in
March. The staff continued to project that real GDP
would accelerate gradually through 2014, supported
by accommodative monetary policy, further improvements in credit availability, and rising consumer and
business sentiment. Increases in economic activity
were expected to be sufficient to decrease the wide
margin of slack in the labor market slowly over the
projection period, but the unemployment rate was
anticipated to still be elevated at the end of 2014.
The staff’s forecast for inflation over the projection
period was just a bit above the forecast prepared for
the March FOMC meeting, reflecting somewhat
higher-than-expected data on core consumer prices
and a slightly narrower margin of economic slack
than in the March forecast. However, with the passthrough of the recent run-up in crude oil prices into
consumer energy prices seen as nearly complete, oil
prices expected to edge lower from current levels,
substantial resource slack persisting over the projection period, and stable long-run inflation expectations, the staff continued to forecast that inflation
would be subdued through 2014.

Participants’ Views on Current Conditions
and the Economic Outlook
In conjunction with this FOMC meeting, meeting
participants—the five members of the Board of
Governors and the presidents of the 12 Federal
Reserve Banks, all of whom participate in the deliberations of the FOMC—submitted their assessments
of real output growth, the unemployment rate, inflation, and the target federal funds rate for each year

Minutes of Federal Open Market Committee Meetings | April

from 2012 through 2014 and over the longer run,
under each participant’s judgment of appropriate
monetary policy. The longer-run projections represent each participant’s assessment of the rate to
which each variable would be expected to converge,
over time, under appropriate monetary policy and in
the absence of further shocks to the economy. These
economic projections and policy assessments are
described in more detail in the Summary of Economic Projections (SEP), which is attached as an
addendum to these minutes.
In their discussion of the economic situation and
outlook, meeting participants agreed that the information received since the Committee’s previous
meeting suggested that the economy continued to
expand moderately. Labor market conditions
improved in recent months. So far this year, payroll
employment had expanded at a faster pace than last
year and the unemployment rate had declined further, although it remained elevated. Household
spending and business fixed investment continued to
expand. There were signs of improvement in the
housing sector, but from a very low level of activity.
Despite some volatility in financial markets over the
intermeeting period, financial conditions in U.S. markets continued to improve; bank credit quality and
loan demand both increased. Mainly reflecting the
increase in the prices of crude oil and gasoline earlier
this year, inflation had picked up somewhat. However, longer-term inflation expectations remained stable.
Participants’ assessments of the economic outlook
were little changed, with the intermeeting information generally seen as suggesting that economic
growth would remain moderate over coming quarters
and then pick up gradually. Reflecting the moderate
pace of economic growth, most anticipated a gradual
decline in the unemployment rate. The incoming
information led some participants to become more
confident about the durability of the recovery. However, others thought it was premature to infer a
stronger underlying trend from the recent positive
indicators, since those readings may partially reflect
the effects of the mild winter weather or other temporary influences. A number of factors continued to
be seen as likely limiting the economic expansion to a
moderate pace in the near term; these included slow
growth in some foreign economies, prospective fiscal
tightening in the United States, slow household
income growth, and—notwithstanding some recent
signs of improvement—ongoing weakness in the
housing market. Participants continued to expect
most of the factors restraining economic expansion

171

to ease over time and so anticipated that the recovery
would gradually gain strength. The strains in global
financial markets, though generally less pronounced
than last fall, continued to pose a significant risk to
the outlook, and the possibility of a sharp fiscal
tightening in the United States was also considered a
sizable risk. Most participants anticipated that inflation would fall back from recent elevated levels as the
effects of higher energy prices waned, and still
expected that inflation subsequently would run at or
below the 2 percent rate that the Committee judges to
be most consistent with its statutory mandate. However, other participants saw upside risks to the inflation outlook given the recent pickup in inflation and
the highly accommodative stance of monetary policy.
In discussing the household sector, meeting participants generally noted that consumer spending continued to expand moderately, notwithstanding high
gasoline prices. The recent strengthening in the pace
of light motor vehicle sales was attributed to both
pent-up demand and the desire for increased fuel efficiency in the wake of higher gasoline prices. Looking
forward, increases in household wealth from the rise
in equity prices, improving consumer sentiment, and
a diminishing drag from household deleveraging were
seen as helping to support continued increases in
household expenditures, notwithstanding sluggish
growth in real disposable income and restrictive fiscal
policies.
Recent housing-sector indicators, including sales and
starts, suggested some upward movement, but some
participants saw the improvement as likely related to
unusually warm winter weather in much of the country. Overall, the level of activity in the sector
remained depressed. House prices appeared to be stabilizing but had not yet begun to rise in most markets. Most participants anticipated that the housing
sector was likely to recover only slowly over time, but
a few were more optimistic about the potential for a
more rapid housing recovery given reports of
stronger demand in some regions and of improved
sentiment among builders, as well as signs that recent
changes to the Home Affordable Refinance Program
were contributing to the refinancing of performing
high loan-to-value mortgages.
Reports from business contacts indicated that activity
in the manufacturing, energy, and agriculture sectors
continued to advance in recent months. Auto production had picked up in light of strengthening demand.
Business contacts suggested that sentiment was
improving, but many firms remained somewhat cau-

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99th Annual Report | 2012

Exports have supported U.S. growth so far this year;
however, some participants noted risks to the export
picture from economic weakness in Europe or from a
more significant slowdown in the pace of expansion
in China and emerging Asia.

job gains may be somewhat weaker unless the pace of
economic growth increases. Participants expressed a
range of views on the extent to which the unemployment rate was being boosted by structural factors
such as mismatches between the skills of unemployed
workers and those being demanded by hiring firms.
A few participants acknowledged there could be
structural factors at work, but said that in their view,
slack remained high and weak aggregate demand was
the major reason that unemployment was still
elevated. Two noted the possibility that sustained
high levels of long-term unemployment could result
in higher structural unemployment, an outcome that
might be forestalled by increased aggregate demand.
A few participants noted that current measures of
labor market slack would be overstated if structural
factors accounted for a large portion of the current
high levels of unemployment. As a result, such measures might be an unreliable guide as to how close the
economy was to maximum employment. These participants pointed out that, over time, estimates of the
potential level of output have declined, reducing, as a
consequence, estimates of the level of economic
slack. Some participants cited the recent rise in inflation, abstracting from the direct effect of the rise in
energy prices, as supportive of the view that the level
of slack was lower than some believe.

Labor market conditions continued to improve,
although unusually warm weather may have inflated
payroll job figures somewhat earlier this year. Contacts in some parts of the country said that highly
qualified workers were in short supply; overall, however, wage pressures had been limited so far. The
decline in labor force participation, which has been
sharpest for younger workers, has been a factor in the
nearly 1 percentage point decline in the unemployment rate since last August, a drop that was larger
than would have been predicted from the historical
relationship between real GDP growth and changes
in the unemployment rate. Assessing the extent to
which the changes in labor force participation reflect
cyclical factors that will be reversed once the recovery
picks up, as opposed to changes in the trend rate of
participation, was seen as important for understanding unemployment dynamics going forward. One
participant cited research suggesting that about half
of the decline in labor force participation had
reflected cyclical factors, and thus, as participation
picks up, unemployment may decline more slowly in
coming quarters compared with the recent pace.
Another posited that the strength in payroll job
growth in recent months may be a one-time reaction
to the sharp layoffs in 2008 and 2009 and that future

Participants judged that, in general, conditions in
domestic credit markets had continued to improve
since the March FOMC meeting. Bank credit quality
and consumer and business loan demand were
increasing, although commercial and residential real
estate lending remained relatively weak. U.S. equity
prices had risen early in the intermeeting period but
subsequently declined, ending the period little
changed on net; investment-grade corporate bond
yields were flat to down slightly and remained at very
low levels. Many U.S. financial institutions had been
taking steps to bolster their resiliency, including
increasing capital levels and liquidity buffers, and
reducing their European exposures. A few participants indicated that they were seeing signs that very
low interest rates might be inducing some investors to
take on imprudent risks in the search for higher
nominal returns. In contrast to improved conditions
in domestic credit markets, investors’ concerns about
the sovereign debt and banking situation in the euro
area intensified during the intermeeting period. Some
participants said they thought the policy actions
taken in Europe would most likely ease stress in
financial markets, but some expressed the view that a
longer-term solution to the banking and fiscal problems in the euro area would require substantial fur-

tious in their hiring and investment decisions, with
most capital investment being undertaken to improve
productivity or gain market share rather than to
expand capacity. Reportedly, this caution reflected in
part continued uncertainty about the strength and
durability of the economic recovery, as well as about
government policies.
Participants expected that the government sector
would be a drag on economic growth over coming
quarters. They generally saw the U.S. fiscal situation
also as a risk to the economic outlook; if agreement
is not reached on a plan for the federal budget, a
sharp fiscal tightening could occur at the start of
2013. Several participants indicated that uncertainty
about the trajectory of future fiscal policy could lead
businesses to defer hiring and investment. It was
noted that agreement on a longer-term plan to
address the country’s fiscal challenges would help to
alleviate uncertainty and consequent negative effects
on consumer and business sentiment.

Minutes of Federal Open Market Committee Meetings | April

ther adjustment in the banking and public sectors.
Participants expected that global financial markets
would remain focused on the evolving situation in Europe.
Readings on consumer price inflation had picked up
somewhat mainly because of increases in oil and
gasoline prices earlier in the year. In recent weeks, oil
prices had begun to fall and readings from the oil
futures market suggested this may continue; nonenergy commodity prices had remained relatively
stable. Several participants noted that increases in
labor costs continued to be subdued. With longer-run
inflation expectations well anchored and the unemployment rate elevated, most participants anticipated
that after the temporary effect of the rise in oil and
gasoline prices had run its course, inflation would be
at or below the 2 percent rate that the Committee
judges to be most consistent with its mandate. Overall, most participants viewed the risks to their inflation outlook as being roughly balanced. However,
some participants saw a risk that inflation pressures
could increase as the expansion continued; they
pointed to the fact that inflation was currently above
target and were skeptical of models that rely on economic slack to forecast inflation partly because of
the difficulty in measuring slack, especially in real
time. These participants were concerned that maintaining the current highly accommodative stance of
monetary policy over the medium run could erode
the stability of inflation expectations and risk higher
inflation. In this regard, one participant noted the
potential risks and costs associated with additional
balance sheet actions.
In their discussion of the economic outlook and
policy, some participants noted the potential usefulness of simple monetary policy rules, of the type the
Committee regularly reviews, as guides for monetary
policy decisionmaking and for external communications about policy. These participants suggested that
because such rules give an indication of how policy
should systematically respond to changes in economic conditions they might help clarify the relationship between appropriate monetary policy and the
evolution of the economic outlook. While acknowledging that there could be differences across participants in the type of rules they might favor—for
example, one participant expressed a preference for
rules based on growth rates rather than output gaps
because of measurement issues—a few participants
indicated that the likely degree of commonality
across participants was suggestive that this might be
a promising approach to explore. However, a few
other participants were more skeptical. One thought

173

that, while prescriptions from rules might provide
useful benchmarks, applying the rules mechanically
and with little thought about the embedded assumptions would be counterproductive. Another participant questioned the value of interest rate rules when
the policy rate is constrained by the zero lower bound
on nominal interest rates and unconventional policy
options are being used, but others indicated they
believed the rules could be appropriately adjusted to
account for these factors. Interest was expressed in
examining the usefulness of simple policy rules in a
more normal environment, as well as in the current
environment in which the policy rate is at the zero
lower bound and large-scale asset purchases and the
maturity extension program have been implemented.
Participants planned to discuss further, at a future
meeting, the potential merits and drawbacks of using
simple rules as guides to monetary policy decisionmaking and for communications.

Committee Policy Action
Members viewed the information on U.S. economic
activity received over the intermeeting period as suggesting that the economy had been expanding moderately and generally agreed that the economic outlook
was broadly similar to that at the time of their March
meeting. Labor market conditions had improved in
recent months, and the unemployment rate had
fallen, but almost all of the members saw the unemployment rate as still elevated relative to levels that
they viewed as consistent with the Committee’s mandate. Growth was expected to be moderate over coming quarters and then to pick up over time. Members
expected the unemployment rate to decline gradually.
Strains in global financial markets stemming from
the sovereign debt and banking situation in Europe
continued to pose significant downside risks to economic activity both here and abroad. The possibilities that U.S. fiscal policy would be more contractionary than anticipated and that uncertainty about
fiscal policy could lead to a deferral of hiring and
investment were other downside risks. Recent readings indicated that inflation remained above the
Committee’s 2 percent longer-run target, primarily
reflecting the increase in oil and gasoline prices seen
earlier in the year. With longer-term inflation expectations stable, most members anticipated that the
increase in inflation would prove temporary and that
subsequently inflation would run at or below the rate
that the Committee judges to be most consistent with
its mandate. However, one member thought that
there were upside risks to inflation, especially if the

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99th Annual Report | 2012

current degree of highly accommodative monetary
policy were maintained much beyond this year.
In their discussion of monetary policy for the period
ahead, the Committee members reached the collective judgment that it would be appropriate to maintain the existing highly accommodative stance of
monetary policy. In particular, the Committee agreed
to keep the target range for the federal funds rate at
0 to ¼ percent, to continue the program of extending
the average maturity of the Federal Reserve’s holdings of securities as announced last September, and
to retain the existing policies regarding the reinvestment of principal payments from Federal Reserve
holdings of securities.
With respect to the statement to be released following
the meeting, members agreed that only relatively
small modifications to the first two paragraphs were
needed to reflect the incoming economic data and the
modest changes to the economic outlook. With the
economic outlook over the medium term not greatly
changed, almost all of the members again agreed to
indicate that the Committee expects to maintain a
highly accommodative stance for monetary policy
and currently anticipates that economic conditions—
including low rates of resource utilization and a subdued outlook for inflation over the medium run—are
likely to warrant exceptionally low levels for the federal funds rate at least through late 2014. Most members continued to anticipate that the unemployment
rate would still be well above their estimates of its
longer-run level, and inflation would be at or below
the Committee’s longer-run objective, in late 2014.
Some Committee members indicated that their policy
judgment reflected in part their perception of downside risks to growth, especially since the Committee’s
ability to respond to weaker-than-expected economic
conditions would be somewhat limited by the constraint imposed on monetary policy when the policy
rate is near the zero lower bound. The need to compensate for a substantial period during which the
policy rate was constrained by the zero bound was
also cited by a few members as a possible reason to
maintain a very low level of the federal funds rate for
a longer period than would otherwise be the case.
While almost all of the members agreed that the
change in the outlook over the intermeeting period
was insufficient to warrant an adjustment to the
Committee’s forward guidance, particularly given the
uncertainty surrounding economic forecasts, it was
noted that the forward guidance is conditional on
economic developments and that the date given in the

statement would be subject to revision should there
be a significant change in the economic outlook.
Some members recalled that gains in employment
strengthened in early 2010 and again in early 2011
only to diminish as those years progressed; moreover,
the uncertain effects of the unusually mild winter
weather were cited as making it harder to discern the
underlying trend in the economic data. They viewed
these factors as reinforcing the case for leaving the
forward guidance unchanged at this meeting and preferred adjusting the forward guidance only once they
were more confident that the medium-term economic
outlook or risks to the outlook had changed significantly. In contrast, another member thought that the
forward guidance should be more responsive to
changes in economic developments; that member
suggested that the Committee would need to determine the appropriate threshold for altering the guidance.
The Committee also stated that it will regularly
review the size and composition of its securities holdings and is prepared to adjust those holdings as
appropriate to promote a stronger economic recovery
in a context of price stability. Several members indicated that additional monetary policy accommodation could be necessary if the economic recovery lost
momentum or the downside risks to the forecast
became great enough.
Committee members discussed the desirability of
providing more clarity about the economic conditions that would likely warrant maintaining the current target range for the federal funds rate and those
that would indicate that a change in monetary policy
was appropriate. Doing so might help the public better understand the conditionality in the Committee’s
forward guidance. The Committee also discussed the
relationship between the Committee’s statement,
which expresses the collective view of the Committee,
and the policy projections of individual participants,
which are included in the SEP. The Chairman asked
the subcommittee on communications to consider
possible enhancements and refinements to the SEP
that might help better clarify the link between economic developments and the Committee’s view of
the appropriate stance of monetary policy.
At the conclusion of the discussion, the Committee
voted to authorize and direct the Federal Reserve
Bank of New York, until it was instructed otherwise,
to execute transactions in the System Account in
accordance with the following domestic policy
directive:

Minutes of Federal Open Market Committee Meetings | April

“The Federal Open Market Committee seeks
monetary and financial conditions that will foster price stability and promote sustainable
growth in output. To further its long-run objectives, the Committee seeks conditions in reserve
markets consistent with federal funds trading in
a range from 0 to ¼ percent. The Committee
directs the Desk to continue the maturity extension program it began in September to purchase,
by the end of June 2012, Treasury securities with
remaining maturities of approximately 6 years to
30 years with a total face value of $400 billion,
and to sell Treasury securities with remaining
maturities of 3 years or less with a total face
value of $400 billion. The Committee also
directs the Desk to maintain its existing policies
of rolling over maturing Treasury securities into
new issues and of reinvesting principal payments
on all agency debt and agency mortgage-backed
securities in the System Open Market Account
in agency mortgage-backed securities in order to
maintain the total face value of domestic securities at approximately $2.6 trillion. The Committee directs the Desk to engage in dollar roll
transactions as necessary to facilitate settlement
of the Federal Reserve’s agency MBS transactions. The System Open Market Account Manager and the Secretary will keep the Committee
informed of ongoing developments regarding
the System’s balance sheet that could affect the
attainment over time of the Committee’s objectives of maximum employment and price
stability.”
The vote encompassed approval of the statement
below to be released at 12:30 p.m.:
“Information received since the Federal Open
Market Committee met in March suggests that
the economy has been expanding moderately.
Labor market conditions have improved in
recent months; the unemployment rate has
declined but remains elevated. Household
spending and business fixed investment have
continued to advance. Despite some signs of
improvement, the housing sector remains
depressed. Inflation has picked up somewhat,
mainly reflecting higher prices of crude oil and
gasoline. However, longer-term inflation expectations have remained stable.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment
and price stability. The Committee expects eco-

175

nomic growth to remain moderate over coming
quarters then to pick up gradually. Consequently, the Committee anticipates that the
unemployment rate will decline gradually
toward levels that it judges to be consistent with
its dual mandate. Strains in global financial markets continue to pose significant downside risks
to the economic outlook. The increase in oil and
gasoline prices earlier this year is expected to
affect inflation only temporarily, and the Committee anticipates that subsequently inflation
will run at or below the rate that it judges most
consistent with its dual mandate.
To support a stronger economic recovery and to
help ensure that inflation, over time, is at the
rate most consistent with its dual mandate, the
Committee expects to maintain a highly accommodative stance for monetary policy. In particular, the Committee decided today to keep the
target range for the federal funds rate at 0 to
¼ percent and currently anticipates that economic conditions—including low rates of
resource utilization and a subdued outlook for
inflation over the medium run—are likely to
warrant exceptionally low levels for the federal
funds rate at least through late 2014.
The Committee also decided to continue its program to extend the average maturity of its holdings of securities as announced in September.
The Committee is maintaining its existing policies of reinvesting principal payments from its
holdings of agency debt and agency mortgagebacked securities in agency mortgage-backed
securities and of rolling over maturing Treasury
securities at auction. The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those
holdings as appropriate to promote a stronger
economic recovery in a context of price
stability.”
Voting for this action: Ben Bernanke, William C.
Dudley, Elizabeth Duke, Dennis P. Lockhart, Sandra
Pianalto, Sarah Bloom Raskin, Daniel K. Tarullo,
John C. Williams, and Janet L. Yellen.
Voting against this action: Jeffrey M. Lacker.
Mr. Lacker dissented because he did not believe that
economic conditions were likely to warrant exceptionally low levels of the federal funds rate through
late 2014. In his view, an increase in the federal funds

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99th Annual Report | 2012

rate was likely to be necessary by mid-2013 to prevent
the emergence of inflationary pressures.
It was agreed that the next meeting of the Committee
would be held on Tuesday–Wednesday, June 19–20,
2012. Because some participants had expressed a
preference for the two-day format over the one-day
format for FOMC meetings, the Chairman raised the
possibility of revising the FOMC meeting schedule
to incorporate more two-day meetings to allow additional time for discussion. The meeting adjourned at
11:10 a.m. on April 25, 2012.

Notation Vote
By notation vote completed on April 2, 2012, the
Committee unanimously approved the minutes of the
FOMC meeting held on March 13, 2012.
William B. English
Secretary

Minutes of Federal Open Market Committee Meetings | April

Addendum:
Summary of Economic Projections

177

erate. As depicted in figure 1, participants judged
that real gross domestic product (GDP) would rise
this year at a rate that slightly exceeds their estimates
of its longer-run sustainable rate of increase, and
then accelerate gradually through 2014. Taking into
account the decline in the unemployment rate since
the time of the previous Summary of Economic Projections (SEP) in January, participants generally
anticipated only a small further reduction in the
unemployment rate this year. They judged that the
unemployment rate would then gradually move lower
as economic growth picks up. Even so, participants
generally projected that the unemployment rate at the
end of 2014 would still be well above their estimates
of the longer-run rate of unemployment that they
currently view as being consistent with the FOMC’s
statutory mandate for promoting maximum employment and price stability. Most participants judged
that inflation, as measured by the annual change in
the price index for personal consumption expenditures (PCE), would be at or below the FOMC’s longrun inflation objective of 2 percent under the
assumption of appropriate monetary policy. Core
inflation was generally projected to run at rates similar to those of overall inflation.

In conjunction with the April 24–25, 2012, Federal
Open Market Committee (FOMC) meeting, meeting
participants—the members of the Board of Governors and the presidents of the Federal Reserve
Banks, all of whom participate in the deliberations of
the FOMC—submitted their assessments of real output growth, the unemployment rate, inflation, and
the target federal funds rate for each year from 2012
through 2014 and over the longer run, under each
participant’s judgment of appropriate monetary
policy. These assessments were based on information
available at the time of the meeting and participants’
individual assumptions about factors likely to affect
economic outcomes. The longer-run projections represent each participant’s assessment of the rate to
which each variable would be expected to converge,
over time, under appropriate monetary policy and in
the absence of further shocks to the economy.
“Appropriate monetary policy” is defined as the
future path of policy that participants deem most
likely to foster outcomes for economic activity and
inflation that best satisfy their individual interpretations of the Federal Reserve’s objectives of maximum
employment and stable prices.

Relative to their previous projections in January,
shown in table 1, participants revised up their projected rate of increase in real GDP in 2012 while
marking down the pace of real growth over the next
two years. With the unemployment rate having
declined in recent months by more than participants

Overall, the assessments that FOMC participants
submitted in April indicated that, with appropriate
monetary policy, the pace of economic recovery over
the 2012–14 period would likely continue to be mod-

Table 1. Economic projections of Federal Reserve Board members and Federal Reserve Bank presidents, April 2012
Percent
Central tendency1

Range2

Variable
2012
Change in real GDP
January projection
Unemployment rate
January projection
PCE inflation
January projection
Core PCE inflation3
January projection

2013

2014

Longer run

2012

2013

2014

Longer run

2.4 to 2.9
2.2 to 2.7
7.8 to 8.0
8.2 to 8.5
1.9 to 2.0
1.4 to 1.8
1.8 to 2.0
1.5 to 1.8

2.7 to 3.1
2.8 to 3.2
7.3 to 7.7
7.4 to 8.1
1.6 to 2.0
1.4 to 2.0
1.7 to 2.0
1.5 to 2.0

3.1 to 3.6
3.3 to 4.0
6.7 to 7.4
6.7 to 7.6
1.7 to 2.0
1.6 to 2.0
1.8 to 2.0
1.6 to 2.0

2.3 to 2.6
2.3 to 2.6
5.2 to 6.0
5.2 to 6.0
2.0
2.0

2.1 to 3.0
2.1 to 3.0
7.8 to 8.2
7.8 to 8.6
1.8 to 2.3
1.3 to 2.5
1.7 to 2.0
1.3 to 2.0

2.4 to 3.8
2.4 to 3.8
7.0 to 8.1
7.0 to 8.2
1.5 to 2.1
1.4 to 2.3
1.6 to 2.1
1.4 to 2.0

2.9 to 4.3
2.8 to 4.3
6.3 to 7.7
6.3 to 7.7
1.5 to 2.2
1.5 to 2.1
1.7 to 2.2
1.4 to 2.0

2.2 to 3.0
2.2 to 3.0
4.9 to 6.0
5.0 to 6.0
2.0
2.0

Note: Projections of change in real gross domestic product (GDP) and projections for both measures of inflation are from the fourth quarter of the previous year to the fourth
quarter of the year indicated. PCE inflation and core PCE inflation are the percentage rates of change in, respectively, the price index for personal consumption expenditures
(PCE) and the price index for PCE excluding food and energy. Projections for the unemployment rate are for the average civilian unemployment rate in the fourth quarter of the
year indicated. Each participant’s projections are based on his or her assessment of appropriate monetary policy. Longer-run projections represent each participant’s
assessment of the rate to which each variable would be expected to converge under appropriate monetary policy and in the absence of further shocks to the economy. The
January projections were made in conjunction with the meeting of the Federal Open Market Committee on January 24–25, 2012.
1
The central tendency excludes the three highest and three lowest projections for each variable in each year.
2
The range for a variable in a given year includes all participants’ projections, from lowest to highest, for that variable in that year.
3
Longer-run projections for core PCE inflation are not collected.

178

99th Annual Report | 2012

Figure 1. Central tendencies and ranges of economic projections, 2012–14 and over the longer run
Percent

Change in real GDP

4

Central tendency of projections
Range of projections

3
2
1
+
0
_
1

Actual

2
3

2007

2008

2009

2010

2011

2012

2013

2014

Longer
run
Percent

Unemployment rate
9
8
7
6
5

2007

2008

2009

2010

2011

2012

2013

2014

Longer
run
Percent

PCE inflation
3

2

1

2007

2008

2009

2010

2011

2012

2013

2014

Longer
run
Percent

Core PCE inflation
3

2

1

2007

2008

2009

2010

2011

2012

Note: Definitions of variables are in the notes to table 1. The data for the actual values of the variables are annual.

2013

2014

Minutes of Federal Open Market Committee Meetings | April

had anticipated in the previous SEP, they generally
lowered their projections for the level of the unemployment rate over coming years. Participants’ expectations for both the longer-run rate of increase in real
GDP and the longer-run unemployment rate were
little changed from January. Their projection for the
rate of inflation in 2012 moved up since January,
reportedly in light of the recent increases in the prices
of crude oil and gasoline, with much smaller
increases in their projections for 2013 and 2014. The
range and central tendency of the projections of
longer-run inflation remained equal to 2 percent.
As shown in figure 2, most participants judged that
highly accommodative monetary policy was likely to
be warranted over coming years to promote a
stronger economic recovery in the context of price
stability. In particular, with inflation generally projected to be subdued over the projection period and
the unemployment rate elevated, 11 participants
thought that it would be appropriate for the first
increase in the target federal funds rate to occur during 2014 or later, the same number as in the January
SEP (upper panel). However, in contrast to their
assessments in January, none of the participants indicated that 2016 was the appropriate year to first
increase the target federal funds rate. The remaining
6 participants judged that it would be appropriate to
raise the federal funds rate in 2012 or 2013 in order
to avoid a buildup of inflationary pressures or the
creation of imbalances in the financial system. Each
participant’s individual assessment of the appropriate year-end level of the target federal funds rate over
the projection period was substantially below his or
her projection of the longer-run level of the federal
funds rate (lower panel). In addition, 9 participants
placed the target federal funds rate at 1 percent or
lower at the end of 2014.
All participants indicated that they expected the Federal Reserve’s balance sheet would be normalized in a
manner consistent with the principles that the
FOMC agreed on at its June 2011 meeting, with the
date that participants gave for the onset of the normalization process dependent on their expected timing of the first increase in the target federal funds
rate. One participant reported that appropriate policy
would include additional balance sheet actions in the
near term to mitigate downside risks to economic growth.
Most participants judged the level of uncertainty
associated with their projections for real activity, the
unemployment rate, and inflation to be unusually
high relative to historical norms, although the number of participants doing so declined somewhat since
the January SEP. About half of the participants now

179

see the risks to real GDP growth as weighted to the
downside and those to the unemployment rate as
weighted to the upside, also down somewhat from the
previous SEP. As in January, a majority of participants viewed the risks to their inflation projections as
broadly balanced.
The Outlook for Economic Activity
Under appropriate monetary policy, participants
continued to judge that the economy would expand
at a moderate pace over the projection period. The
central tendency of participants’ projections for the
change in real GDP growth in 2012 was 2.4 to
2.9 percent, a bit higher than in January. Growth at
this rate would be a noticeable pickup from the pace
of expansion in 2011 and a little above most participants’ assessments of trend growth over the longer
run. Most participants characterized the incoming
data on consumer spending—especially for motor
vehicles—as being at least somewhat stronger than
had been anticipated in January, and several also
pointed to some encouraging signs in recent readings
on housing activity. A few participants indicated they
had seen some improvements in household and business confidence. Participants projected that real GDP
growth would pick up gradually over the 2013–14
period. Economic growth would be supported by
monetary policy accommodation as well as some
gradual improvements in credit conditions, the housing sector, and household balance sheets. The central
tendencies of participants’ projections of real growth
in 2013 and 2014 were 2.7 to 3.1 percent and 3.1 to
3.6 percent, respectively, down somewhat from the
central tendencies of the January projections. The
central tendency of participants’ projections for the
longer-run rate of increase of real GDP was 2.3 to
2.6 percent, unchanged from January.
Participants cited several factors that would likely
continue to restrain the pace of economic expansion
over the projection period. In particular, tighter fiscal
policy seemed likely to impart a significant drag on
economic activity for a time. Moreover, uncertainty
about the fiscal environment could hold back both
household spending on durable goods and business
capital expenditures. In addition, some participants
noted that the recent stronger data might reflect temporary factors. For example, the pace of consumer
spending was seen as likely to fall back some and be
more in line with that of disposable personal income,
and federal outlays were not expected to continue at
their recent pace. Moreover, a couple of participants
also pointed to the unseasonably warm winter
weather as a possible contributor to the more favorable tone to the recent incoming data.

180

99th Annual Report | 2012

Figure 2. Overview of FOMC participants’ assessments of appropriate monetary policy, April 2012

Appropriate timing of policy firming

Number of participants
10
9
8
7

7
6
5
4

3

4

3

3
2
1
0

2012

2013

2014

2015

Appropriate pace of policy firming

Percent
6

Target federal funds rate at year-end
5

4

3

2

1

0
2012

2013

2014

Longer run

Note: In the upper panel, the height of each bar denotes the number of FOMC participants who judge that, under appropriate monetary policy, the first increase in the target federal funds rate from its current range of 0 to ¼ percent will occur in the specified calendar year. In January 2012, the numbers of FOMC participants who judged that the first
increase in the target federal funds rate would occur in 2012, 2013, 2014, 2015, and 2016 were, respectively, 3, 3, 5, 4, and 2. In the lower panel, each shaded circle indicates
the value (rounded to the nearest ¼ percent) of an individual participant’s judgment of the appropriate level of the target federal funds rate at the end of the specified calendar
year or over the longer run.

Minutes of Federal Open Market Committee Meetings | April

Most participants marked down their projections for
the rate of unemployment over the projection period.
The unemployment rate had declined from 8.7 percent, on average, in the final quarter of last year to
8.2 percent at the end of the first quarter of 2012,
more than most participants anticipated when they
prepared their January projections. With real GDP
expected to increase at a moderate pace, the unemployment rate was projected to decline only a bit further this year, with the central tendency of participants’ forecasts at 7.8 to 8.0 percent at year-end. Participants projected that in 2013 and 2014, the pickup
in the pace of the expansion would be accompanied
by a further gradual improvement in labor market
conditions. The central tendency of participants’
forecasts for the unemployment rate was 7.3 to
7.7 percent at the end of 2013 and 6.7 to 7.4 percent
at the end of 2014. The central tendency of participants’ estimates of the longer-run normal rate of
unemployment that would prevail in the absence of
further shocks to the economy was 5.2 to 6.0 percent,
unchanged from January. Most participants anticipated that five or six years would be required to close
the gap between the current unemployment rate and
their estimates of the longer-run rate, although a few
anticipated that less time would be needed.
The diversity of participants’ projections for real
GDP growth and the unemployment rate over the
next three years and over the longer run is depicted in
figures 3.A and 3.B. The dispersion in these projections reflects differences in participants’ assessments
of many factors, including appropriate monetary
policy and its effects on the economy, the underlying
momentum in economic activity, the likely evolution
of credit and financial market conditions, the prospective path for U.S. fiscal policy, the effects of the
European situation, and the extent to which current
dislocations in the labor market were structural versus cyclical. Given the decline in the rate of unemployment in the first quarter, the distribution of participants’ projections of this variable for the fourth
quarter of 2012 shifted noticeably lower, and the
range of these projections became considerably narrower, relative to the January assessments. The distributions of the unemployment rate projections for
2013 and 2014 exhibited less pronounced shifts
toward lower rates. Participants made only minor
adjustments to their projections of the rates of output growth and unemployment over the longer run,
leaving the dispersions of their projections for both
little changed. As in January, the dispersion of estimates for the longer-run rate of output growth is
fairly narrow, with only one participant’s estimate
outside of a range of 2.2 to 2.7 percent. By comparison, participants’ views about the level to which the

181

unemployment rate would converge in the longer run
are more diverse, reflecting, among other things, different views on the outlook for labor supply and the
structure of the labor market.
The Outlook for Inflation
Participants’ views about the outlook for inflation
generally firmed a little since January. In particular, a
majority of participants indicated that the incoming
readings on inflation, especially for the prices of
crude oil and gasoline, were a little higher than had
been anticipated. Nonetheless, assuming no further
shocks, most participants judged that both headline
and core inflation would remain subdued over the
2012–14 period, running at rates at or below the
FOMC’s longer-run objective of 2 percent under the
assumption of appropriate monetary policy. Participants pointed to several factors that would help
restrain inflation pressures over the projection
period, including expected declines in commodity
prices, modest increases in business costs, and the
ongoing stability of inflation expectations. Specifically, the central tendency of participants’ projections
for inflation, as measured by the PCE price index,
moved up in 2012 to 1.9 to 2.0 percent, and it edged
up in 2013 and 2014 to 1.6 to 2.0 percent and 1.7 to
2.0 percent, respectively; the central tendencies of the
forecasts for core PCE inflation were very close to
those for the total measure. Participants indicated
that it would take about five or six years, or less, for
inflation to converge to its longer-run level.
Information about the diversity of participants’
views regarding the outlook for inflation is provided
in figures 3.C and 3.D. Relative to the assessments
that were compiled in January and reflecting the
recent incoming data, the projections for inflation
shifted higher in 2012 and exhibited a noticeably narrower range. The dispersion of inflation projections
also narrowed in 2013, although to a lesser degree,
and was little changed in 2014. In general, the dispersion of views on the outlook for inflation over the
projection period represented differences in judgments regarding a range of issues, including the current degree of slack in resource utilization and the
extent to which such slack influences inflation and
inflation expectations. In addition, participants differed in their estimates of how the stance of monetary policy would influence inflation expectations.
Appropriate Monetary Policy
About half of the participants judged that exceptionally low levels of the federal funds rate would remain
appropriate at least until late 2014. In particular,
seven participants viewed appropriate policy firming
as commencing during 2014, while four others judged

182

99th Annual Report | 2012

Figure 3.A. Distribution of participants’ projections for the change in real GDP, 2012–14 and over the longer run
Number of participants

2012

18

April projections
January projections

16
14
12
10
8
6
4
2

2.02.1

2.22.3

2.42.5

2.62.7

2.82.9

3.03.1

3.23.3

3.43.5

3.63.7

3.83.9

4.04.1

4.24.3

Percent range
Number of participants

2013

18
16
14
12
10
8
6
4
2

2.02.1

2.22.3

2.42.5

2.62.7

2.82.9

3.03.1

3.23.3

3.43.5

3.63.7

3.83.9

4.04.1

4.24.3

Percent range
Number of participants

2014

18
16
14
12
10
8
6
4
2

2.02.1

2.22.3

2.42.5

2.62.7

2.82.9

3.03.1

3.23.3

3.43.5

3.63.7

3.83.9

4.04.1

4.24.3

Percent range
Number of participants

Longer run

18
16
14
12
10
8
6
4
2

2.02.1

2.22.3

2.42.5

2.62.7

2.82.9

3.03.1

Percent range
Note: Definitions of variables are in the general note to table 1.

3.23.3

3.43.5

3.63.7

3.83.9

4.04.1

4.24.3

Minutes of Federal Open Market Committee Meetings | April

183

Figure 3.B. Distribution of participants’ projections for the unemployment rate, 2012–14 and over the longer run
Number of participants

2012

18

April projections
January projections

16
14
12
10
8
6
4
2

4.84.9

5.05.1

5.25.3

5.45.5

5.65.7

5.85.9

6.06.1

6.26.3

6.46.5

6.66.7

6.86.9

7.07.1

7.27.3

7.47.5

7.67.7

7.87.9

8.08.1

8.28.3

8.48.5

8.68.7

Percent range
Number of participants

2013

18
16
14
12
10
8
6
4
2

4.84.9

5.05.1

5.25.3

5.45.5

5.65.7

5.85.9

6.06.1

6.26.3

6.46.5

6.66.7

6.86.9

7.07.1

7.27.3

7.47.5

7.67.7

7.87.9

8.08.1

8.28.3

8.48.5

8.68.7

Percent range
Number of participants

2014

18
16
14
12
10
8
6
4
2

4.84.9

5.05.1

5.25.3

5.45.5

5.65.7

5.85.9

6.06.1

6.26.3

6.46.5

6.66.7

6.86.9

7.07.1

7.27.3

7.47.5

7.67.7

7.87.9

8.08.1

8.28.3

8.48.5

8.68.7

Percent range
Number of participants

Longer run

18
16
14
12
10
8
6
4
2

4.84.9

5.05.1

5.25.3

5.45.5

5.65.7

5.85.9

6.06.1

6.26.3

6.46.5

6.66.7

6.86.9

Percent range
Note: Definitions of variables are in the general note to table 1.

7.07.1

7.27.3

7.47.5

7.67.7

7.87.9

8.08.1

8.28.3

8.48.5

8.68.7

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99th Annual Report | 2012

Figure 3.C. Distribution of participants’ projections for PCE inflation, 2012–14 and over the longer run
Number of participants

2012

18

April projections
January projections

16
14
12
10
8
6
4
2

1.31.4

1.51.6

1.71.8

1.92.0

2.12.2

2.32.4

2.52.6

Percent range
Number of participants

2013

18
16
14
12
10
8
6
4
2
1.31.4

1.51.6

1.71.8

1.92.0

2.12.2

2.32.4

2.52.6

Percent range
Number of participants

2014

18
16
14
12
10
8
6
4
2
1.31.4

1.51.6

1.71.8

1.92.0

2.12.2

2.32.4

2.52.6

Percent range
Number of participants

Longer run

18
16
14
12
10
8
6
4
2

1.31.4

1.51.6

1.71.8

1.92.0

Percent range
Note: Definitions of variables are in the general note to table 1.

2.12.2

2.32.4

2.52.6

Minutes of Federal Open Market Committee Meetings | April

185

Figure 3.D. Distribution of participants’ projections for core PCE inflation, 2012–14
Number of participants

2012

18

April projections
January projections

16
14
12
10
8
6
4
2

1.31.4

1.51.6

1.71.8

1.92.0

2.12.2

Percent range
Number of participants

2013

18
16
14
12
10
8
6
4
2
1.31.4

1.51.6

1.71.8

1.92.0

2.12.2

Percent range
Number of participants

2014

18
16
14
12
10
8
6
4
2
1.31.4

1.51.6

1.71.8

Percent range
Note: Definitions of variables are in the general note to table 1.

1.92.0

2.12.2

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99th Annual Report | 2012

that the first increase in the target federal funds rate
would not be warranted until 2015. Nine participants
anticipated that the appropriate federal funds rate at
the end of 2014 would be 1 percent or lower. Those
who saw the first increase occurring in 2015 anticipated that the federal funds rate would be either
1 percent or 1½ percent at the end of that year. In
contrast, six participants judged that an increase in
the target federal funds rate would be appropriate in
2012 or 2013, and those participants anticipated that
the target rate would need to be increased to around
2 to 2¾ percent by the end of 2014. All participants
reported levels for the appropriate target federal
funds rate at the end of 2014 that were well below
their estimates of the level expected to prevail in the
longer run. Participants’ estimates of the longer-run
target federal funds rate ranged from 3½ to 4½ percent, reflecting the Committee’s inflation objective of
2 percent and participants’ individual judgments
about the longer-run equilibrium level of the real federal funds rate.
Several key factors informed participants’ individual
expectations about the appropriate setting for monetary policy, including their assessments of the maximum level of employment, the Committee’s longerrun inflation objective, the extent to which current
conditions had deviated from these mandateconsistent levels and why the deviations had arisen,
and their projections of the likely time periods
required to return employment and inflation to levels
they judge to be most consistent with the Committee’s mandate. Several participants commented that
their assessments took into account the risks and
uncertainties associated with their outlooks for economic activity and inflation, and one pointed specifically to the potential effects of a protracted period of
very low interest rates on financial stability. Participants also noted that because the appropriate stance
of monetary policy depends importantly on the evolution of real activity and inflation over time, their
assessments of the appropriate future path of the
federal funds rate would change if economic conditions were to evolve in an unexpected manner.
Participants also provided qualitative information on
their views regarding the appropriate path of the
Federal Reserve’s balance sheet. All participants
expect that the Committee would carry out the normalization of the balance sheet according to the principles approved at the June 2011 FOMC meeting.
That is, prior to the first increase in the federal funds
rate, the Committee would likely cease reinvesting
some or all principal payments on securities in the
System Open Market Account (SOMA), and it
would likely begin sales of agency securities from the

SOMA sometime after the first rate increase, aiming
to eliminate the SOMA’s holdings of agency securities over a period of three to five years. In general,
the participants linked their preferred start dates for
the normalization process to their views for the
appropriate timing for the first increase in the target
federal funds rate. Two participants judged that once
begun, asset sales should proceed relatively quickly,
while one participant’s assessment of appropriate
monetary policy incorporated an expansion of the
maturity extension program in the near term. In
addition, some participants indicated that they
remained open to considering additional policyrelated adjustments to the balance sheet if the economic outlook deteriorated.
The distribution of participants’ judgments regarding the appropriate level of the target federal funds
rate at the end of each calendar year from 2012 to
2014 and over the longer run is presented in figure 3.E. Participants’ views on the appropriate level
of the federal funds rate at the end of 2014 continued
to be relatively widely dispersed, with seven participants seeing the appropriate level of the federal funds
rate at that time as most likely to be 50 basis points
or less and seven seeing the appropriate rate as 2 percent or higher. Relative to the other participants, the
group of participants who judged that a longer
period of exceptionally low levels of the federal funds
rate would be appropriate tended to include those
who anticipated a somewhat more gradual increase in
the pace of the economic expansion and a slower
decline in the unemployment rate over the projection
period. Some of these participants also mentioned
their assessment that a longer period of exceptionally
low federal funds rates is appropriate when the federal funds rate has previously been constrained by its
effective lower bound. In contrast, the six participants who judged that policy firming should begin in
2012 or 2013 included some who projected a somewhat faster pickup in economic activity over the near
term. Participants seeing an earlier increase in the
target federal funds rate tended to indicate that the
Committee would need to begin removing policy
accommodation relatively soon in order to keep
inflation at mandate-consistent levels and to limit the
risk of undermining the Federal Reserve’s credibility
and causing a rise in inflation expectations. One of
these participants also stressed the risk of distortions
in the financial system from an extended period of
exceptionally low interest rates.
Uncertainty and Risks
Most participants judged that their projections for
real GDP growth and the unemployment rate were
subject to a higher level of uncertainty than was the

Minutes of Federal Open Market Committee Meetings | April

187

Figure 3.E. Distribution of participants’ projections for the target federal funds rate, 2012–14 and over the longer run
Number of participants

2012

18

April projections
January projections

16
14
12
10
8
6
4
2

0.000.37

0.380.62

0.630.87

0.881.12

1.131.37

1.381.62

1.631.87

1.882.12

2.132.37

2.382.62

2.632.87

2.883.12

3.133.37

3.383.62

3.633.87

3.884.12

4.134.37

4.384.62

Percent range
Number of participants

2013

18
16
14
12
10
8
6
4
2

0.000.37

0.380.62

0.630.87

0.881.12

1.131.37

1.381.62

1.631.87

1.882.12

2.132.37

2.382.62

2.632.87

2.883.12

3.133.37

3.383.62

3.633.87

3.884.12

4.134.37

4.384.62

Percent range
Number of participants

2014

18
16
14
12
10
8
6
4
2

0.000.37

0.380.62

0.630.87

0.881.12

1.131.37

1.381.62

1.631.87

1.882.12

2.132.37

2.382.62

2.632.87

2.883.12

3.133.37

3.383.62

3.633.87

3.884.12

4.134.37

4.384.62

Percent range
Number of participants

Longer run

18
16
14
12
10
8
6
4
2

0.000.37

0.380.62

0.630.87

0.881.12

1.131.37

1.381.62

1.631.87

1.882.12

2.132.37

2.382.62

2.632.87

2.883.12

3.133.37

3.383.62

Percent range
Note: The target federal funds rate is measured as the level of the target rate at the end of the calendar year or in the longer run.

3.633.87

3.884.12

4.134.37

4.384.62

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99th Annual Report | 2012

norm during the previous 20 years (figure 4).1 However, the number reporting elevated uncertainty
moved down somewhat relative to the January SEP.
Many participants also judged the levels of uncertainty associated with their inflation forecasts to be
higher than the longer-run historical norm, but such
an assessment continued to be somewhat less prevalent among participants than was the case for uncertainty about real activity. Several factors were said to
be contributing to the elevated level of uncertainty
about the economic outlook, including ongoing
developments regarding the fiscal and financial situation in Europe. Many participants also cited considerable uncertainty about U.S. fiscal policy over coming quarters and its potential implications for economic activity. More broadly, participants again
noted difficulties in projecting the path of the economic recovery because deep recessions brought on
by severe financial crises differed importantly from
most historical experience. In that regard, participants continued to be uncertain about the pace at
which credit conditions would improve and about the
prospects for recovery in the housing sector. In addition, participants generally saw the longer-term outlook for fiscal and regulatory policies as still highly
uncertain. Some participants also expressed uncertainty about the extent to which the labor market was
undergoing structural changes. Among the sources of
uncertainty about the outlook for inflation were the
difficulties in assessing the current and prospective
margins of slack in resource markets and the effect of
such slack on prices. Participants also cited uncertainty about the future path of global commodity
prices, which were seen as depending on idiosyncratic
supply and demand factors as well as on global growth.
Turning to the balance of risks that participants
attached to their economic projections, about half
reported that they judged the risks to their forecasts of
both real GDP growth and the unemployment rate as
broadly balanced, a few more than was the case in
January. Nearly all of the remaining participants
viewed the risks to real GDP growth as weighted to the
downside and the risks to the unemployment rate as
skewed to the upside. Participants identified several
downside risks to the projected pace of economic
expansion, including the fiscal and financial strains in
the euro area and the possibility of an abrupt fiscal
consolidation in the United States. In addition, some
1

Table 2 provides estimates of the forecast uncertainty for the
change in real GDP, the unemployment rate, and total consumer price inflation over the period from 1992 to 2011. At the
end of this summary, the box “Forecast Uncertainty” discusses
the sources and interpretation of uncertainty in the economic
forecasts and explains the approach used to assess the uncertainty and risks attending the participants’ projections.

Table 2. Average historical projection error ranges
Percentage points
Variable
Change in real GDP1
Unemployment rate1
Total consumer prices2

2012

2013

2014

±1.1
±0.5
±0.8

±1.6
±1.2
±1.0

±1.7
±1.7
±1.0

Note: Error ranges shown are measured as plus or minus the root mean squared
error of projections for 1992 through 2011 that were released in the spring by
various private and government forecasters. As described in the box “Forecast
Uncertainty,” under certain assumptions, there is about a 70 percent probability
that actual outcomes for real GDP, unemployment, and consumer prices will be in
ranges implied by the average size of projection errors made in the past. Further
information is in David Reifschneider and Peter Tulip (2007), “Gauging the
Uncertainty of the Economic Outlook from Historical Forecasting Errors,” Finance
and Economics Discussion Series 2007-60 (Washington: Board of Governors of
the Federal Reserve System, November).
1
For definitions, refer to general note in table 1.
2
Measure is the overall consumer price index, the price measure that has been
most widely used in government and private economic forecasts. Projection
is percent change, fourth quarter of the previous year to the fourth quarter of
the year indicated.

of the factors that had restrained the U.S. recovery in
recent years could persist for longer than currently
expected and thus weigh on economic activity to a
greater extent going forward than participants had
assumed in their baseline forecasts. In particular, some
participants mentioned the downside risks to consumer spending in light of meager gains in disposable
personal income and households’ still-weak balance
sheets. Others cited the possible damping effects of
high levels of uncertainty regarding regulatory policies
on businesses’ willingness to invest and hire. A few participants noted the risk of another disruption in global
oil markets or greater tensions in the Middle East that
could not only boost inflation but also reduce real
incomes, consumer confidence, and spending. Some of
the participants who judged the risks to be broadly
balanced recognized some of these downside risks to
the outlook, but they saw them as about counterbalanced by the chance that the recent signs of improvement in labor markets and consumer spending could
signal the emergence of a more vigorous recovery.
Most participants judged the risks to their projections
of inflation as broadly balanced, including a few more
than held that view in January. However, a few saw the
risks as tilted to the upside, pointing to the possibility
of disruptions in global oil and commodity markets or
to effects from the current stance of monetary policy.
Two of these participants indicated that the current
highly accommodative stance of monetary policy and
the substantial liquidity currently in the financial
system risked a pickup in inflation to a level above the
Committee’s longer-run objective, or cited the risk that
uncertainty about the Committee’s ability to effectively
remove policy accommodation when appropriate
could lead to a rise in inflation expectations.

Minutes of Federal Open Market Committee Meetings | April

Figure 4. Uncertainty and risks in economic projections
Number of participants

Uncertainty about GDP growth

Number of participants

18

April projections
January projections

16

Risks to GDP growth

18

April projections
January projections

16

14

10

8

8

6

6

4

4

2

Broadly
similar

12

10

Lower

14

12

2

Higher

Weighted to
downside

Broadly
balanced

Number of participants

Uncertainty about the unemployment rate

Weighted to
upside
Number of participants

18

Risks to the unemployment rate

18

16

12

10

10

8

8

6

6

4

4

2

Broadly
similar

14

12

Lower

16

14

2

Higher

Weighted to
downside

Broadly
balanced

Number of participants

Uncertainty about PCE inflation

Weighted to
upside
Number of participants

18

Risks to PCE inflation

18

16

12

10

10

8

8

6

6

4

4

2

Broadly
similar

14

12

Lower

16

14

2

Higher

Weighted to
downside

Broadly
balanced

Number of participants

Uncertainty about core PCE inflation

Weighted to
upside
Number of participants

18

Risks to core PCE inflation

18

16

10

8

8

6

6

4

4

2

Higher

12

10

Broadly
similar

14

12

Lower

16

14

2

Weighted to
downside

Broadly
balanced

Weighted to
upside

Note: For definitions of uncertainty and risks in economic projections, see the box “Forecast Uncertainty.” Definitions of variables are in the general note to table 1.

189

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99th Annual Report | 2012

Forecast Uncertainty
The economic projections provided by the members
of the Board of Governors and the presidents of the
Federal Reserve Banks inform discussions of monetary policy among policymakers and can aid public
understanding of the basis for policy actions. Considerable uncertainty attends these projections, however. The economic and statistical models and relationships used to help produce economic forecasts
are necessarily imperfect descriptions of the real
world, and the future path of the economy can be
affected by myriad unforeseen developments and
events. Thus, in setting the stance of monetary
policy, participants consider not only what appears to
be the most likely economic outcome as embodied in
their projections, but also the range of alternative
possibilities, the likelihood of their occurring, and the
potential costs to the economy should they occur.
Table 2 summarizes the average historical accuracy
of a range of forecasts, including those reported in
past Monetary Policy Reports and those prepared by
the Federal Reserve Board’s staff in advance of
meetings of the Federal Open Market Committee.
The projection error ranges shown in the table illustrate the considerable uncertainty associated with
economic forecasts. For example, suppose a participant projects that real gross domestic product (GDP)
and total consumer prices will rise steadily at annual
rates of, respectively, 3 percent and 2 percent. If the
uncertainty attending those projections is similar to
that experienced in the past and the risks around the
projections are broadly balanced, the numbers
reported in table 2 would imply a probability of about
70 percent that actual GDP would expand within a
range of 1.9 to 4.1 percent in the current year, 1.4 to
4.6 percent in the second year, and 1.3 to 4.7 percent

in the third year. The corresponding 70 percent confidence intervals for overall inflation would be 1.2 to
2.8 percent in the current year and 1.0 to 3.0 percent
in the second and third years.
Because current conditions may differ from those
that prevailed, on average, over history, participants
provide judgments as to whether the uncertainty
attached to their projections of each variable is
greater than, smaller than, or broadly similar to typical levels of forecast uncertainty in the past, as
shown in table 2. Participants also provide judgments
as to whether the risks to their projections are
weighted to the upside, are weighted to the downside, or are broadly balanced. That is, participants
judge whether each variable is more likely to be
above or below their projections of the most likely
outcome. These judgments about the uncertainty
and the risks attending each participant’s projections
are distinct from the diversity of participants’ views
about the most likely outcomes. Forecast uncertainty
is concerned with the risks associated with a particular projection rather than with divergences across a
number of different projections.
As with real activity and inflation, the outlook for the
future path of the federal funds rate is subject to considerable uncertainty. This uncertainty arises primarily
because each participant’s assessment of the appropriate stance of monetary policy depends importantly
on the evolution of real activity and inflation over
time. If economic conditions evolve in an unexpected
manner, then assessments of the appropriate setting
of the federal funds rate would change from that
point forward.

Minutes of Federal Open Market Committee Meetings | June

Meeting Held on June 19–20, 2012

Richard M. Ashton1
Assistant General Counsel

A meeting of the Federal Open Market Committee
was held in the offices of the Board of Governors of
the Federal Reserve System in Washington, D.C., on
Tuesday, June 19, 2012, at 11:00 a.m. and continued
on Wednesday, June 20, 2012, at 8:30 a.m.

191

Steven B. Kamin
Economist
David W. Wilcox
Economist

Ben Bernanke
Chairman

David Altig, Thomas A. Connors, Michael P. Leahy,
William Nelson, Simon Potter, David Reifschneider,
Mark S. Sniderman, William Wascher,
John A. Weinberg, and Kei-Mu Yi
Associate Economists

William C. Dudley
Vice Chairman

Brian Sack
Manager, System Open Market Account

Elizabeth Duke

Nellie Liang
Director, Office of Financial Stability Policy and
Research, Board of Governors

Present

Jeffrey M. Lacker
Dennis P. Lockhart
Sandra Pianalto
Jerome H. Powell
Sarah Bloom Raskin
Jeremy C. Stein
Daniel K. Tarullo
John C. Williams
Janet L. Yellen
James Bullard, Christine Cumming, Charles L. Evans,
Esther L. George, and Eric Rosengren
Alternate Members of the Federal Open Market
Committee
Richard W. Fisher, Narayana Kocherlakota, and
Charles I. Plosser
Presidents of the Federal Reserve Banks of Dallas,
Minneapolis, and Philadelphia, respectively
William B. English
Secretary and Economist
Deborah J. Danker
Deputy Secretary
Matthew M. Luecke
Assistant Secretary
David W. Skidmore
Assistant Secretary
Michelle A. Smith
Assistant Secretary
Scott G. Alvarez
General Counsel

Jon W. Faust and Andrew T. Levin
Special Advisors to the Board, Office of Board
Members, Board of Governors
Linda Robertson
Assistant to the Board, Office of Board Members,
Board of Governors
Seth B. Carpenter
Senior Associate Director, Division of Monetary
Affairs, Board of Governors
Timothy P. Clark
Senior Associate Director, Division of Banking
Supervision and Regulation, Board of Governors
Thomas Laubach
Senior Adviser, Division of Research and Statistics,
Board of Governors
Ellen E. Meade, Stephen A. Meyer, and
Joyce K. Zickler
Senior Advisers, Division of Monetary Affairs,
Board of Governors
Daniel M. Covitz, Eric M. Engen, Michael T. Kiley,2
David E. Lebow, and Michael G. Palumbo
Associate Directors, Division of Research and
Statistics, Board of Governors
David Bowman
Deputy Associate Director, Division of International
Finance, Board of Governors
Steven A. Sharpe and John J. Stevens
Assistant Directors, Division of Research and
Statistics, Board of Governors
1
2

Attended Tuesday’s morning session only.
Attended Tuesday’s session only.

192

99th Annual Report | 2012

David H. Small
Project Manager, Division of Monetary Affairs,
Board of Governors
Francisco Covas and Jennifer E. Roush
Senior Economists, Division of Monetary Affairs,
Board of Governors
Andrea De Michelis
Senior Economist, Division of International Finance,
Board of Governors
Sarah G. Green
First Vice President, Federal Reserve Bank of
Richmond
Loretta J. Mester and Harvey Rosenblum
Executive Vice Presidents, Federal Reserve Banks of
Philadelphia and Dallas, respectively
Troy Davig, Geoffrey Tootell, and
Christopher J. Waller
Senior Vice Presidents, Federal Reserve Banks of
Kansas City, Boston, and St. Louis, respectively
John Fernald
Group Vice President, Federal Reserve Bank of
San Francisco
Lorie K. Logan and Anna Paulson
Vice Presidents, Federal Reserve Banks of New York
and Chicago, respectively

Organizational Matters
By unanimous vote, Simon Potter was selected to
serve at the pleasure of the Committee as Manager,
System Open Market Account, effective June 30,
2012, on the understanding that his selection was
subject to being satisfactory to the Federal Reserve
Bank of New York.
Secretary’s note: Advice subsequently was
received that the selection of Mr. Potter as Manager was satisfactory to the Federal Reserve
Bank of New York.
By unanimous vote, the Committee selected James J.
McAndrews to serve as Associate Economist, effective June 30, 2012, until the selection of his successor
at the first regularly scheduled meeting of the Committee in 2013.
By unanimous vote, the Committee amended the
FOMC Policy on External Communications of Fed-

eral Reserve System Staff to clarify some specific
aspects of the policy.3

Discussion of Communications regarding
Economic Projections
Meeting participants discussed several possibilities
for enhancing the clarity and transparency of the
Committee’s economic projections and their role in
policy decisions and policy communications. In particular, participants noted that while the Summary of
Economic Projections (SEP) provides information
about their individual projections of key macroeconomic variables and about the path of monetary
policy that each sees as appropriate and consistent
with his or her projections, the SEP does not provide
guidance about how those diverse views come
together in the Committee’s collective judgment
about the outlook and appropriate policy as
expressed in its postmeeting statement. Many participants indicated that if it were possible to construct a
quantitative economic projection and associated path
of appropriate policy that reflected the collective
judgment of the Committee, such a projection could
potentially be helpful in clarifying how the outlook
and policy decisions are related. Participants discussed examples of the economic and policy projections published by a number of foreign central banks.
Participants generally indicated a willingness to
explore adjustments to the SEP, while highlighting
the importance of communicating not only the Committee’s collective judgment but also the diversity of
their views regarding the economic outlook and
monetary policy. Many participants noted that developing a quantitative forecast that reflects the Committee’s collective judgment could be challenging,
given the range of their views about the economy’s
structure and dynamics. Several participants judged
that the incremental gains in transparency that would
result from developing and presenting such a consensus projection would be modest, given the breadth of
information already provided in the Committee’s
policy statements, the minutes of Federal Open Market Committee (FOMC) meetings, and the Chairman’s press briefings. Participants agreed to continue
to explore ways to increase clarity and transparency
in the Committee’s policy communications; many
noted that the Committee had introduced a number
of changes in its communications over the past year
or so, and emphasized that further changes should be
3

The policy is available at www.federalreserve.gov/
monetarypolicy/files/FOMC_ExtCommunicationStaff.pdf.

Minutes of Federal Open Market Committee Meetings | June

considered carefully. At the end of the discussion, the
Chairman asked the subcommittee on communications to explore the feasibility and workability of
potential approaches to developing an FOMC consensus forecast.

Developments in Financial Markets and
the Federal Reserve’s Balance Sheet
The Manager of the System Open Market Account
(SOMA) reported on developments in domestic and
foreign financial markets during the period since the
FOMC met on April 24–25, 2012. He also reported
on System open market operations, including the
ongoing reinvestment into agency-guaranteed
mortgage-backed securities (MBS) of principal payments received on SOMA holdings of agency debt
and agency-guaranteed MBS as well as the operations related to the maturity extension program
authorized at the September 20–21, 2011, FOMC
meeting. By unanimous vote, the Committee ratified
the Desk’s domestic transactions over the intermeeting period. There were no intervention operations in
foreign currencies for the System’s account over the
intermeeting period.
By unanimous vote, the Authorization for Domestic
Open Market Operations was amended to include the
authority to conduct small-value operations for the
purposes of routine testing of operational readiness.
In addition, the Authorization was amended to
include the authority to conduct intraday repurchase
agreement (repo) transactions with foreign and international accounts to prevent daylight overdrafts in
those accounts.4

Staff Review of the Economic Situation
The information reviewed at the June 19–20 meeting
suggested that economic activity was expanding at a
somewhat more modest pace than earlier in the year.
Improvements in labor market conditions slowed in
recent months, and the unemployment rate remained
elevated. Consumer price inflation declined, primarily reflecting reductions in the prices of crude oil and
gasoline, and measures of long-run inflation expectations continued to be stable.
Private nonfarm employment rose at a slower pace in
April and May than in the first quarter of the year,
while total government employment continued to
trend down. The unemployment rate stood at 8.2 per4

The authorization is available at www.federalreserve.gov/
monetarypolicy/files/FOMC_DomesticAuthorization.pdf.

193

cent in May, essentially the same as its average in the
first quarter. The rate of long-duration unemployment remained very high, and the share of workers
employed part time for economic reasons was little
changed in recent months. Indicators of job openings
and firms’ hiring plans were mixed, while initial
claims for unemployment insurance were essentially
unchanged over the intermeeting period at a level
consistent with modest net job gains in the coming
months.
Manufacturing production edged up, on net, in April
and May after rising at a robust pace in the first
quarter. Meanwhile, the rate of manufacturing
capacity utilization remained about the same as earlier in the year. In recent months, the output of
motor vehicles and parts increased further, on balance, although at a slower rate than in the first quarter, while factory output outside of the motor vehicle
sector only inched up. Motor vehicle assemblies were
scheduled to hold steady in the coming months, and
broader indicators of manufacturing production,
such as the diffusion indexes of new orders from the
national and regional manufacturing surveys, were
generally at levels consistent with modest increases in
output in the near term.
Real personal consumption expenditures increased
solidly in the first quarter. In April and May, however, nominal retail sales excluding purchases of
motor vehicles declined while sales of motor vehicles
slowed from their brisk pace in the first quarter. Factors that tend to support households’ expenditures
were, on balance, a little softer in recent months. The
estimated level of households’ real disposable income
was revised down for the fourth quarter of last year.
Moreover, real disposable income rose at a subdued
pace in the first quarter of this year, though it
received some boost from lower energy prices in
April. Households’ net worth increased in the first
quarter, but the decline in equity prices during the
intermeeting period suggested that net worth may
have fallen more recently. Consumer sentiment was
lower in early June than earlier in the year, and it
continued to be subdued.
Activity in the housing sector generally improved in
recent months, but it was still restrained by tight
credit standards for mortgage loans and the substantial inventory of foreclosed and distressed properties.
Both starts and permits of new single-family homes
rose in April and May but remained at low levels.
Although starts of new multifamily units ran at a
somewhat lower pace, on average, in April and May

194

99th Annual Report | 2012

than in the first quarter, permits increased in recent
months, likely pointing to further gains in multifamily construction. Home prices rose for the fourth consecutive month in April. Sales of existing homes were
a little higher in April than their monthly average in
the first quarter, but the pace of new home sales was
roughly unchanged.
Real business expenditures on equipment and software increased moderately in the first quarter. In
April, nominal shipments and orders of nondefense
capital goods excluding aircraft decreased. Recent
forward-looking indicators, such as surveys of business conditions and capital spending plans, pointed
toward continued moderate increases in outlays for
business equipment in subsequent months. Nominal
business spending for nonresidential construction
was essentially flat in April relative to the first quarter. Meanwhile, inventories in most industries looked
to be roughly aligned with sales in recent months.
Real federal government purchases fell markedly in
the first quarter, led by a sharp decrease in defense
spending. Data for federal government spending in
April and May pointed to a slower pace of decline in
defense outlays in the second quarter. Real state and
local government purchases also decreased in the first
quarter. Moreover, the payrolls of state and local
governments contracted in April and May after edging up in the first quarter, and nominal construction
spending by these governments continued to decline
in April.
The U.S. international trade deficit widened in
March and then narrowed in April to a level near its
average in the first quarter. Both imports and exports
rose strongly in March before receding a bit in April.
In particular, exports to the euro area, which had
increased strongly in the first quarter on a seasonally
adjusted basis despite the weakness in economic
activity in the region, fell back in April.
Overall U.S. consumer prices were flat in April and
then fell in May as consumer energy prices declined
considerably in both months. Survey data indicated
that gasoline prices fell further in the first half of
June, in line with continued decreases in crude oil
prices. Meanwhile, consumer food prices only edged
up in recent months. Consumer prices excluding food
and energy increased moderately in April and May.
Near-term inflation expectations from the Thomson
Reuters/University of Michigan Surveys of Consumers declined in May and held steady in early June,

while longer-term inflation expectations in the survey
remained stable.
Measures of labor compensation indicated that
increases in nominal wages continued to be subdued.
Gains in compensation per hour in the nonfarm business sector were quite muted over the year ending in
the first quarter, and with small gains in productivity, unit labor costs rose only slightly. The employment cost index increased only a little faster than the
compensation per hour measure over the same
period. More recently, average hourly earnings for all
employees edged up in April and May, and their rate
of increase from 12 months earlier continued to be
slow.
Recent indicators suggested that overall foreign economic activity was expanding at a below-trend pace
in the second quarter. Euro-area economies appeared
to be slowing: Industrial production declined in the
euro area in April, and the composite purchasing
managers index and indicators of business confidence fell in May to their lowest levels in more than
two years. In China, data on production and sales in
April and May suggested that economic activity was
increasing at a less rapid pace than last year. In both
advanced and emerging market economies, declining
prices for energy and other commodities contributed
to decreases in 12-month measures of inflation since
late last year.

Staff Review of the Financial Situation
Growing concerns about developments in the euro
area and weaker-than-expected economic data in the
United States and abroad both weighed on financial
markets since the time of the April FOMC meeting.
The deterioration in investor sentiment was tempered
to an extent by market participants’ expectations for
further policy accommodation by central banks as
well as by the anticipation of additional measures to
address European fiscal and banking issues.
Yields on longer-dated nominal and inflationprotected Treasury securities moved down substantially, on net, over the intermeeting period. The yield
on nominal 10-year Treasury securities reached a historically low level immediately following the release
of the May employment report. A sizable portion of
the decline in longer-term Treasury rates over the
period appeared to reflect greater safe-haven
demands by investors, along with some increase in
market participants’ expectations of further Federal

Minutes of Federal Open Market Committee Meetings | June

Reserve balance sheet actions. Indicators of inflation
expectations derived from nominal and inflationprotected Treasury securities also fell, apparently
responding at least in part to the decline in commodity prices. The expected path for the federal funds
rate derived from money market futures quotes
shifted down in 2014 and beyond.
There was limited evidence of increased strains in
unsecured, short-term dollar funding markets over
the intermeeting period despite heightened concerns
about the situation in Europe. In secured funding
markets, the overnight general collateral Treasury
repo rate edged higher. Market participants attributed some portion of the firming in short-term rates
over the past several months to a temporary increase
in short-dated Treasury securities held by dealers as a
result of cumulative net Treasury issuance of such
securities and sales of these securities by the Federal
Reserve under its maturity extension program.
Broad U.S. stock price indexes declined, and optionimplied volatility on the S&P 500 index rose. Equity
prices for large domestic banks significantly underperformed the broad indexes amid uncertainty about
the situation in Europe and the outlook for the
global economy. Disclosure of a large trading loss at
a major U.S. bank also contributed to the underperformance. Investors’ expectation that five large U.S.
banks would have their credit ratings downgraded at
the end of June, as part of rating agencies’ review of
major financial institutions, may also have weighed
on the equity prices of those banks.
In the June 2012 Senior Credit Officer Opinion Survey on Dealer Financing Terms (SCOOS), respondents reported that terms in a variety of dealerintermediated markets were little changed over the
past three months. Some respondents reported a
decline in the use of leverage by hedge funds across
various transaction types.
Yields on investment- and speculative-grade corporate debt remained low by historical standards, but
their spreads over comparable-maturity Treasury
securities widened a bit. Nonfinancial firms continued to raise funds at a solid pace over the period,
with the proceeds primarily used to refinance existing
debt. Both commercial and industrial (C&I) loans
and nonfinancial commercial paper outstanding
increased, on net, during April and May. New syndicated loan issuance also appeared to remain solid,
although there were some reports of tighter terms.
Gross public equity issuance by nonfinancial firms

195

remained strong in April and into May but then
slowed after the poor performance of a prominent
initial public offering.
Financing conditions for the commercial real estate
sector remained strained over the intermeeting
period. Even so, issuance of commercial mortgagebacked securities in April and May outpaced issuance during the first quarter.
Credit conditions in residential mortgage markets
continued to be tight. Mortgage refinancing activity
rose in April and May but remained subdued despite
further declines in mortgage rates to historically low
levels. Consumer credit expanded at a solid pace in
recent months, as increases in student loans boosted
nonrevolving credit while revolving credit was about
flat. Delinquency rates for consumer credit remained
low, partly reflecting a shift in the composition of
borrowers toward those with higher credit scores.
Gross issuance of long-term municipal bonds picked
up in April and May, with net issuance turning positive for the first time since the beginning of 2011.
However, credit default swap spreads for state governments generally moved higher, and spreads on
long-term general obligation municipal bonds over
comparable-maturity Treasury securities rose as well.
Bank credit expanded in April and May. Banks’
holdings of securities continued to rise, and core
loans—C&I, real estate, and consumer loans—also
increased modestly. The May Survey of Terms of
Business Lending indicated that lending conditions
again eased slightly, although perhaps less so for
small businesses.
M2 increased at a somewhat slower pace in April and
May than in the first quarter of the year. The level of
M2 and its largest component—liquid deposits—remained elevated, apparently reflecting investors’ continued desire to hold safe and liquid assets.
Heightened financial strains in the euro area and
indications of a weaker pace of global economic
activity weighed on foreign financial markets during
the intermeeting period. Yields on most euro-area
peripheral countries’ sovereign debt rose, particularly
after the May 6 elections in Greece failed to produce
a new government. In addition, indicators of the
conditions of European banks continued to deteriorate: Rating agencies downgraded major banks in
Germany, Italy, Spain, and several other European
countries; prices of euro-area bank stocks fell

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99th Annual Report | 2012

sharply; and credit default swap premiums for many
euro-area banks increased. Pressures on Spanish
banks led euro-area authorities to agree to provide
official aid to the Spanish government for the purpose of recapitalizing the country’s troubled banks.
Indicators of funding market stresses remained
muted, as many banks obtained funds from the
European Central Bank (ECB) rather than interbank
markets. The spreads of euro London interbank
offered rates (or euro LIBOR) over comparable overnight index swap rates, along with implied basis
spreads from euro–dollar swaps, were little changed
at short maturities, and the amount of dollar swaps
outstanding with the ECB declined on balance. The
total outstanding amount drawn on the Federal
Reserve’s dollar liquidity swap lines with foreign central banks dropped to $24.2 billion over the intermeeting period.
Although equity prices in many countries rallied
modestly late in the intermeeting period, global
equity prices declined, on balance, over the period,
with especially large net decreases in Japan and many
emerging market economies. Flight-to-safety flows
helped push yields on both U.K. and German
10-year sovereign debt to record lows before these
rates partly retraced their declines. The staff’s broad
nominal dollar index ended the intermeeting period
up moderately. Signs of a slowdown in global economic growth prompted policy easing by central
banks in Brazil, China, and Australia, and the Bank
of England announced new lending initiatives.
The risks to the U.S. financial system emanating
from strains in Europe appeared to increase over the
intermeeting period. Although signs of strains in
short-term funding markets were muted, the reliance
of some financial firms on these markets remained a
potential vulnerability, given that investors could
withdraw rapidly in a period of financial stress.
Respondents to the June 2012 SCOOS reported that
financial institutions and market participants had
increased the amount of resources and attention
devoted to the management of concentrated exposures to central counterparties and other financial
utilities.

Staff Economic Outlook
In the economic projection prepared by the staff for
the June FOMC meeting, the forecast for real gross
domestic product (GDP) growth in the near term was
revised down. The revision reflected data indicating a
slower pace of private-sector job gains, more-

subdued retail sales, a lower trajectory for personal
income, greater restraint in government purchases,
and weaker net exports than the staff anticipated at
the time of the previous projection. Moreover, recent
adverse developments in Europe and tighter domestic
financial conditions led the staff to revise down
somewhat the medium-term forecast for real GDP
growth. With the drag from fiscal policy anticipated
to increase next year, the staff projected that the
growth rate of real GDP would not materially exceed
that of potential output until 2014 when economic
activity was expected to accelerate gradually, supported by accommodative monetary policy, further
improvements in credit availability, and rising consumer and business sentiment. Increases in economic
activity were anticipated to narrow the wide margin
of slack in labor and product markets only slowly
over the projection period, and the unemployment
rate was expected to still be elevated at the end of
2014.
The staff’s near-term projection for inflation was
revised down from the forecast prepared for the April
FOMC meeting, reflecting a greater-than-expected
drop in consumer energy prices. However, the staff’s
projection for inflation over the medium term was
essentially unchanged. With the upward pressure
from the earlier run-up in crude oil prices on consumer energy prices unwinding and oil prices
expected to decline further, long-run inflation expectations anticipated to remain stable, and substantial
resource slack persisting over the forecast period, the
staff continued to project that inflation would be
subdued through 2014.

Participants’ Views on Current Conditions
and the Economic Outlook
In conjunction with this FOMC meeting, meeting
participants—the 7 members of the Board of Governors and the presidents of the 12 Federal Reserve
Banks, all of whom participate in the deliberations of
the FOMC—submitted their assessments of real output growth, the unemployment rate, inflation, and
the target federal funds rate for each year from 2012
through 2014 and over the longer run, under each
participant’s judgment of appropriate monetary
policy. The longer-run projections represent each
participant’s assessment of the rate to which each
variable would be expected to converge, over time,
under appropriate monetary policy and in the
absence of further shocks to the economy. These economic projections and policy assessments are

Minutes of Federal Open Market Committee Meetings | June

described in the Summary of Economic Projections,
which is attached as an addendum to these minutes.
In their discussion of the economic situation and
outlook, participants agreed that the information
received since the Committee’s previous meeting suggested that the economy had continued to expand
moderately, though many noted that a variety of
indicators showed smaller gains than had been anticipated. Growth in employment, in particular,
appeared to have slowed in recent months, and the
unemployment rate remained elevated. Business fixed
investment had continued to advance, and household
spending appeared to be rising at a somewhat slower
pace than earlier in the year. There were further signs
of improvement in the housing sector, but the level of
activity remained very low. Volatility in financial
markets increased over the intermeeting period, and
investors’ appetite for riskier assets declined, likely in
response to heightened fiscal and financial strains in
Europe as well as some weaker-than-expected incoming data about the U.S. economy and foreign economies. Inflation had slowed somewhat, mainly reflecting the decline in the prices of crude oil and gasoline
in recent months, and longer-term inflation expectations remained stable.
Participants generally interpreted the information
that became available during the intermeeting period
as suggesting that economic growth would most
likely remain moderate over coming quarters and
then pick up very gradually. Most participants saw
the incoming information as indicating somewhat
slower growth in total demand, output, and employment over coming quarters than they had projected
in April, and most carried forward some of that
downward revision to their projections of mediumterm growth. However, some participants judged that
the recent weakness in a variety of economic indicators was more likely to prove transitory, and thought
that the outlook beyond this year was essentially
unchanged. Reflecting the projected moderate pace
of growth in production and employment, most participants anticipated that the unemployment rate
would decline only slowly. A number of factors continued to be seen as likely to limit the economic
expansion to a moderate pace in the near term; these
included slow growth or even contraction in some
major foreign economies, ongoing and prospective
fiscal tightening in the United States, modest growth
in household income, and—despite some recent signs
of improvement—continued weakness in the housing
sector. As in April, participants expected that most of
the factors restraining economic expansion would

197

ease over time, and so anticipated that the recovery
eventually would gain strength. However, strains in
global financial markets, which stemmed primarily
from fiscal and banking concerns in Europe, had
become more pronounced over the intermeeting
period and continued to pose significant downside
risks to the economic outlook; the possibility of a
sharper-than-anticipated fiscal tightening in the
United States also posed a downside risk. Looking
beyond the temporary effects on inflation of this
year’s fluctuations in oil and other commodity prices,
almost all participants continued to anticipate that
inflation over the medium-term would run at or
below the 2 percent rate that the Committee judges to
be most consistent with its statutory mandate. In one
participant’s judgment, appropriate monetary policy
would lead to inflation modestly greater than 2 percent for a time in order to bring unemployment down
somewhat faster. Some participants indicated that
they saw persistent slack in resource utilization as
posing downside risks to the outlook for inflation; a
few participants judged that the highly accommodative stance of monetary policy posed upside risks to
the medium-term inflation outlook.
In discussing the household sector, meeting participants noted that real personal consumption expenditures had continued to expand despite weak growth
in real disposable income, but that the pace of expansion appeared to have slowed since earlier this year. A
few participants expressed concern that slow growth
in employment and low levels of consumer confidence would further restrain consumer spending.
Many participants, however, said that business contacts had reported that consumer spending was holding up. Several observed that recent declines in gasoline prices would increase households’ real incomes
and could boost consumer spending in coming quarters. More broadly, improving household balance
sheets and a diminishing drag from household
deleveraging were seen as likely to help support rising
household expenditures over time.
Indicators of home sales, construction, and prices
suggested some improvement in the housing sector.
However, not all regions shared in the gains, and the
sector remained depressed overall. Most participants
anticipated that housing markets were likely to
recover only slowly over time, in part because tight
credit standards in mortgage lending meant that low
mortgage rates were now generating less of a pickup
in home sales and construction than had been the
case during the recoveries from earlier recessions. A
few participants were more sanguine about the

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99th Annual Report | 2012

potential for a sizable upturn in housing activity. Still,
with residential investment currently a much smaller
share of real GDP than during past recoveries, the
housing sector seemed unlikely to contribute substantially to a stronger economic recovery.

fects that would be manifested through declining U.S.
exports—would be noticeable but not large. However,
another participant noted that recent appreciation of
the dollar in foreign exchange markets would also
contribute to reduced exports.

Anecdotal evidence from business contacts indicated
that activity in the energy and agriculture sectors
continued to advance in recent months. Information
from manufacturing and transportation firms was
generally less optimistic than earlier in the year.
There were a number of reports of slowing sales to
Europe and Asia. Contacts in some parts of the
country also indicated that firms had become more
cautious in their hiring and investment decisions,
with most capital investment being undertaken to
improve productivity and reduce costs rather than to
expand capacity. Some participants cited examples of
business contacts saying that heightened uncertainty
about future tax and regulatory policies had led them
to put potential investment projects on hold until the
uncertainty is resolved.

The pace of improvement in labor market conditions
diminished in recent months; in particular, growth in
employment slowed. Job growth late last year and
early this year was boosted by unusually mild winter
weather; some slowing had been expected as weather
became more normal during the spring, but the
reported slowing was more substantial than many
participants had anticipated. One participant noted
that the apparent tension between strong employment growth and moderate output growth seen earlier in the year had been resolved more recently by
slower job growth rather than faster output growth.
Even so, average monthly growth in payrolls from
January through May was in line with last year’s
pace.

Participants expected that fiscal policy would continue to be a drag on economic growth over coming
quarters. They generally also saw the federal budget
situation as a downside risk to the economic outlook:
If an agreement was not reached to address the expiring tax cuts and scheduled spending reductions in
current law, a sharp tightening of fiscal policy would
occur at the start of 2013. A few participants
reported hearing that defense contractors were making contingency plans to reduce their workforces if
potential spending cuts go into effect; one reported
that some firms already had begun to make such
reductions. In contrast, it was noted that an agreement on a credible longer-term plan that put the federal budget on a sustainable path over the medium
run in a way that removes the near-term fiscal risks
to the recovery would help alleviate uncertainty, likely
would have positive effects on consumer and business
sentiment, and so could spur an increase in business
investment and hiring.
Exports helped support U.S. economic growth during
the early months of this year. However, recent
reports from some business contacts pointed to slowing exports to Europe and China, and several participants noted the risk that economic weakness in
Europe or a more significant slowing in the pace of
expansion in emerging markets in Asia could damp
exports further. A couple of participants expressed
the view that the direct effects on the U.S. economy
stemming from slower economic growth abroad—ef-

Meeting participants again discussed the extent of
slack in labor markets. Some participants judged that
the unemployment rate was being substantially
boosted by structural factors such as mismatches
between the skills of unemployed workers and those
required for available jobs, a view that would imply
less slack in labor markets than suggested by a simple
comparison of the current unemployment rate to
participants’ estimates of its longer-run normal level.
A couple of participants said they would have
expected inflation to slow noticeably if there were
substantial and persistent slack. One implication of
the view that there is relatively little slack is that providing more monetary stimulus would be likely to
raise inflation above the Committee’s objective. Some
other participants acknowledged that structural factors were contributing to unemployment, but said
that, in their view, slack remained high and weak
aggregate demand was the major reason that the
unemployment rate was still elevated. These participants cited a range of evidence to support their judgment: the still-high fraction of workers who report
working part-time jobs because they cannot find fulltime work; research showing that job-finding rates
among the long-term unemployed were somewhat
higher in the recent past than a year earlier; anecdotal evidence to the effect that employers do not see
long spells of unemployment as making applicants
less attractive for most jobs; and reports that employers were receiving large numbers of applications for
each opening and were being especially discriminating when filling vacant positions. Another partici-

Minutes of Federal Open Market Committee Meetings | June

pant pointed to research showing that, in many countries, inflation is less responsive to downward pressure from labor market slack when inflation is
already low than when inflation is elevated, and to
evidence that firms in the United States have been
reluctant to cut nominal wages in recent years, as
indications that sizable slack might not cause inflation to decline from its already low level. These arguments imply that slack in labor markets remains considerable and therefore that a reduction in the unemployment rate toward its longer-run normal level
would not have much effect on inflation.
Measures of consumer price inflation declined over
the intermeeting period, mainly reflecting reductions
in oil and gasoline prices since earlier in the year.
Several participants noted that they saw little if any
evidence of price pressures, commenting that
increases in labor costs continued to be subdued and
that non-energy commodity prices had declined of
late. With longer-run inflation expectations well
anchored and the unemployment rate elevated,
almost all participants anticipated that inflation in
coming quarters and over the medium run would be
at or below the 2 percent rate that the Committee
judges to be most consistent with its mandate; several
had revised down their inflation forecasts. Most participants viewed the risks to their inflation outlook as
being roughly balanced. Some participants, however,
saw persistent slack in resource utilization as weighting the risks to the outlook for inflation to the downside. In contrast, a few saw inflation risks as tilted to
the upside; they generally were skeptical of models
that rely on economic slack to forecast inflation and
were concerned that maintaining the current highly
accommodative stance of monetary policy over the
medium run risked eroding the stability of inflation
expectations, with a couple noting that large long-run
fiscal imbalances also posed a risk.
Many FOMC participants judged that overall financial conditions had become somewhat less supportive
of growth in demand for goods and services. Investors’ concerns about the sovereign debt and banking
situation in the euro area reportedly intensified during the intermeeting period, leading to higher risk
spreads and lower prices for riskier assets including
equities and to broad-based appreciation of the U.S.
dollar on foreign exchange markets. In contrast, a
few participants observed that the marked drop in
yields on longer-term U.S. Treasury securities could
provide some impetus to growth. Focusing more narrowly on the banking sector in the United States, it
was noted that measures of credit quality for bank

199

loans generally had continued to improve, that bank
capital levels were quite high, and that banks had
ample liquidity. Consumer and business loans were
increasing, although credit standards remained tight
and commercial and residential real estate lending
were relatively weak. A few participants indicated
that they were seeing signs that very low interest rates
might be inducing some investors to take on imprudent risks in the search for higher nominal returns.
Participants discussed the risk that strains in global
financial markets and pressures on European financial institutions could worsen and spill over to parts
of the domestic financial sector, and some noted the
importance of undertaking adequate preparations to
address such spillovers if they were to occur; it also
was recognized that investor sentiment could improve
and strains in global markets might ease. Several participants commented that it would be desirable to
explore the possibility of developing new tools to
promote more-accommodative financial conditions
and thereby support a stronger economic recovery.

Committee Policy Action
Committee members saw the information received
over the intermeeting period as suggesting that the
economy had been expanding moderately. However,
growth in employment had slowed in recent months,
and almost all members saw the unemployment rate
as still elevated relative to levels that they viewed as
consistent with the Committee’s mandate. Members
generally expected growth to be moderate over coming quarters and then to pick up very gradually, with
the unemployment rate declining only slowly. Most
projected somewhat slower growth through next year,
and a smaller reduction in unemployment, than they
had projected in April. Furthermore, strains in global
financial markets, which largely stemmed from the
sovereign debt and banking situation in Europe, had
increased during the intermeeting period and continued to pose significant downside risks to economic
activity both here and abroad, making the outlook
quite uncertain. The possibility that U.S. fiscal policy
would be more contractionary than anticipated was
also cited as a downside risk. Inflation had slowed,
mainly reflecting the decline in the prices of crude oil
and gasoline in recent months. Averaging through its
recent fluctuations, inflation appeared to be running
near the Committee’s 2 percent longer-run objective;
with longer-term inflation expectations stable, members anticipated that inflation over the medium run
would be at or below that rate. Some members
judged that persistent slack in resource utilization
posed downside risks to the outlook for inflation. In

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99th Annual Report | 2012

contrast, one member thought that maintaining the
current highly accommodative stance of monetary
policy well into 2014 would pose upside risks to
inflation.
In their discussion of monetary policy for the period
ahead, members agreed that it would be appropriate
to keep the target range for the federal funds rate at
0 to ¼ percent in order to support a stronger economic recovery and to help ensure that inflation, over
time, is at the 2 percent rate that the Committee
judges most consistent with its mandate. In addition,
all members but one agreed that it would be appropriate to continue through the end of this year the
Committee’s program to extend the average maturity
of the Federal Reserve’s holdings of securities; specifically, they agreed to continue purchasing Treasury
securities with remaining maturities of 6 years to
30 years at the current pace of about $44 billion per
month while selling or redeeming an equal amount of
Treasury securities with remaining maturities of
approximately 3 years or less. These steps would
increase the Federal Reserve’s holdings of longerterm Treasury securities by about $267 billion while
reducing its holdings of shorter-term Treasury securities by the same amount. Members also agreed to
maintain the Committee’s existing policy regarding
the reinvestment of principal payments from Federal
Reserve holdings of agency securities into agency
MBS. Members generally judged that continuing the
maturity extension program would put some downward pressure on longer-term interest rates and help
make broader financial conditions more accommodative. Some members noted the risk that continued
purchases of longer-term Treasury securities could,
at some point, lead to deterioration in the functioning of the Treasury securities market that could
undermine the intended effects of the policy. However, members generally agreed that such risks
seemed low at present, and were outweighed by the
expected benefits of the action. Several members
noted that the downward pressure on longer-term
rates from continuing the Committee’s maturity
extension program was likely to be modest. One
member anticipated little if any effect on economic
growth and unemployment and did not agree that the
outlook for economic activity and inflation called for
further policy accommodation.
With respect to the statement to be released following
the meeting, members agreed that only relatively
small modifications to the first two paragraphs were
needed to reflect the incoming economic data and the
changes to the economic outlook. In light of their

assessment of the economic situation, almost all
members again agreed to indicate that the Committee
expects to maintain a highly accommodative stance
for monetary policy and currently anticipates that
economic conditions—including low rates of
resource utilization and a subdued outlook for inflation over the medium run—are likely to warrant
exceptionally low levels for the federal funds rate at
least through late 2014. Some Committee members
indicated that their policy judgment reflected in part
their perception of significant downside risks to
growth, especially since the Committee’s ability to
respond to weaker-than-expected economic conditions would be somewhat limited by the constraint
imposed on monetary policy when the policy rate is
at or near its effective lower bound. Members again
noted that the forward guidance is conditional on
economic developments and that the date given in the
statement would be subject to revision should there
be a significant change in the economic outlook.
A few members expressed the view that further policy
stimulus likely would be necessary to promote satisfactory growth in employment and to ensure that the
inflation rate would be at the Committee’s goal. Several others noted that additional policy action could
be warranted if the economic recovery were to lose
momentum, if the downside risks to the forecast
became sufficiently pronounced, or if inflation
seemed likely to run persistently below the Committee’s longer-run objective. The Committee agreed
that it was prepared to take further action as appropriate to promote a stronger economic recovery and
sustained improvement in labor market conditions in
a context of price stability. A few members observed
that it would be helpful to have a better understanding of how large the Federal Reserve’s asset purchases would have to be to cause a meaningful deterioration in securities market functioning, and of the
potential costs of such deterioration for the economy
as a whole.
At the conclusion of the discussion, the Committee
voted to authorize and direct the Federal Reserve
Bank of New York, until it was instructed otherwise,
to execute transactions in the System Account in
accordance with the following domestic policy
directive:
“The Federal Open Market Committee seeks
monetary and financial conditions that will foster price stability and promote sustainable
growth in output. To further its long-run objectives, the Committee seeks conditions in reserve

Minutes of Federal Open Market Committee Meetings | June

markets consistent with federal funds trading in
a range from 0 to ¼ percent. The Committee
directs the Desk to continue the maturity extension program it began in September to purchase,
by the end of June 2012, Treasury securities with
remaining maturities of 6 years to 30 years with
a total face value of $400 billion, and to sell
Treasury securities with remaining maturities of
3 years or less with a total face value of $400 billion. Following the conclusion of these purchases, the Committee directs the Desk to purchase Treasury securities with remaining maturities of 6 years to 30 years with a total face value
of about $267 billion by the end of December 2012, and to sell or redeem Treasury securities with remaining maturities of approximately
3 years or less with a total face value of about
$267 billion. For the duration of this program,
the Committee directs the Desk to suspend its
current policy of rolling over maturing Treasury
securities into new issues. The Committee directs
the Desk to maintain its existing policy of reinvesting principal payments on all agency debt
and agency mortgage-backed securities in the
System Open Market Account in agency
mortgage-backed securities. These actions
should maintain the total face value of domestic
securities at approximately $2.6 trillion. The
Committee directs the Desk to engage in dollar
roll transactions as necessary to facilitate settlement of the Federal Reserve’s agency MBS
transactions. The System Open Market Account
Manager and the Secretary will keep the Committee informed of ongoing developments
regarding the System’s balance sheet that could
affect the attainment over time of the Committee’s objectives of maximum employment and
price stability.”
The vote encompassed approval of the statement
below to be released at 12:30 p.m.:
“Information received since the Federal Open
Market Committee met in April suggests that
the economy has been expanding moderately
this year. However, growth in employment has
slowed in recent months, and the unemployment
rate remains elevated. Business fixed investment
has continued to advance. Household spending
appears to be rising at a somewhat slower pace
than earlier in the year. Despite some signs of
improvement, the housing sector remains

201

depressed. Inflation has declined, mainly reflecting lower prices of crude oil and gasoline, and
longer-term inflation expectations have
remained stable.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment
and price stability. The Committee expects economic growth to remain moderate over coming
quarters and then to pick up very gradually.
Consequently, the Committee anticipates that
the unemployment rate will decline only slowly
toward levels that it judges to be consistent with
its dual mandate. Furthermore, strains in global
financial markets continue to pose significant
downside risks to the economic outlook. The
Committee anticipates that inflation over the
medium term will run at or below the rate that it
judges most consistent with its dual mandate.
To support a stronger economic recovery and to
help ensure that inflation, over time, is at the
rate most consistent with its dual mandate, the
Committee expects to maintain a highly accommodative stance for monetary policy. In particular, the Committee decided today to keep the
target range for the federal funds rate at 0 to
¼ percent and currently anticipates that economic conditions—including low rates of
resource utilization and a subdued outlook for
inflation over the medium run—are likely to
warrant exceptionally low levels for the federal
funds rate at least through late 2014.
The Committee also decided to continue
through the end of the year its program to
extend the average maturity of its holdings of
securities. Specifically, the Committee intends to
purchase Treasury securities with remaining
maturities of 6 years to 30 years at the current
pace and to sell or redeem an equal amount of
Treasury securities with remaining maturities of
approximately 3 years or less. This continuation
of the maturity extension program should put
downward pressure on longer-term interest rates
and help to make broader financial conditions
more accommodative. The Committee is maintaining its existing policy of reinvesting principal
payments from its holdings of agency debt and
agency mortgage-backed securities in agency
mortgage-backed securities. The Committee is
prepared to take further action as appropriate to

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99th Annual Report | 2012

promote a stronger economic recovery and sustained improvement in labor market conditions
in a context of price stability.”
Voting for this action: Ben Bernanke, William C.
Dudley, Elizabeth Duke, Dennis P. Lockhart, Sandra
Pianalto, Jerome H. Powell, Sarah Bloom Raskin,
Jeremy C. Stein, Daniel K. Tarullo, John C. Williams,
and Janet L. Yellen.

effect in current circumstances. Should inflation fall
substantially and persistently below the Committee’s
2 percent goal, however, he felt that monetary stimulus might then be appropriate to ensure the return of
inflation toward target.
It was agreed that the next meeting of the Committee
would be held on Tuesday–Wednesday, July 31–
August 1, 2012. The meeting adjourned at 11:05 a.m.
on June 20, 2012.

Voting against this action: Jeffrey M. Lacker.
Mr. Lacker dissented because he opposed continuation of the maturity extension program. He did not
believe that further monetary stimulus at this time
would make a substantial difference for economic
growth and employment without also increasing
inflation by more than would be desirable. In Mr.
Lacker’s view, the outlook for economic growth had
clearly weakened of late, but he questioned whether
the maturity extension program would have much

Notation Vote
By notation vote completed on May 15, 2012, the
Committee unanimously approved the minutes of the
FOMC meeting held on April 24–25, 2012.
William B. English
Secretary

Minutes of Federal Open Market Committee Meetings | June

Addendum:
Summary of Economic Projections

203

Overall, the assessments that FOMC participants
submitted in June indicated that, under appropriate
monetary policy, the pace of economic expansion
over the 2012−14 period would likely continue to be
moderate and inflation would remain subdued (see
table 1 and figure 1). Participants judged that the
growth rate of real gross domestic product (GDP)
would pick up gradually and that the unemployment
rate would edge down very slowly. Participants projected that inflation, as measured by the annual
change in the price index for personal consumption
expenditures (PCE), would run close to or below the
FOMC’s longer-run inflation objective of 2 percent.

In conjunction with the June 19–20, 2012, Federal
Open Market Committee (FOMC) meeting, meeting
participants—the 7 members of the Board of Governors and the 12 presidents of the Federal Reserve
Banks, all of whom participate in the deliberations of
the FOMC—submitted their assessments, under each
participant’s judgment of appropriate monetary
policy, of real output growth, the unemployment
rate, inflation, and the target federal funds rate for
each year from 2012 through 2014 and over the longer run. These assessments were based on information available at the time of the meeting and participants’ individual assumptions about the factors likely
to affect economic outcomes. The longer-run projections represent each participant’s judgment of the
rate to which each variable would be expected to converge, over time, under appropriate monetary policy
and in the absence of further shocks to the economy.
“Appropriate monetary policy” is defined as the
future path of policy that participants deem most
likely to foster outcomes for economic activity and
inflation that best satisfy their individual interpretations of the Federal Reserve’s objectives of maximum
employment and stable prices.

As shown in figure 2, most participants judged that
highly accommodative monetary policy was likely to
be warranted over the forecast period. In particular,
13 participants thought that it would be appropriate
for the first increase in the target federal funds rate to
occur during 2014 or later. A majority of participants judged that appropriate monetary policy would
involve an extension of the maturity extension program (MEP) through the end of 2012.
Overall, participants judged the uncertainty associated with the outlook for real activity and the unemployment rate to be unusually high relative to histori-

Table 1. Economic projections of Federal Reserve Board members and Federal Reserve Bank presidents, June 2012
Percent
Central tendency1

Range2

Variable
2012
Change in real GDP
April projection
Unemployment rate
April projection
PCE inflation
April projection
Core PCE inflation3
April projection

2013

2014

Longer run

2012

2013

2014

Longer run

1.9 to 2.4
2.4 to 2.9
8.0 to 8.2
7.8 to 8.0
1.2 to 1.7
1.9 to 2.0
1.7 to 2.0
1.8 to 2.0

2.2 to 2.8
2.7 to 3.1
7.5 to 8.0
7.3 to 7.7
1.5 to 2.0
1.6 to 2.0
1.6 to 2.0
1.7 to 2.0

3.0 to 3.5
3.1 to 3.6
7.0 to 7.7
6.7 to 7.4
1.5 to 2.0
1.7 to 2.0
1.6 to 2.0
1.8 to 2.0

2.3 to 2.5
2.3 to 2.6
5.2 to 6.0
5.2 to 6.0
2.0
2.0

1.6 to 2.5
2.1 to 3.0
7.8 to 8.4
7.8 to 8.2
1.2 to 2.0
1.8 to 2.3
1.7 to 2.0
1.7 to 2.0

2.2 to 3.5
2.4 to 3.8
7.0 to 8.1
7.0 to 8.1
1.5 to 2.1
1.5 to 2.1
1.4 to 2.1
1.6 to 2.1

2.8 to 4.0
2.9 to 4.3
6.3 to 7.7
6.3 to 7.7
1.5 to 2.2
1.5 to 2.2
1.5 to 2.2
1.7 to 2.2

2.2 to 3.0
2.2 to 3.0
4.9 to 6.3
4.9 to 6.0
2.0
2.0

Note: Projections of change in real gross domestic product (GDP) and projections for both measures of inflation are from the fourth quarter of the previous year to the fourth
quarter of the year indicated. PCE inflation and core PCE inflation are the percentage rates of change in, respectively, the price index for personal consumption expenditures
(PCE) and the price index for PCE excluding food and energy. Projections for the unemployment rate are for the average civilian unemployment rate in the fourth quarter of the
year indicated. Each participant’s projections are based on his or her assessment of appropriate monetary policy. Longer-run projections represent each participant’s
assessment of the rate to which each variable would be expected to converge under appropriate monetary policy and in the absence of further shocks to the economy. The April
projections were made in conjunction with the meeting of the Federal Open Market Committee on April 24–25, 2012.
1
The central tendency excludes the three highest and three lowest projections for each variable in each year.
2
The range for a variable in a given year includes all participants’ projections, from lowest to highest, for that variable in that year.
3
Longer-run projections for core PCE inflation are not collected.

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99th Annual Report | 2012

Figure 1. Central tendencies and ranges of economic projections, 2012–14 and over the longer run
P ercent

Change in real GDP

5

Central tendency of projections
Range of projections

4
3
2
1
+
0
1

A ctual

2
3

2007

2008

2009

2010

2011

2012

2013

2014

Longer
run
P ercent

Unemplo yment rate

10
9
8
7
6
5

2007

2008

2009

2010

2011

2012

2013

2014

Longer
run
P ercent

PCE inflation
3

2

1

2007

2008

2009

2010

2011

2012

2013

2014

Longer
run
P ercent

Core PCE inflation
3

2

1

2007

2008

2009

2010

2011

2012

2013

Note: Definitions of variables are in the general note to table 1. The data for the actual values of the variables are annual.

2014

Longer
run

Minutes of Federal Open Market Committee Meetings | June

205

Figure 2. Overview of FOMC participants’ assessments of appropriate monetary policy, June 2012
Number of participants

Appropriate timing of policy firming
9
8
7
7
6
6
5
4
3

3
3
2
1

2012

2013

2014

2015

Appropriate pace of policy firming

P ercent

Target federal funds rate at year-end
6

5

4

3

2

1

0

2012

2013

2014

Longer run

Note: In the upper panel, the height of each bar denotes the number of FOMC participants who judge that, under appropriate monetary policy, the first increase in the target federal funds rate from its current range of 0 to ¼ percent will occur in the specified calendar year. In April 2012, the numbers of FOMC participants who judged that the first
increase in the target federal funds rate would occur in 2012, 2013, 2014, and 2015 were, respectively, 3, 3, 7, and 4. In the lower panel, each shaded circle indicates the value
(rounded to the nearest ¼ percentage point) of an individual participant’s judgment of the appropriate level of the target federal funds rate at the end of the specified calendar
year or over the longer run.

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99th Annual Report | 2012

cal norms, with the risks weighted mainly toward
slower economic growth and a higher unemployment
rate. Many participants also viewed the uncertainty
surrounding their projections for inflation to be
greater than normal, but most saw the risks to inflation to be broadly balanced.
The Outlook for Economic Activity
Conditional upon their individual assumptions about
appropriate monetary policy, participants judged
that the economy would continue to expand at a
moderate pace in 2012 and 2013 before picking up in
2014 to a pace somewhat above what participants
view as the longer-run rate of output growth. The
central tendency of their projections for the change
in real GDP in 2012 was 1.9 to 2.4 percent, lower
than in April. Many participants characterized the
incoming data—especially for household spending
and the labor market—as having been weaker than
they had anticipated in April. In addition, most
noted that the worsening situation in Europe was
leading to a slowdown in global economic growth
and greater volatility in financial markets. Compared
with their April submissions, most participants lowered their medium-run projections of economic
activity somewhat. The central tendencies of participants’ projections of real economic growth in 2013
and 2014 were 2.2 to 2.8 percent and 3.0 to 3.5 percent, respectively. The central tendency for the
longer-run rate of increase of real GDP was 2.3 to
2.5 percent, little changed from April. Participants
cited several headwinds that were likely to hold back
the pace of economic expansion over the forecast
period, including the difficult fiscal and financial
situation in Europe, a still-depressed housing market,
tight credit for some borrowers, and fiscal restraint in
the United States.
Consistent with the downward revisions to their projections for real GDP growth in 2012 and 2013,
nearly all participants marked up their assessments
for the rate of unemployment. Participants projected
the unemployment rate at the end of 2012 to remain
at or slightly below recent levels, with a central tendency of 8.0 to 8.2 percent, somewhat higher than
their April submissions. Participants anticipated
gradual improvement in labor market conditions by
2014, but even so, they generally thought that the
unemployment rate at the end of that year would still
lie well above their individual estimates of its longerrun normal level. The central tendencies of participants’ forecasts for the unemployment rate were
7.5 to 8.0 percent at the end of 2013 and 7.0 to
7.7 percent at the end of 2014. The central tendency
of participants’ estimates of the longer-run normal
rate of unemployment that would prevail under the

assumption of appropriate monetary policy and in
the absence of further shocks to the economy was
5.2 to 6.0 percent, unchanged from April. Most participants projected that the gap between the current
unemployment rate and their estimates of its longerrun normal rate would be closed in five or six years, a
couple judged that less time would be needed, and
one thought more time would be necessary because
of the persistent headwinds impeding the economic
expansion.
Figures 3.A and 3.B provide details on the diversity
of participants’ views regarding the likely outcomes
for real GDP growth and the unemployment rate
over the next three years and over the longer run.
The dispersion in these projections reflects differences in participants’ assessments of many factors,
including appropriate monetary policy and its effects
on the economy, the underlying momentum in economic activity, the spillover effects of the fiscal and
financial situation in Europe, the prospective path for
U.S. fiscal policy, the extent of structural dislocations
in the labor market, and the likely evolution of credit
and financial market conditions. Compared with
their April assessments, the range of participants’
forecasts for the change in real GDP in 2012 and
2013 shifted lower, while the dispersion of individual
forecasts for growth in 2014 was about unchanged.
Consistent with the downward shift in the distribution of forecasts for economic growth, the distribution of projections for the unemployment rate shifted
up in 2012 and 2013 and, to a lesser extent, in 2014.
As in April, the dispersion of estimates for the
longer-run rate of output growth was fairly narrow,
generally in a range of 2.2 to 2.7 percent. In contrast,
participants’ views about the level to which the
unemployment rate would converge in the longer run
were more diverse, reflecting, among other things,
different views on the outlook for labor supply and
the structure of the labor market.
The Outlook for Inflation
Participants’ views about the medium-run outlook
for inflation under the assumption of appropriate
monetary policy were little changed from April.
However, nearly all of them marked down their
assessment of headline inflation in the near term,
pointing to recent declines in the prices of crude oil
and gasoline that were sharper than previously projected. Almost all participants judged that both headline and core inflation would remain subdued over
the 2012−14 period, running at rates at or below the
FOMC’s longer-run objective of 2 percent. Some
participants noted that inflation expectations had
remained stable, and several pointed to resource slack
and moderate increases in labor compensation as

Minutes of Federal Open Market Committee Meetings | June

207

Figure 3.A. Distribution of participants’ projections for the change in real GDP, 2012–14 and over the longer run
Number of participants

2012

20
18
16
14
12
10
8
6
4
2

June projections
April projections

1.6 1.7

1.8 1.9

2.0 2.1

2.2 2.3

2.4 2.5

2.6 2.7

2.8 2.9

3.0 3.1

3.2 3.3

3.4 3.5

3.6 3.7

3.8 3.9

4.0 4.1

4.2 4.3

Percent range
Number of participants

2013

1.6 1.7

20
18
16
14
12
10
8
6
4
2
1.8 1.9

2.0 2.1

2.2 2.3

2.4 2.5

2.6 2.7

2.8 2.9

3.0 3.1

3.2 3.3

3.4 3.5

3.6 3.7

3.8 3.9

4.0 4.1

4.2 4.3

Percent range
Number of participants

2014

1.6 1.7

20
18
16
14
12
10
8
6
4
2
1.8 1.9

2.0 2.1

2.2 2.3

2.4 2.5

2.6 2.7

2.8 2.9

3.0 3.1

3.2 3.3

3.4 3.5

3.6 3.7

3.8 3.9

4.0 4.1

4.2 4.3

Percent range
Number of participants

Longer run

1.6 1.7

20
18
16
14
12
10
8
6
4
2
1.8 1.9

2.0 2.1

2.2 2.3

2.4 2.5

2.6 2.7

2.8 2.9

3.0 3.1

Percent range
Note: Definitions of variables are in the general note to table 1.

3.2 3.3

3.4 3.5

3.6 3.7

3.8 3.9

4.0 4.1

4.2 4.3

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99th Annual Report | 2012

Figure 3.B. Distribution of participants’ projections for the unemployment rate, 2012–14 and over the longer run
Number of participants

2012

20
18
16
14
12
10
8
6
4
2

June projections
April projections

4.8 4.9

5.0 5.1

5.2 5.3

5.4 5.5

5.6 5.7

5.8 5.9

6.0 6.1

6.2 6.3

6.4 6.5

6.6 6.7

6.8 6.9

7.0 7.1

7.2 7.3

7.4 7.5

7.6 7.7

7.8 7.9

8.0 8.1

8.2 8.3

8.4 8.5

Percent range
Number of participants

2013

4.8 4.9

20
18
16
14
12
10
8
6
4
2
5.0 5.1

5.2 5.3

5.4 5.5

5.6 5.7

5.8 5.9

6.0 6.1

6.2 6.3

6.4 6.5

6.6 6.7

6.8 6.9

7.0 7.1

7.2 7.3

7.4 7.5

7.6 7.7

7.8 7.9

8.0 8.1

8.2 8.3

8.4 8.5

Percent range
Number of participants

2014

4.8 4.9

20
18
16
14
12
10
8
6
4
2
5.0 5.1

5.2 5.3

5.4 5.5

5.6 5.7

5.8 5.9

6.0 6.1

6.2 6.3

6.4 6.5

6.6 6.7

6.8 6.9

7.0 7.1

7.2 7.3

7.4 7.5

7.6 7.7

7.8 7.9

8.0 8.1

8.2 8.3

8.4 8.5

Percent range
Number of participants

Longer run

4.8 4.9

5.0 5.1

20
18
16
14
12
10
8
6
4
2
5.2 5.3

5.4 5.5

5.6 5.7

5.8 5.9

6.0 6.1

6.2 6.3

6.4 6.5

6.6 6.7

6.8 6.9

Percent range
Note: Definitions of variables are in the general note to table 1.

7.0 7.1

7.2 7.3

7.4 7.5

7.6 7.7

7.8 7.9

8.0 8.1

8.2 8.3

8.4 8.5

Minutes of Federal Open Market Committee Meetings | June

sources of restraint on prices. Specifically, the central
tendency of participants’ projections for inflation, as
measured by the PCE price index, moved down in
2012 to 1.2 to 1.7 percent and was little changed in
2013 and 2014 at 1.5 to 2.0 percent. The central tendencies of the forecasts for core inflation were
broadly the same as those for the headline measure in
2013 and 2014.
Figures 3.C and 3.D provide information about the
diversity of participants’ views about the outlook for
inflation. Relative to the assessments compiled in
April, the projections for headline inflation shifted
down in 2012, reflecting the declines in energy prices.
The distributions of participants’ projections for
headline and core inflation in 2013 and 2014 were
slightly lower than those reported in April.
Appropriate Monetary Policy
As indicated in figure 2, most participants judged
that exceptionally low levels of the federal funds rate
would remain appropriate at least until late 2014. In
particular, seven participants thought that it would
be appropriate to commence policy firming in 2014,
while another six participants thought that the first
increase in the target federal funds rate would not be
warranted until 2015 (upper panel). Eleven participants indicated that the appropriate federal funds
rate at the end of 2014 would be 75 basis points or
lower (lower panel), and those who judged that
policy liftoff would not occur until 2015 thought the
federal funds rate would be 1½ percent or lower at
the end of that year. As in April, six participants
judged that economic conditions would warrant an
increase in the target federal funds rate in either 2012
or 2013 in order to achieve the Committee’s statutory
mandate. Those participants judged that the appropriate value for the federal funds rate would range
from 1½ to 3 percent at the end of 2014.
All participants reported levels for the appropriate
target federal funds rate at the end of 2014 that were
well below their estimates of the level expected to
prevail in the longer run. Estimates of the longer-run
target federal funds rate ranged from 3 to 4½ percent, reflecting the Committee’s inflation objective of
2 percent and participants’ judgments about the
longer-run equilibrium level of the real federal funds
rate.
Participants also provided qualitative information on
their views regarding the appropriate path of the
Federal Reserve’s balance sheet. Of the 12 participants whose assessments of appropriate monetary
policy included additional balance sheet policies, 11
indicated that their assumptions incorporated an

209

extension through the end of 2012 of the MEP, and 2
participants conditioned their economic forecasts on
a new program of securities purchases. Two indicated
that they would consider such purchases in the event
that the economy did not make satisfactory progress
in improving labor market conditions or in the event
of a significant deterioration in the economic outlook or a further increase in downside risks to that
outlook. Almost all participants assumed that the
Committee would carry out the normalization of the
balance sheet according to the principles approved at
the June 2011 FOMC meeting. That is, prior to the
first increase in the federal funds rate, the Committee
would likely cease reinvesting some or all principal
payments on securities in the System Open Market
Account (SOMA), and it would likely begin sales of
agency securities from the SOMA sometime after the
first rate increase, aiming to eliminate the SOMA’s
holdings of agency securities over a period of three
to five years. In general, participants linked their preferred start dates for the normalization process to
their views for the appropriate timing for the first
increase in the target federal funds rate. One participant who thought that the liftoff of the federal funds
rate should occur relatively soon indicated that the
reinvestment of maturing securities should continue
for a time after liftoff.
The key factors informing participants’ individual
assessments of the appropriate setting for monetary
policy included their judgments regarding the maximum level of employment, the extent to which current conditions had deviated from mandateconsistent levels, and participants’ projections of the
likely time horizon necessary to return employment
and inflation to such levels. Several participants
noted that their assessments of appropriate monetary
policy reflected the subpar pace of the economic
expansion and the persistent shortfall in aggregate
demand since the 2007–09 recession, and two commented that the neutral level of the federal funds rate
was likely somewhat below its historical norm. One
participant expressed concern that a protracted
period of very accommodative monetary policy
could lead to a buildup of risks in the financial
system. Participants also noted that because the
appropriate stance of monetary policy depends
importantly on the evolution of real activity and
inflation over time, their assessments of the appropriate future path of the federal funds rate and the balance sheet could change if economic conditions were
to evolve in an unexpected manner.
Figure 3.E details the distribution of participants’
judgments regarding the appropriate level of the target federal funds rate at the end of each calendar year

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99th Annual Report | 2012

Figure 3.C. Distribution of participants’ projections for PCE inflation, 2012–14 and over the longer run
Number of participants

2012

20
18
16
14
12
10
8
6
4
2

June projections
April projections

1.1 1.2

1.3 1.4

1.5 1.6

1.7 1.8

1.9 2.0

2.1 2.2

2.3 2.4

Percent range
Number of participants

2013

20
18
16
14
12
10
8
6
4
2
1.1 1.2

1.3 1.4

1.5 1.6

1.7 1.8

1.9 2.0

2.1 2.2

2.3 2.4

Percent range
Number of participants

2014

20
18
16
14
12
10
8
6
4
2
1.1 1.2

1.3 1.4

1.5 1.6

1.7 1.8

1.9 2.0

2.1 2.2

2.3 2.4

Percent range
Number of participants

Longer run

1.1 1.2

20
18
16
14
12
10
8
6
4
2
1.3 1.4

1.5 1.6

1.7 1.8

Percent range
Note: Definitions of variables are in the general note to table 1.

1.9 2.0

2.1 2.2

2.3 2.4

Minutes of Federal Open Market Committee Meetings | June

211

Figure 3.D. Distribution of participants’ projections for core PCE inflation, 2012–14
Number of participants

2012

20

June projections
April projections

18
16
14
12
10
8
6
4
2

1.3 1.4

1.5 1.6

1.7 1.8

1.9 2.0

2.1 2.2

Percent range
Number of participants

2013

20
18
16
14
12
10
8
6
4
2
1.3 1.4

1.5 1.6

1.7 1.8

1.9 2.0

2.1 2.2

Percent range
Number of participants

2014

20
18
16
14
12
10
8
6
4
2
1.3 1.4

1.5 1.6

1.7 1.8

Percent range
Note: Definitions of variables are in the general note to table 1.

1.9 2.0

2.1 2.2

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99th Annual Report | 2012

Figure 3.E. Distribution of participants’ projections for the target federal funds rate, 2012–14 and over the longer run
Number of participants

2012
June projections
April projections

0.00 0.37

0.38 0.62

0.63 0.87

20
18
16
14
12
10
8
6
4
2
0.88 1.12

1.13 1.37

1.38 1.62

1.63 1.87

1.88 2.12

2.13 2.37

2.38 2.62

2.63 2.87

2.88 3.12

3.13 3.37

3.38 3.62

3.63 3.87

3.88 4.12

4.13 4.37

4.38 4.62

Percent range
Number of participants

2013
20
18
16
14
12
10
8
6
4
2
0.00 0.37

0.38 0.62

0.63 0.87

0.88 1.12

1.13 1.37

1.38 1.62

1.63 1.87

1.88 2.12

2.13 2.37

2.38 2.62

2.63 2.87

2.88 3.12

3.13 3.37

3.38 3.62

3.63 3.87

3.88 4.12

4.13 4.37

4.38 4.62

Percent range
Number of participants

2014
20
18
16
14
12
10
8
6
4
2
0.00 0.37

0.38 0.62

0.63 0.87

0.88 1.12

1.13 1.37

1.38 1.62

1.63 1.87

1.88 2.12

2.13 2.37

2.38 2.62

2.63 2.87

2.88 3.12

3.13 3.37

3.38 3.62

3.63 3.87

3.88 4.12

4.13 4.37

4.38 4.62

Percent range
Number of participants

Longer run
20
18
16
14
12
10
8
6
4
2
0.00 0.37

0.38 0.62

0.63 0.87

0.88 1.12

1.13 1.37

1.38 1.62

1.63 1.87

1.88 2.12

2.13 2.37

2.38 2.62

2.63 2.87

2.88 3.12

3.13 3.37

3.38 3.62

Percent range
Note: The target federal funds rate is measured as the level of the target rate at the end of the calendar year or in the longer run.

3.63 3.87

3.88 4.12

4.13 4.37

4.38 4.62

Minutes of Federal Open Market Committee Meetings | June

from 2012 to 2014 and over the longer run. Most
participants judged that economic conditions would
warrant maintaining the current low level of the federal funds rate through the end of 2013. Views on the
appropriate level of the federal funds rate at the end
of 2014 were more widely dispersed, with 11 participants seeing the appropriate level of the federal funds
rate as ¾ percentage point or lower and 4 of them
seeing the appropriate rate as 2 percent or higher.
Those who judged that a longer period of very
accommodative monetary policy would be appropriate generally projected that the unemployment rate
would remain further above its longer-run normal
level at the end of 2014. In contrast, the 6 participants who judged that policy firming should begin in
2012 or 2013 indicated that the Committee would
need to act soon to keep inflation near the FOMC’s
longer-run objective of 2 percent and to prevent a
rise in inflation expectations.
Uncertainty and Risks
Nearly all participants judged that their current level
of uncertainty about GDP growth and unemployment was higher than was the norm during the previous 20 years (figure 4).5 About half of all participants judged the level of uncertainty associated with
their inflation forecasts to be higher as well, while
another eight participants viewed uncertainty about
inflation as broadly similar to historical norms. The
main factors cited as underlying the elevated uncertainty about economic outcomes were the ongoing
fiscal and financial situation in Europe, the outlook
for fiscal policy in the United States, and a general
slowdown in global economic growth, including the
possibility of a significant slowdown in China. As in
April, participants noted the difficulties associated
with forecasting the path of the U.S. economic recovery following a financial crisis and recession that differed markedly from recent historical experience. Several commented that in the aftermath of the financial

5

Table 2 provides estimates of the forecast uncertainty for the
change in real GDP, the unemployment rate, and total consumer price inflation over the period from 1992 to 2011. At the
end of this summary, the box “Forecast Uncertainty” discusses
the sources and interpretation of uncertainty in the economic
forecasts and explains the approach used to assess the uncertainty and risks attending the participants’ projections.

213

Table 2. Average historical projection error ranges
Percentage points
Variable
Change in real GDP1
Unemployment rate1
Total consumer prices2

2012

2013

2014

±1.0
±0.4
±0.8

±1.6
±1.2
±1.0

±1.7
±1.7
±1.1

Note: Error ranges shown are measured as plus or minus the root mean squared
error of projections for 1992 through 2011 that were released in the summer by
various private and government forecasters. As described in the box “Forecast
Uncertainty,” under certain assumptions, there is about a 70 percent probability
that actual outcomes for real GDP, unemployment, and consumer prices will be in
ranges implied by the average size of projection errors made in the past. Further
information is in David Reifschneider and Peter Tulip (2007), “Gauging the
Uncertainty of the Economic Outlook from Historical Forecasting Errors,” Finance
and Economics Discussion Series 2007-60 (Washington: Board of Governors of
the Federal Reserve System, November).
1
Definitions of variables are in the general note to table 1.
2
Measure is the overall consumer price index, the price measure that has been
most widely used in government and private economic forecasts. Projection
is percent change, fourth quarter of the previous year to the fourth quarter of
the year indicated.

crisis, they were more uncertain about the level of
potential output and its trend rate of growth.
A majority of participants reported that they saw the
risks to their forecasts of real GDP growth as
weighted toward the downside and, accordingly, the
risks to their projections of the unemployment rate
as tilted to the upside. The most frequently identified
sources of risk were the situation in Europe, which
many participants thought had the potential to slow
global economic activity, particularly over the near
term, and the fiscal situation in the United States.
Most participants continued to judge the risks to
their projections for inflation as broadly balanced,
with several highlighting the recent stability of inflation expectations. However, five participants saw the
risks to inflation as tilted to the downside, a larger
number than in April; a couple of them noted that
slack in resource markets could turn out to be greater
or could put more downward pressure on inflation
than they were anticipating. Two participants saw the
risks to inflation as weighted to the upside, in light of
concerns about U.S. fiscal imbalances, the current
highly accommodative stance of monetary policy, or
the Committee’s ability to effectively remove policy
accommodation when it becomes appropriate to
do so.

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99th Annual Report | 2012

Figure 4. Uncertainty and risks in economic projections
Number of participants

Uncertainty about GDP growth

20
18
16
14
12
10
8
6
4
2

June projections
April projections

Lower

Broadly
similar

Number of participants

Higher

Risks to GDP growth

20
18
16
14
12
10
8
6
4
2

June projections
April projections

Weighted to
downside

Broadly
balanced

Number of participants

Uncertainty about the unemployment rate

Lower

Broadly
similar

Number of participants

20
18
16
14
12
10
8
6
4
2

Higher

Risks to the unemployment rate

Weighted to
downside

Broadly
balanced

Number of participants

Uncertainty about PCE inflation

Lower

Broadly
similar

Broadly
similar

Higher

Weighted to
downside

20
18
16
14
12
10
8
6
4
2

Broadly
balanced

Weighted to
upside
Number of participants

20
18
16
14
12
10
8
6
4
2

Higher

Weighted to
upside

Risks to PCE inflation

Number of participants

Lower

20
18
16
14
12
10
8
6
4
2

Number of participants

20
18
16
14
12
10
8
6
4
2

Uncertainty about core PCE inflation

Weighted to
upside

Risks to core PCE inflation

Weighted to
downside

Broadly
balanced

20
18
16
14
12
10
8
6
4
2

Weighted to
upside

Note: For definitions of uncertainty and risks in economic projections, see the box “Forecast Uncertainty.” Definitions of variables are in the general note to table 1.

Minutes of Federal Open Market Committee Meetings | June

215

Forecast Uncertainty
The economic projections provided by the members
of the Board of Governors and the presidents of the
Federal Reserve Banks inform discussions of monetary policy among policymakers and can aid public
understanding of the basis for policy actions. Considerable uncertainty attends these projections, however. The economic and statistical models and relationships used to help produce economic forecasts
are necessarily imperfect descriptions of the real
world, and the future path of the economy can be
affected by myriad unforeseen developments and
events. Thus, in setting the stance of monetary
policy, participants consider not only what appears to
be the most likely economic outcome as embodied in
their projections, but also the range of alternative
possibilities, the likelihood of their occurring, and the
potential costs to the economy should they occur.
Table 2 summarizes the average historical accuracy
of a range of forecasts, including those reported in
past Monetary Policy Reports and those prepared by
the Federal Reserve Board’s staff in advance of
meetings of the Federal Open Market Committee.
The projection error ranges shown in the table illustrate the considerable uncertainty associated with
economic forecasts. For example, suppose a participant projects that real gross domestic product (GDP)
and total consumer prices will rise steadily at annual
rates of, respectively, 3 percent and 2 percent. If the
uncertainty attending those projections is similar to
that experienced in the past and the risks around the
projections are broadly balanced, the numbers
reported in table 2 would imply a probability of about
70 percent that actual GDP would expand within a
range of 2.0 to 4.0 percent in the current year, 1.4 to
4.6 percent in the second year, and 1.3 to 4.7 percent

in the third year. The corresponding 70 percent confidence intervals for overall inflation would be 1.2 to
2.8 percent in the current year, 1.0 to 3.0 percent in
the second year, and 0.9 to 3.1 percent in the third
year.
Because current conditions may differ from those
that prevailed, on average, over history, participants
provide judgments as to whether the uncertainty
attached to their projections of each variable is
greater than, smaller than, or broadly similar to typical levels of forecast uncertainty in the past, as
shown in table 2. Participants also provide judgments
as to whether the risks to their projections are
weighted to the upside, are weighted to the downside, or are broadly balanced. That is, participants
judge whether each variable is more likely to be
above or below their projections of the most likely
outcome. These judgments about the uncertainty
and the risks attending each participant’s projections
are distinct from the diversity of participants’ views
about the most likely outcomes. Forecast uncertainty
is concerned with the risks associated with a particular projection rather than with divergences across a
number of different projections.
As with real activity and inflation, the outlook for the
future path of the federal funds rate is subject to considerable uncertainty. This uncertainty arises primarily
because each participant’s assessment of the appropriate stance of monetary policy depends importantly
on the evolution of real activity and inflation over
time. If economic conditions evolve in an unexpected
manner, then assessments of the appropriate setting
of the federal funds rate would change from that
point forward.

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99th Annual Report | 2012

Meeting Held
on July 31–August 1, 2012
A meeting of the Federal Open Market Committee
was held in the offices of the Board of Governors of
the Federal Reserve System in Washington, D.C., on
Tuesday, July 31, 2012, at 1:00 p.m. and continued on
Wednesday, August 1, 2012, at 9:00 a.m.

Present
Ben Bernanke
Chairman
William C. Dudley
Vice Chairman
Elizabeth Duke
Jeffrey M. Lacker
Dennis P. Lockhart
Sandra Pianalto
Jerome H. Powell
Sarah Bloom Raskin
Jeremy C. Stein
Daniel K. Tarullo
John C. Williams
Janet L. Yellen
James Bullard, Christine Cumming,
Charles L. Evans, Esther L. George, and
Eric Rosengren
Alternate Members of the Federal Open Market
Committee
Richard W. Fisher, Narayana Kocherlakota, and
Charles I. Plosser
Presidents of the Federal Reserve Banks of Dallas,
Minneapolis, and Philadelphia, respectively
William B. English
Secretary and Economist
Deborah J. Danker
Deputy Secretary
Matthew M. Luecke
Assistant Secretary
David W. Skidmore
Assistant Secretary
Michelle A. Smith
Assistant Secretary

Scott G. Alvarez
General Counsel
Thomas C. Baxter
Deputy General Counsel
Steven B. Kamin
Economist
David W. Wilcox
Economist
David Altig, Thomas A. Connors, Michael P. Leahy,
James J. McAndrews, William Nelson,
David Reifschneider, and William Wascher
Associate Economists
Simon Potter
Manager, System Open Market Account
Michael S. Gibson
Director, Division of Banking Supervision and
Regulation, Board of Governors
Nellie Liang
Director, Office of Financial Stability Policy and
Research, Board of Governors
Jon W. Faust and Andrew T. Levin
Special Advisors to the Board, Office of Board
Members, Board of Governors
James A. Clouse
Deputy Director, Division of Monetary Affairs,
Board of Governors
Linda Robertson
Assistant to the Board, Office of Board Members,
Board of Governors
Seth B. Carpenter
Senior Associate Director, Division of Monetary
Affairs, Board of Governors
Thomas Laubach
Senior Adviser, Division of Research and Statistics,
Board of Governors
Joyce K. Zickler
Senior Adviser, Division of Monetary Affairs,
Board of Governors
Michael T. Kiley and David E. Lebow
Associate Directors, Division of Research and
Statistics, Board of Governors
Karen M. Pence
Assistant Director, Division of Research and
Statistics, Board of Governors

Minutes of Federal Open Market Committee Meetings | July–August

David H. Small
Project Manager, Division of Monetary Affairs,
Board of Governors
Elizabeth Klee
Senior Economist, Division of Monetary Affairs,
Board of Governors
Robert J. Tetlow
Senior Economist, Division of Research and
Statistics, Board of Governors
David A. Sapenaro
First Vice President, Federal Reserve Bank of
St. Louis
Jeff Fuhrer and Daniel G. Sullivan
Executive Vice Presidents, Federal Reserve Banks of
Boston and Chicago, respectively
Troy Davig and Christopher J. Waller
Senior Vice Presidents, Federal Reserve Banks of
Kansas City and St. Louis, respectively
Reuven Glick
Group Vice President, Federal Reserve Bank of
San Francisco
Todd E. Clark, Lorie K. Logan,
Keith Sill, and Mark A. Wynne
Vice Presidents, Federal Reserve Banks of Cleveland,
New York, Philadelphia, and Dallas, respectively
Robert L. Hetzel and Samuel Schulhofer-Wohl
Senior Economists, Federal Reserve Banks of
Richmond and Minneapolis, respectively

Simple Rules for Monetary Policy
A staff presentation summarized research on the efficacy of alternative simple monetary policy rules in
fostering the Federal Reserve’s monetary policy
objectives of maximum employment and price stability. The presentation reviewed the characteristics of a
variety of rules and noted a number of reasons why
current conditions might warrant deviating from the
prescriptions of simple rules designed for more normal times. The presentation also discussed how
simple rules might be used as part of a comprehensive policy framework to provide clear and transparent benchmarks for monetary policy decisionmaking
and the possibility that such rules could be helpful in
communicating the connection between policy
choices and the Federal Open Market Committee’s
(FOMC) objectives.
Meeting participants expressed a range of views
regarding the appropriate role of policy rules in mon-

217

etary policy decisionmaking. A number of participants indicated that such rules have played a useful
role in informing the Committee’s monetary policy
deliberations. However, several participants pointed
to specific considerations—including the possible
mismeasurement of unobservable variables, such as
potential output, and uncertainty about the appropriate economic models to use in estimating the magnitude of those variables—that might limit the usefulness of simple rules both internally and in public
communications. Several participants saw value in
examining the performance of rules across a range of
economic models. Participants discussed the case for
making adjustments to the prescriptions of simple
policy rules in the current circumstances to take into
account various considerations such as the effective
lower bound for the federal funds rate, the effects of
the Committee’s balance sheet policies, and potential
shifts in the dynamics of the economy. Some participants noted that adjustment of standard policy rules
for balance sheet policies would tend to push up the
federal funds rate prescription, while a number of
participants indicated that other factors related to
current circumstances may warrant maintaining an
accommodative stance of policy for longer than
would be prescribed by standard rules. With regard
to the latter, some participants suggested that inertial
policy rules—that is, rules under which any movements in the stance of policy tend to be fairly persistent—would be most appropriate in the current
context.

Developments in Financial Markets and
the Federal Reserve’s Balance Sheet
The Manager of the System Open Market Account
(SOMA) reported on developments in domestic and
foreign financial markets during the period since the
FOMC met on June 19–20, 2012. He also reported
on System open market operations, including the
ongoing reinvestment into agency-guaranteed
mortgage-backed securities (MBS) of principal payments received on SOMA holdings of agency debt
and agency-guaranteed MBS as well as the operations related to the continuation of the maturity
extension program authorized at the June 19–20,
2012, FOMC meeting. His report included a summary of analysis prepared by the staff on the potential implications of the size and composition of the
Federal Reserve’s securities portfolio for privatesector holdings of Treasury securities and agency
MBS and for trading conditions in markets related to
these securities. The Manager also reported on recent
developments in European money markets and impli-

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cations for the yields on the euro-denominated assets
that the Federal Reserve holds in its foreign exchange
reserves. By unanimous vote, the Committee ratified
the Desk’s domestic transactions over the intermeeting period. There were no intervention operations in
foreign currencies for the System’s account over the
intermeeting period.

Staff Review of the Economic Situation
The information reviewed at the July 31–August 1
meeting indicated that economic activity increased at
a slower pace in the second quarter than earlier in the
year and that labor market conditions had improved
little in recent months. In addition, revised data for
2009 through 2011 from the Bureau of Economic
Analysis indicated that the recession had been
slightly less deep and the early part of the subsequent
recovery had been a bit more gradual than previously
thought, leaving the level of real gross domestic product (GDP) at the end of last year essentially the same
as estimated earlier. In the second quarter, consumer
price inflation was markedly lower than in the first
quarter, mostly reflecting substantial declines in consumer energy prices, while measures of longer-run
inflation expectations remained stable.
Private nonfarm employment expanded in June at
about the same modest pace as in the second quarter
as a whole, and government employment decreased
slightly. The unemployment rate was 8.2 percent in
June, the same as its average during the first half of
the year. The rate of long-duration unemployment
stayed elevated, and the share of workers employed
part time for economic reasons was still high. Indicators of job openings and firms’ hiring plans were
generally subdued. While initial claims for unemployment insurance trended down a bit over the intermeeting period, they remained at a level consistent
with continued modest increases in employment in
the coming months.
Manufacturing production decelerated significantly
in the second quarter following a large gain in the
first quarter, while the rate of manufacturing capacity utilization was unchanged on balance. The production of motor vehicles and parts increased considerably last quarter, but factory output outside of
the motor vehicle sector was essentially flat. Automakers’ schedules indicated that the pace of motor
vehicle assemblies in the third quarter would be
about the same as in the second quarter. Broader
indicators of manufacturing output, such as the dif-

fusion indexes of new orders from the national and
regional manufacturing surveys, declined in recent
months and were at levels consistent with only muted
increases in production in the near term.
Real personal consumption expenditures increased at
a slower rate in the second quarter than in the first
quarter, primarily reflecting a decrease in spending
for motor vehicles. Meanwhile, real disposable personal income rose at a faster pace than consumer
spending in both the first and second quarters,
boosted in part in recent months by lower energy
prices. Consumer sentiment as measured by the
Thomson Reuters/University of Michigan Surveys of
Consumers (Michigan Survey) was more downbeat
in June and July than earlier in the year.
Conditions in the housing market generally improved
further in recent months, but activity remained at a
low level against the backdrop of the large inventory
of foreclosed and distressed properties and tight
underwriting standards for mortgage loans. Both
starts and permits of new single-family homes
increased in the second quarter. Starts of new multifamily units were about the same last quarter as in
the previous quarter, but permits rose, which pointed
to higher multifamily construction in the coming
months. Home prices increased in May for the fifth
consecutive month. Sales of new homes in the second
quarter were moderately higher than in the first quarter, but existing home sales decreased slightly.
Real business expenditures on equipment and software rose in the second quarter at a faster pace than
in the first quarter. However, new orders for nondefense capital goods excluding aircraft decreased last
quarter, and the backlog of unfilled orders decelerated sharply. Other recent forward-looking indicators, such as surveys of business conditions and capital spending plans, also suggested that increases in
outlays for business equipment would slow in coming
months. Real business spending for nonresidential
construction increased somewhat in the second quarter but remained at a relatively low level. Meanwhile,
business inventories generally appeared to be relatively well aligned with sales.
Real federal government purchases decreased a little
in the second quarter, following a much sharper
decline in the previous three quarters, as the continued contraction in defense spending eased. Real state
and local government purchases continued to contract at a moderate rate last quarter.

Minutes of Federal Open Market Committee Meetings | July–August

The U.S. international trade deficit narrowed in May,
as exports edged up and imports declined. The
increase in exports primarily reflected higher exports
of services and agricultural products. The decrease in
imports was the result of a decline in oil imports, as
both the price and the quantity of oil imports fell.
Imports of consumer goods and industrial supplies
also moved down, but imports of capital goods and
automotive products increased. Based on an estimate
of the trade data for June, the advance release of the
national income and product accounts showed that
real net exports of goods and services made a small
negative arithmetic contribution to the increase in
U.S. real GDP in the second quarter.
Overall U.S. consumer prices increased at a slower
pace in the second quarter than in the first. Consumer energy prices declined significantly last quarter, and survey data indicated that gasoline prices fell
somewhat further in the first few weeks of July.
Meanwhile, consumer food prices posted only a small
increase last quarter, but the recent sizable run-up in
spot and futures prices of farm commodities, reflecting the effects of the drought and hot weather in the
midwestern part of the United States, pointed to
some temporary upward pressures on retail food
prices later this year. Consumer prices excluding food
and energy increased more moderately in the second
quarter than in the first. Near-term inflation expectations from the Michigan Survey rose a little in June
and July, while longer-term inflation expectations in
the survey continued to be stable.
Available measures of labor compensation indicated
that nominal wage gains remained restrained. The
employment cost index rose at a modest pace again
in the second quarter. Average hourly earnings for all
employees also increased at a relatively slow rate last
quarter.
Foreign economic growth continued to be subdued,
as fiscal retrenchment and financial stresses in the
euro area continued to weigh on economic activity in
Europe and elsewhere. Recent indicators of production and confidence in the euro area remained weak,
and the preliminary second-quarter estimate of real
GDP in the United Kingdom showed a contraction.
Real GDP in China accelerated somewhat in the second quarter following a relatively weak expansion in
the first quarter, and recent monthly data suggested
some further improvement. However, data for other
emerging market economies generally pointed to a
deceleration in economic activity last quarter. Foreign inflation eased in the second quarter and

219

remains well contained, as earlier declines in the
prices of energy and other commodities passed
through to the retail level.

Staff Review of the Financial Situation
Several factors influenced developments in financial
markets since the time of the June FOMC meeting.
Generally weaker-than-expected economic data in the
United States, concerns about the fiscal and banking
situation in the euro area, and the outlook for global
economic growth weighed on investor sentiment.
However, the effects of these factors were offset to
some extent by actual and expected easing of monetary policy in the United States and abroad and by
better-than-anticipated profits at some S&P 500
firms.
Interest rates generally moved down, on net, over the
intermeeting period. The yield on nominal 10-year
Treasury securities declined to a historically low level,
partly due to a lower expected path of the federal
funds rate, the continuation of the maturity extension program announced at the June FOMC meeting, and perceptions of an increased likelihood that
the Federal Reserve will ease monetary policy further. In addition, persistent concerns about euro-area
developments were reportedly associated with
increased safe-haven demands that contributed to the
decline in Treasury yields. Anecdotal reports suggested that the decrease in shorter-term yields may
also have reflected somewhat increased expectations
that the Federal Reserve would reduce the interest
rate paid on reserve balances in coming months.
Near-term indicators of inflation expectations
derived from nominal and inflation-protected Treasury securities fell modestly despite an increase in
some commodity prices; such indicators changed
little at longer horizons. The expected path for the
federal funds rate derived from money market futures
quotes shifted down.
Conditions in short-term unsecured dollar funding
markets remained stable over the intermeeting
period, although most peripheral euro-area institutions continued to have little, if any, access to such
markets. In secured funding markets, Treasury general collateral repurchase agreement rates rose
slightly on balance.
Broad indexes of U.S. equity prices rose somewhat,
on net, over the intermeeting period, with significant
gains prompted in part by comments from European
officials that apparently raised investor expectations

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for near-term European policy actions. Optionimplied volatility on the S&P 500 index rose slightly.
Stock prices for the large domestic bank holding
companies posted mixed changes over the period,
and credit default swap (CDS) spreads for those
firms generally moved lower on net.
Yields on investment- and speculative-grade corporate bonds fell further over the intermeeting period,
approaching record lows. Their spreads relative to
comparable-maturity Treasury securities narrowed
but were still above their average levels prior to the
financial crisis. Nonfinancial firms continued to issue
debt at a strong pace over the period. Gross
investment-grade corporate bond issuance remained
robust in June and July, while the volume of nonfinancial commercial paper outstanding rose early in
the second quarter but decreased slightly in June.
Commercial and industrial (C&I) loans advanced
further over the intermeeting period. Issuance in the
syndicated leveraged loan market remained solid in
the second quarter; terms and structures of new leveraged loan deals reportedly loosened modestly on
the margin. Gross public equity issuance by nonfinancial firms was anemic in June and July.
Financial conditions in the commercial real estate
market remained somewhat strained against a backdrop of weak fundamentals and still-tight underwriting. That said, issuance of commercial mortgagebacked securities picked up in the second quarter.
Despite new historical lows for residential mortgage
rates over the intermeeting period, refinancing activity remained relatively muted. Evidence from the
Senior Loan Officer Opinion Survey on Bank Lending Practices (SLOOS) conducted in July indicated
that mortgage underwriting standards at banks generally have not eased much from their tightest postcrisis levels. Consumer credit expanded further in
May as a result of rapid increases in student loans
and, to a lesser extent, auto loans. Delinquency rates
for consumer credit remained low, likely in part
because of a compositional shift of credit supply
over the past few years toward the least-risky
borrowers.
Gross issuance of long-term municipal bonds was
robust in June and July. Net issuance of long-term
bonds turned positive in the second quarter after
staying in negative territory for much of the past
year. Yields on long-term general obligation municipal bonds generally followed Treasury yields lower,

while default rates remained very low and CDS
spreads for states were roughly unchanged on net.
Bank credit and total loans continued to expand
modestly in the second quarter, largely because of the
further robust increase in C&I loans. The gradual
expansion in total loans was broadly consistent with
the July SLOOS, in which domestic banks generally
indicated that demand strengthened for many types
of loans in the second quarter and that lending standards eased somewhat, on balance, across most
major loan categories.
The staff’s broad nominal index for the foreign
exchange value of the dollar changed little, on net,
over the intermeeting period, although the dollar
appreciated against the euro. Financial markets in the
euro area were volatile, as a deterioration in market
sentiment gave way to periods of optimism following
the euro-area summit in late June, the decision by the
European Central Bank (ECB) to ease policy in early
July, and indications from the ECB later in July that
the central bank might take further steps to support
the monetary union. On net, European stock markets
finished the period higher. Yield spreads on Spanish
and Italian 10-year bonds over their German equivalents, which rose sharply over most of July, fell back
from their intermeeting peaks but remained elevated.
Several foreign central banks eased monetary policy
over the intermeeting period. The ECB cut its benchmark policy rate by 25 basis points and reduced the
rate on its overnight deposit facility to zero. The
Bank of England increased the size of its asset purchase program and announced details on its new program designed to boost bank lending to the nonfinancial sector. The central banks of Brazil, China,
and South Korea all reduced official rates as well.
Amid policy easing in the euro area and United
Kingdom, yields on German and U.K. sovereign
bonds declined, with two-year German sovereign
bonds trading at yields below zero.

Staff Economic Outlook
In the economic forecast prepared by the staff for the
July 31–August 1 FOMC meeting, the near-term projection for real GDP growth was revised down somewhat. The revision primarily reflected a slower pace
of consumer spending than the staff expected at the
time of the previous projection, along with a deterioration in some forward-looking indicators. However,
the staff’s medium-term forecast for real GDP

Minutes of Federal Open Market Committee Meetings | July–August

growth was little changed, as the slightly weaker
underlying pace of economic activity suggested by
the recent data was roughly offset by the anticipated
effects of the continuation of the maturity extension
program announced following the June FOMC meeting, which had not been incorporated in the previous
projection. With the restraint from fiscal policy
assumed to increase next year, the staff projected that
increases in real GDP would not significantly exceed
the growth rate of potential output in 2013. Thereafter, economic activity was expected to accelerate
gradually, supported by an eventual easing in fiscal
policy restraint, gains in consumer and business sentiment, further improvements in credit conditions,
and continued accommodative monetary policy. The
expansion in economic activity was anticipated to
reduce the substantial margin of slack in labor and
product markets only slowly over the projection
period, and the unemployment rate was expected to
remain elevated at the end of 2014.
The staff’s forecast for inflation was little changed
from the projection prepared for the June FOMC
meeting. With crude oil prices expected to decline a
bit from their current levels, the boost to retail food
prices from the current drought in the Midwest
anticipated to be only temporary and relatively small,
longer-run inflation expectations remaining stable,
and substantial resource slack persisting over the
forecast period, the staff continued to project that
inflation would be subdued through 2014.

Participants’ Views on Current Conditions
and the Economic Outlook
In their discussion of the economic situation and the
outlook, meeting participants agreed that the information received since the Committee met in June
suggested that economic activity had decelerated in
recent months to a slower pace than they had anticipated. Although business investment had continued
to advance, consumer spending had slowed considerably since earlier in the year. Conditions in the housing sector appeared to have improved somewhat, but
from a very low level. Indicators of manufacturing
activity had softened. Recent monthly gains in payroll employment had continued to be small, and the
unemployment rate in June remained at an elevated
level. Consumer price inflation had been low in
recent months, as declines in the costs of crude oil
were passed through to retail energy prices. Longerterm inflation expectations had remained stable.

221

Regarding the economic outlook, most participants
agreed that economic growth was likely to remain
moderate over coming quarters and then pick up
gradually. However, some participants indicated that
they had lowered their near-term forecasts for economic growth in light of the weaker-than-expected
increases in consumer spending and employment in
recent months. In addition, some participants
expressed concern about the persistent headwinds
restraining the pace of the recovery, including the
weak housing sector, still-tight borrowing conditions
for some households and firms, and fiscal restraint at
all levels of government. Many participants judged
that a high level of uncertainty about possible spillovers from the fiscal and banking strains in the euro
area and about the outlook for U.S. fiscal or regulatory policies was holding back household and business spending. And they saw the possibilities of an
intensification of strains in the euro area and of a
sharper-than-anticipated U.S. fiscal consolidation as
significant downside risks to the economic outlook.
Although participants generally agreed that improvements in recent years in the capital and liquidity of
financial institutions and in the strength of household and business balance sheets have increased the
resilience of the economy, some were concerned that
at its current pace, the recovery was still vulnerable to
adverse shocks. Given participants’ forecasts of economic activity, they generally anticipated that the
unemployment rate would decline only slowly toward
levels that participants judge to be consistent with the
Committee’s mandate. Participants’ assessments of
the outlook for inflation were largely unchanged
from those reported in June. Smoothing through the
effects of fluctuations in food and energy prices, participants anticipated that inflation over the medium
term would remain at or below the Committee’s
2 percent longer-run objective.
Meeting participants again exchanged views on the
extent of slack in labor and product markets. A number of participants expressed the view that structural
changes in the labor market were not sufficient to
explain the high level of unemployment. Those participants saw substantial slack in resource utilization
and hence continued to judge that inflation was likely
to remain subdued over the medium term as the
economy continued to recover. However, several
other participants interpreted the moderate pace of
the recovery as pointing to a more substantial markdown in the trajectory of potential output. In particular, a couple of participants noted that they

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would have expected inflation to have fallen more in
recent years if the output gap had been as substantial
as some measures suggested. One participant posited
that the sharp decline in net worth and reduced credit
availability in recent years not only weighed on
aggregate demand, but also reduced aggregate supply
by hampering new business formation and product
innovation; another participant cited evidence that
structural unemployment was elevated as a result of
mismatches between the skills demanded by employers and those of the long-duration unemployed.
In discussing developments in the household sector,
many participants noted the recent deceleration in
overall consumer spending, although a couple cited
new autos and tourism as areas of relative strength.
Participants saw several factors as likely contributing
to slower consumer spending, including the weakness
in earned income and a high level of uncertainty
among households about the economic outlook. Several pointed out that while households had made
considerable progress in reducing their debt and
rebuilding their savings, the deleveraging process was
still ongoing, the level of housing debt remained
high, and a significant number of mortgage borrowers continued to be underwater on their loans. Home
sales and construction were generally viewed as
gradually improving, supported in part by historically low mortgage interest rates. Many participants
reported that house prices in their Districts were rising or had bottomed out, and several noted that their
contacts saw signs of progress in reducing the overhang of unsold properties. However, it was noted
that the reduction in inventories should be viewed
cautiously because owners who are underwater on
their mortgages may be withholding their homes
from the market, implying a substantial “shadow”
inventory.
Regarding the business sector, many participants
reported that, with the exception of motor vehicle
production, manufacturing activity in their Districts
was slow or had declined in recent months. Nonetheless, forward-looking surveys of orders and manufacturing production in a couple of Districts were more
positive. Energy-related activity continued to expand,
and investment projects in that sector were reported
to be moving forward. However, contacts in several
Districts indicated that export demand had weakened
as a result of the slowdown in economic activity in
Europe; Asia; and some emerging market countries,
including China. More generally, some participants
reported that their business contacts regarded the
economic outlook to be highly uncertain, in part due

to unresolved fiscal and regulatory matters. Although
several participants noted that the uncertainty had
not led businesses in their Districts to reduce payrolls
or cut back spending, others cited reports of shortfalls from business plans that could lead to costcutting, of restructuring to position firms for leaner
operations, or even of postponed investment and hiring. Two participants provided an update on the situation in the agricultural sector in light of the drought
in the Midwest: With crop yields projected to be
down markedly and prices rising, livestock producers
appeared likely to suffer losses as a result of higher
input costs while crop producers would need to rely
on higher prices and crop insurance to stabilize their
income.
The incoming information on inflation over the intermeeting period was largely in line with participants’
expectations. Consumer prices had decelerated as a
result of the pass-through of lower crude oil costs to
retail prices of gasoline and fuel oil. Crude oil prices
had turned up again more recently, but one participant noted that global inventories of oil were
elevated and, with world demand easing, prices
should be restrained going forward. Participants
acknowledged that the drought would likely result in
a temporary run-up in consumer food prices later
this year. Nonetheless, inflation was expected to
remain subdued, on balance, over coming quarters.
In explaining that outlook, participants cited the lack
of upward pressure from labor costs and prices of
imported commodities as well as the stability of
inflation expectations. A couple of participants
referred to information from business contacts suggesting that inflation was unlikely to decline further,
and a few expressed concerns that maintaining a
highly accommodative stance of monetary policy for
an extended period could erode the stability of inflation expectations over time and hence posed upside
risks to the inflation outlook.
Financial markets remained sensitive to ongoing
developments related to the sovereign debt and banking situation in the euro area, and participants continued to view the possibility of an intensification of
strains in global financial markets as a significant
downside risk to the domestic economic outlook.
Several participants indicated that recent trends in
euro-area equity indexes and sovereign debt yields
had not been encouraging, and some noted that the
uncertainty prevailing in global financial markets was
showing through in a cautious posture of investors.
Nonetheless, participants generally agreed that conditions in domestic credit markets remained more

Minutes of Federal Open Market Committee Meetings | July–August

favorable than they were a year ago. One participant
pointed out that credit risk spreads—while still above
pre-recession norms—may have been boosted by
safe-haven demands for Treasury securities and indicated that broader financial market conditions
seemed reasonably accommodative. Banks were
reported to be seeing an increase in their residential
mortgage business along with a continued rise in C&I
lending, especially to large firms; consumer credit
was also increasing.
Participants discussed a number of policy tools that
the Committee might employ if it decided to provide
additional monetary accommodation to support a
stronger economic recovery in a context of price stability. One of the policy options discussed was an
extension of the period over which the Committee
expected to maintain its target range for the federal
funds rate at 0 to ¼ percent. It was noted that such
an extension might be particularly effective if done in
conjunction with a statement indicating that a highly
accommodative stance of monetary policy was likely
to be maintained even as the recovery progressed.
Given the uncertainty attending the economic outlook, a few participants questioned whether the conditionality of the forward guidance was sufficiently
clear, and they suggested that the Committee should
consider replacing the calendar date with guidance
that was linked more directly to the economic factors
that the Committee would consider in deciding to
raise its target for the federal funds rate, or omit the
forward guidance language entirely.
Participants also exchanged views on the likely benefits and costs of a new large-scale asset purchase
program. Many participants expected that such a
program could provide additional support for the
economic recovery both by putting downward pressure on longer-term interest rates and by contributing
to easier financial conditions more broadly. In addition, some participants noted that a new program
might boost business and consumer confidence and
reinforce the Committee’s commitment to making
sustained progress toward its mandated objectives.
Participants also discussed the merits of purchases of
Treasury securities relative to agency MBS. However,
others questioned the possible efficacy of such a program under present circumstances, and a couple suggested that the effects on economic activity might be
transitory. In reviewing the costs that such a program
might entail, some participants expressed concerns
about the effects of additional asset purchases on
trading conditions in markets related to Treasury
securities and agency MBS, but others agreed with

223

the staff’s analysis showing substantial capacity for
additional purchases without disrupting market functioning. Several worried that additional purchases
might alter the process of normalizing the Federal
Reserve’s balance sheet when the time came to begin
removing accommodation. A few participants were
concerned that an extended period of accommodation or an additional large-scale asset purchase program could increase the risks to financial stability or
lead to a rise in longer-term inflation expectations.
Many participants indicated that any new purchase
program should be sufficiently flexible to allow
adjustments, as needed, in response to economic
developments or to changes in the Committee’s
assessment of the efficacy and costs of the program.
Some participants commented on other possible
tools for adding policy accommodation, including a
reduction in the interest rate paid on required and
excess reserve balances. While a couple of participants favored such a reduction, several others raised
concerns about possible adverse effects on money
markets. It was noted that the ECB’s recent cut in its
deposit rate to zero provided an opportunity to learn
more about the possible consequences for market
functioning of such a move. In light of the Bank of
England’s Funding for Lending Scheme, a couple of
participants expressed interest in exploring possible
programs aimed at encouraging bank lending to
households and firms, although the importance of
institutional differences between the two countries
was noted.

Committee Policy Action
The information received over the intermeeting
period indicated that economic activity had decelerated in recent months, with a notable slowing in consumer spending. Employment gains continued to be
modest, and the unemployment rate was unchanged
at a level that almost all members saw as elevated
relative to levels consistent with the Committee’s
mandate. Inflation had declined from its rate earlier
in the year, mainly reflecting lower prices of crude oil
and gasoline, and inflation expectations had been
stable. Members generally expected that economic
growth would be moderate over coming quarters and
then would pick up very gradually. While most members did not view the medium-run economic outlook
as having changed significantly since the June meeting, several noted that they had lowered their expectations for economic growth over coming quarters.
Furthermore, members generally attached an unusually high level of uncertainty to their assessments of

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the economic outlook and continued to judge that
the risks to economic growth were tilted to the downside because of strains in financial markets stemming
from the sovereign debt and banking situation in
Europe as well as the potential for a significant slowdown in global economic growth and for a sharperthan-anticipated fiscal contraction in the United
States. A number of members noted that if the recent
modest rate of economic growth were to persist, the
economy would be less able to weather a material
adverse shock without slipping back into recession.
Most members continued to anticipate that, with
longer-term inflation expectations stable and the
existing slack in resource utilization being taken up
very gradually, inflation would run over the medium
term at a rate at or below the Committee’s objective
of 2 percent. In contrast, one member thought that
the economy may be operating near its current
potential and, thus, that maintaining the Committee’s current highly accommodative policy stance well
into 2014 would pose upside risks to the inflation
outlook.
The Committee had provided additional accommodation at its previous meeting by announcing the
continuation of the maturity extension program
through the end of the year, and more time was seen
as necessary to evaluate the effects of that decision.
Nonetheless, many members expected that at the end
of 2014, the unemployment rate would still be well
above their estimates of its longer-term normal rate
and that inflation would be at or below the Committee’s longer-run objective of 2 percent. A number of
them indicated that additional accommodation could
help foster a more rapid improvement in labor market conditions in an environment in which price pressures were likely to be subdued. Many members
judged that additional monetary accommodation
would likely be warranted fairly soon unless incoming information pointed to a substantial and sustainable strengthening in the pace of the economic recovery. Several members noted the benefits of accumulating further information that could help clarify the
contours of the outlook for economic activity and
inflation as well as the need for further policy action.
One member judged that additional accommodation
would likely not be effective in improving the economic outlook and viewed the potential costs associated with such action as unacceptably high. At the
conclusion of the discussion, members agreed that
they would closely monitor economic and financial
developments and carefully weigh the potential benefits and costs of various tools in assessing whether
additional policy action would be warranted.

With respect to the statement to be released following
the meeting, members agreed that it should acknowledge the deceleration in economic activity, the small
gains in employment, and the slowing in inflation
reflected in the economic data over the intermeeting
period. Because most saw no significant changes in
the medium-run outlook, they agreed to continue to
indicate that the Committee anticipates a very
gradual pickup in economic activity over time and a
slow decline in unemployment, with inflation at or
below the rate that it judges most consistent with its
dual mandate. Many members expressed support for
extending the Committee’s forward guidance, but
they agreed to defer a decision on this matter until
the September meeting in order to consider such an
adjustment in the context of updates to participants’
individual economic projections and the Committee’s
further consideration of its policy options. The statement also reiterated the Committee’s intention to
extend the average maturity of its securities holdings
as announced in June. Consistent with the concerns
expressed by many members about the slow pace of
the economic recovery, the downside risks to economic growth, and the considerable slack in resource
utilization, the Committee decided that the statement
should conclude by indicating that it will provide
additional accommodation as needed to promote a
stronger economic recovery and sustained improvement in labor market conditions in a context of price
stability.
At the conclusion of the discussion, the Committee
voted to authorize and direct the Federal Reserve
Bank of New York, until it was instructed otherwise,
to execute transactions in the System Account in
accordance with the following domestic policy
directive:
“The Federal Open Market Committee seeks
monetary and financial conditions that will foster price stability and promote sustainable
growth in output. To further its long-run objectives, the Committee seeks conditions in reserve
markets consistent with federal funds trading in
a range from 0 to ¼ percent. The Committee
directs the Desk to continue the maturity extension program it announced in June to purchase
Treasury securities with remaining maturities of
6 years to 30 years with a total face value of
about $267 billion by the end of December 2012, and to sell or redeem Treasury securities with remaining maturities of approximately
3 years or less with a total face value of about
$267 billion. For the duration of this program,

Minutes of Federal Open Market Committee Meetings | July–August

the Committee directs the Desk to suspend its
current policy of rolling over maturing Treasury
securities into new issues. The Committee directs
the Desk to maintain its existing policy of reinvesting principal payments on all agency debt
and agency mortgage-backed securities in the
System Open Market Account in agency
mortgage-backed securities. These actions
should maintain the total face value of domestic
securities at approximately $2.6 trillion. The
Committee directs the Desk to engage in dollar
roll transactions as necessary to facilitate settlement of the Federal Reserve’s agency MBS
transactions. The System Open Market Account
Manager and the Secretary will keep the Committee informed of ongoing developments
regarding the System’s balance sheet that could
affect the attainment over time of the Committee’s objectives of maximum employment and
price stability.”
The vote encompassed approval of the statement
below to be released at 2:15 p.m.:
“Information received since the Federal Open
Market Committee met in June suggests that
economic activity decelerated somewhat over the
first half of this year. Growth in employment
has been slow in recent months, and the unemployment rate remains elevated. Business fixed
investment has continued to advance. Household spending has been rising at a somewhat
slower pace than earlier in the year. Despite
some further signs of improvement, the housing
sector remains depressed. Inflation has declined
since earlier this year, mainly reflecting lower
prices of crude oil and gasoline, and longer-term
inflation expectations have remained stable.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment
and price stability. The Committee expects economic growth to remain moderate over coming
quarters and then to pick up very gradually.
Consequently, the Committee anticipates that
the unemployment rate will decline only slowly
toward levels that it judges to be consistent with
its dual mandate. Furthermore, strains in global
financial markets continue to pose significant
downside risks to the economic outlook. The
Committee anticipates that inflation over the
medium term will run at or below the rate that it
judges most consistent with its dual mandate.

225

To support a stronger economic recovery and to
help ensure that inflation, over time, is at the
rate most consistent with its dual mandate, the
Committee expects to maintain a highly accommodative stance for monetary policy. In particular, the Committee decided today to keep the
target range for the federal funds rate at 0 to
¼ percent and currently anticipates that economic conditions—including low rates of
resource utilization and a subdued outlook for
inflation over the medium run—are likely to
warrant exceptionally low levels for the federal
funds rate at least through late 2014.
The Committee also decided to continue
through the end of the year its program to
extend the average maturity of its holdings of
securities as announced in June, and it is maintaining its existing policy of reinvesting principal
payments from its holdings of agency debt and
agency mortgage-backed securities in agency
mortgage-backed securities. The Committee will
closely monitor incoming information on economic and financial developments and will provide additional accommodation as needed to
promote a stronger economic recovery and sustained improvement in labor market conditions
in a context of price stability.”
Voting for this action: Ben Bernanke, William C.
Dudley, Elizabeth Duke, Dennis P. Lockhart, Sandra
Pianalto, Jerome H. Powell, Sarah Bloom Raskin,
Jeremy C. Stein, Daniel K. Tarullo, John C. Williams,
and Janet L. Yellen.
Voting against this action: Jeffrey M. Lacker.
Mr. Lacker dissented because he did not believe that
exceptionally low levels for the federal funds rate were
likely to be warranted for the length of time specified
in the Committee’s statement. In his view, significant
uncertainty regarding the evolution of economic conditions over the next few years made the future path
of interest rates difficult to forecast, and the Committee’s statement implied more confidence on this
score than justified by the current outlook.

Consensus Forecast Experiment
In light of the discussion at the previous FOMC
meeting, the subcommittee on communications
developed an initial experimental exercise intended to
shed light on the feasibility and desirability of con-

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99th Annual Report | 2012

structing an FOMC consensus forecast. At this meeting, participants discussed various aspects of the
exercise, such as the possible monetary policy
assumptions on which to condition an FOMC consensus forecast, the measurement of the degree of
uncertainty surrounding each of the projected variables in the forecast, and the potential for communications benefits. In conclusion, participants generally
expressed support for a second exercise to be undertaken in conjunction with the September FOMC
meeting.
It was agreed that the next meeting of the Committee
would be held on Wednesday–Thursday, Septem-

ber 12–13, 2012. The meeting adjourned at 2:15 p.m.
on August 1, 2012.

Notation Vote
By notation vote completed on July 10, 2012, the
Committee unanimously approved the minutes of the
FOMC meeting held on June 19–20, 2012.
William B. English
Secretary

Minutes of Federal Open Market Committee Meetings | September

Meeting Held
on September 12–13, 2012
A meeting of the Federal Open Market Committee
was held in the offices of the Board of Governors of
the Federal Reserve System in Washington, D.C., on
Wednesday, September 12, 2012, at 10:30 a.m. and
continued on Thursday, September 13, 2012, at
8:30 a.m.

Present
Ben Bernanke
Chairman
William C. Dudley
Vice Chairman
Elizabeth Duke
Jeffrey M. Lacker
Dennis P. Lockhart
Sandra Pianalto
Jerome H. Powell
Sarah Bloom Raskin
Jeremy C. Stein
Daniel K. Tarullo
John C. Williams
Janet L. Yellen
James Bullard, Christine Cumming, Charles L. Evans,
Esther L. George, and Eric Rosengren
Alternate Members of the Federal Open Market
Committee
Richard W. Fisher, Narayana Kocherlakota, and
Charles I. Plosser
Presidents of the Federal Reserve Banks of Dallas,
Minneapolis, and Philadelphia, respectively
William B. English
Secretary and Economist
Deborah J. Danker
Deputy Secretary
Matthew M. Luecke
Assistant Secretary
David W. Skidmore
Assistant Secretary
Michelle A. Smith
Assistant Secretary

227

Scott G. Alvarez
General Counsel
Thomas C. Baxter
Deputy General Counsel
Steven B. Kamin
Economist
David W. Wilcox
Economist
David Altig, Thomas A. Connors, Michael P. Leahy,
William Nelson, David Reifschneider,
Glenn D. Rudebusch, William Wascher, and
John A. Weinberg
Associate Economists
Simon Potter
Manager, System Open Market Account
Nellie Liang
Director, Office of Financial Stability Policy and
Research, Board of Governors
Jon W. Faust
Special Adviser to the Board, Office of Board
Members, Board of Governors
James A. Clouse
Deputy Director, Division of Monetary Affairs,
Board of Governors
Maryann F. Hunter
Deputy Director, Division of Banking Supervision
and Regulation, Board of Governors
Andreas Lehnert1
Deputy Director, Office of Financial Stability Policy
and Research, Board of Governors
Linda Robertson
Assistant to the Board, Office of Board Members,
Board of Governors
Seth B. Carpenter
Senior Associate Director, Division of Monetary
Affairs, Board of Governors
Thomas Laubach
Senior Adviser, Division of Research and Statistics,
Board of Governors
Ellen E. Meade and Joyce K. Zickler
Senior Advisers, Division of Monetary Affairs,
Board of Governors

1

Attended Wednesday’s session only.

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99th Annual Report | 2012

Brian J. Gross2
Special Assistant to the Board, Office of
Board Members, Board of Governors

Kelly J. Dubbert
First Vice President, Federal Reserve Bank of
Kansas City

purchases. While significant uncertainty surrounds
such estimates, the presentation indicated that asset
purchases could be effective in fostering more rapid
progress toward the Committee’s objectives. The staff
noted that, for a flow-based program, the public’s
understanding of the conditions under which the
Committee would end purchases would shape expectations of the magnitude of the Federal Reserve’s
holdings of longer-term securities, and thus also
influence the financial and economic effects of such a
program. The staff also discussed the potential implications of additional asset purchases for the evolution of the Federal Reserve’s balance sheet and
income. The presentation noted that significant additional asset purchases should not adversely affect the
ability of the Committee to tighten the stance of
policy when doing so becomes appropriate. In their
discussion of the staff presentation, a few participants noted the uncertainty surrounding estimates of
the effects of large-scale asset purchases or the need
for additional work regarding the implications of
such purchases for the normalization of policy.

Loretta J. Mester, Harvey Rosenblum, and
Daniel G. Sullivan
Executive Vice Presidents, Federal Reserve Banks of
Philadelphia, Dallas, and Chicago, respectively

Developments in Financial Markets and
the Federal Reserve’s Balance Sheet

Eric M. Engen, Michael G. Palumbo, and
Wayne Passmore
Associate Directors, Division of Research and
Statistics, Board of Governors
Fabio M. Natalucci
Deputy Associate Director, Division of Monetary
Affairs, Board of Governors
Edward Nelson
Section Chief, Division of Monetary Affairs,
Board of Governors
Jeremy B. Rudd
Senior Economist, Division of Research and
Statistics, Board of Governors

Cletus C. Coughlin, Troy Davig,
Mark E. Schweitzer, and Kei-Mu Yi
Senior Vice Presidents, Federal Reserve Banks of
St. Louis, Kansas City, Cleveland, and Minneapolis,
respectively
Lorie K. Logan, Jonathan P. McCarthy,
Giovanni Olivei, and Nathaniel Wuerffel3
Vice Presidents, Federal Reserve Banks of New York,
New York, Boston, and New York, respectively
Michelle Ezer4
Markets Officer, Federal Reserve Bank of New York

Potential Effects of a Large-Scale Asset
Purchase Program
The staff presented an analysis of various aspects of
possible large-scale asset purchase programs, including a comparison of flow-based purchase programs
to programs of fixed size. The presentation reviewed
the modeling approach used by the staff in estimating the financial and macroeconomic effects of such
2
3

4

Attended Thursday’s session only.
Attended after the discussion on potential effects of a largescale asset purchase program.
Attended the discussion on potential effects of a large-scale
asset purchase program.

The Manager of the System Open Market Account
(SOMA) reported on developments in domestic and
foreign financial markets during the period since the
Federal Open Market Committee (FOMC) met on
July 31–August 1, 2012. He also reported on System
open market operations, including the ongoing reinvestment into agency-guaranteed mortgage-backed
securities (MBS) of principal payments received on
SOMA holdings of agency debt and agencyguaranteed MBS as well as the operations related to
the maturity extension program authorized at the
June 19–20, 2012, FOMC meeting. By unanimous
vote, the Committee ratified the Desk’s domestic
transactions over the intermeeting period. There were
no intervention operations in foreign currencies for
the System’s account over the intermeeting period.

Staff Review of the Economic Situation
The information reviewed at the September 12–13
meeting suggested that economic activity continued
to increase at a moderate pace in recent months.
Employment rose slowly, and the unemployment rate
was still high. Consumer price inflation stayed subdued, while measures of long-run inflation expectations remained stable.

Minutes of Federal Open Market Committee Meetings | September

Private nonfarm employment increased in July and
August at only a slightly faster pace than in the second quarter, and the rate of decline in government
employment eased somewhat. The unemployment
rate was 8.1 percent in August, just a bit lower than
its average during the first half of the year, and the
labor force participation rate edged down further.
The share of workers employed part time for economic reasons remained large, and the rate of longduration unemployment continued to be high. Indicators of job openings and firms’ hiring plans were
little changed, on balance, and initial claims for
unemployment insurance were essentially flat over
the intermeeting period.
Manufacturing production increased at a faster pace
in July than in the second quarter, and the rate of
manufacturing capacity utilization rose slightly.
However, automakers’ schedules indicated that the
pace of motor vehicle assemblies would be somewhat
lower in the coming months than it was in July, and
broader indicators of manufacturing activity, such as
the diffusion indexes of new orders from the national
and regional manufacturing surveys, generally
remained quite muted in recent months at levels consistent with only meager gains in factory output in
the near term.

229

month in July, and sales of both new and existing
homes also rose.
Real business expenditures on equipment and software appeared to be decelerating. Both nominal shipments and new orders for nondefense capital goods
excluding aircraft declined in July, and the backlog of
unfilled orders decreased. Other forward-looking
indicators, such as downbeat readings from surveys
of business conditions and capital spending plans,
also pointed toward only muted increases in real
expenditures for business equipment in the near term.
Nominal business spending for new nonresidential
construction declined in July after only edging up in
the second quarter. Inventories in most industries
looked to be roughly aligned with sales in recent
months.
Real federal government purchases appeared to
decrease further, as data for nominal federal spending
in July pointed to continued declines in real defense
expenditures. Real state and local government purchases also appeared to still be trending down. State
and local government payrolls contracted in July and
August, although at a somewhat slower rate than in
the second quarter, and nominal construction spending by these governments decreased slightly in July.

Following a couple of months when real personal
consumption expenditures (PCE) were roughly flat,
spending increased in July, and the gains were fairly
widespread across categories of consumer goods and
services. Incoming data on factors that tend to support household spending were somewhat mixed. Real
disposable incomes increased solidly in July, boosted
in part by lower energy prices. The continued rise in
house values through July, and the increase in equity
prices during the intermeeting period, suggested that
households’ net worth may have improved a little in
recent months. However, consumer sentiment
remained more downbeat in August than earlier in
the year.

The U.S. international trade deficit was about
unchanged in July after narrowing significantly in
June. Exports declined in July, as decreases in the
exports of industrial supplies, automotive products,
and consumer goods were only partially offset by
greater exports of agricultural products. Imports also
declined in July, reflecting lower imports of capital
goods and petroleum products and somewhat higher
imports of automotive products. The trade data for
July pointed toward real net exports having a roughly
neutral effect on the growth of U.S. real gross domestic product (GDP) in the third quarter after they
made a positive contribution to the increase in real
GDP in the second quarter.

Housing market conditions continued to improve,
but construction activity was still at a low level,
reflecting the restraint imposed by the substantial
inventory of foreclosed and distressed properties and
by tight credit standards for mortgage loans. Starts of
new single-family homes declined in July, but permits
increased, which pointed to further gains in singlefamily construction in the coming months. Both
starts and permits for new multifamily units rose in
July. Home prices increased for the sixth consecutive

Overall U.S. consumer prices, as measured by the
PCE price index, were flat in July. Consumer food
prices were essentially unchanged, but the substantial
increases in spot and futures prices of farm commodities in recent months, reflecting the effects of
the drought in the Midwest, pointed toward some
temporary upward pressures on retail food prices
later this year. Consumer energy prices declined
slightly in July, but survey data indicated that retail
gasoline prices rose in August. Consumer prices

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99th Annual Report | 2012

excluding food and energy also were flat in July.
Near-term inflation expectations from the Thomson
Reuters/University of Michigan Surveys of Consumers increased somewhat in August, while longer-term
inflation expectations in the survey edged up but
remained within the narrow range that they have
occupied for many years. Long-run inflation expectations from the Federal Reserve Bank of Philadelphia
Survey of Professional Forecasters continued to be
stable in the third quarter.
Measures of labor compensation indicated that
increases in nominal wages remained modest. The
rise in compensation per hour in the nonfarm business sector was muted over the year ending in the second quarter, and with small gains in productivity, unit labor costs rose only slightly. The employment cost index increased a little more slowly than
the measure of compensation per hour over the same
period. More recently, the gains in average hourly
earnings for all employees in July and August were
small.
Overall foreign economic growth appeared to be subdued in the third quarter after slowing in the second
quarter. In the euro area, policy developments contributed to an improvement in financial conditions;
recent indicators pointed to further decreases in production, however, and both business and consumer
confidence continued to decline. Indicators of activity in the emerging market economies generally weakened. In China, export growth slowed, while retail
sales and investment spending changed little. The rate
of economic growth rose in Brazil but was still sluggish, and increases in economic activity in Mexico
were below the faster pace seen earlier in the year.
Consistent with the slowing in foreign economic
growth, readings on foreign inflation continued to
moderate.

factored in some probability that the anticipated liftoff date for the federal funds rate in the forwardguidance language would be moved back at that
meeting. Treasury yields subsequently rose further as
concerns about the situation in the euro area moderated. Later in the period, Treasury yields retraced
some of their earlier gains as market participants’
expectations of additional policy action increased following the release of the minutes of the August
FOMC meeting, the Chairman’s speech at the economic symposium in Jackson Hole, and the weakerthan-expected August employment report. On net,
the expected path of the federal funds rate derived
from overnight index swap rates was little changed.
Indicators of inflation expectations derived from
nominal and inflation-protected Treasury securities
edged up over the period but stayed in the ranges
observed over recent quarters.
Conditions in unsecured short-term dollar funding
markets remained stable over the intermeeting
period. In secured funding markets, conditions were
also little changed.
In the September Senior Credit Officer Opinion Survey on Dealer Financing Terms, respondents
reported no significant changes in credit terms for
important classes of counterparties over the past
three months, although a few noted a slight easing in
terms for some clients. The use of leverage by hedge
funds was reported to have remained basically
unchanged. However, respondents noted greater
demand for funding of agency and non-agency residential MBS.

Sentiment in financial markets improved somewhat
since the time of the August FOMC meeting. Investors’ concerns about the situation in Europe seemed
to ease somewhat, and market participants also
appeared to have increased their expectations of
additional monetary policy accommodation.

Broad price indexes for U.S. equities rose moderately,
on net, over the intermeeting period, prompted by
generally better-than-expected readings on economic
activity released early in the period, somewhat
reduced concerns about the situation in Europe, and
some additional anticipation of monetary policy easing later in the period. Option-implied volatility on
the S&P 500 index fell in early August to levels not
seen since the middle of 2007; it subsequently partially retraced. Equity prices for large domestic banks
rose about in line with the broad equity price indexes,
and credit default swap (CDS) spreads for the largest
bank holding companies continued to move down.

On balance, the nominal Treasury yield curve steepened over the intermeeting period, with yields on
longer-dated Treasury securities rising notably. Following the August FOMC statement, Treasury yields
moved up, reportedly in part because investors had

Yields on investment-grade corporate bonds were
little changed at near-record low levels over the intermeeting period, while yields on speculative-grade corporate bonds edged down. The spread of yields on
corporate bonds over those on comparable-maturity

Staff Review of the Financial Situation

Minutes of Federal Open Market Committee Meetings | September

Treasury securities narrowed. Net debt issuance by
nonfinancial firms continued to be strong over the
period. Investment- and speculative-grade bond issuance increased in August from an already robust pace
in preceding months, and commercial and industrial
(C&I) loans rose further. In the syndicated leveraged
loan market, gross issuance of institutional loans
continued to be solid in July and August. Issuance of
collateralized loan obligations remained on pace to
post its strongest year since 2007. The rate of gross
public equity issuance by nonfinancial firms
increased slightly in August but was still at a subdued
level.
Financial conditions in the commercial real estate
(CRE) market were still somewhat strained against a
backdrop of weak fundamentals and tight underwriting standards. Nevertheless, issuance of commercial
mortgage-backed securities continued at a solid pace
over the intermeeting period.
Mortgage rates remained at very low levels over the
intermeeting period. Refinancing activity increased
but was still restrained by tight underwriting conditions, capacity constraints at mortgage originators,
and low levels of home equity. Nonrevolving consumer credit continued to expand briskly in June,
largely due to robust growth in student loans originated by the federal government, while revolving
credit remained subdued. Delinquency rates for consumer credit were still low, mostly reflecting a shift in
lending toward higher-credit-quality borrowers.
Gross issuance of long-term municipal bonds picked
up in August from the subdued pace in July, but net
issuance continued to decline. CDS spreads for debt
issued by state governments moved lower over the
intermeeting period, and the ratio of yields on longterm general obligation municipal bonds to yields on
comparable-maturity Treasury securities decreased,
on balance.
Bank credit continued to expand at a moderate pace
over the intermeeting period, as growth in C&I loans
remained brisk while CRE and home equity loans
both trended down further. The August Survey of
Terms of Business Lending indicated that overall
interest-rate spreads on C&I loans were little
changed; spreads on loans drawn on recently established commitments narrowed materially, although
they remained wide.
M2 growth was rapid in July, likely reflecting investors’ heightened demand for safe and liquid assets

231

amid concerns about the situation in Europe, but it
slowed to a moderate pace in August as those concerns eased somewhat. The monetary base rose in
July and August as reserve balances and currency
expanded.
Sentiment improved in foreign financial markets as
the European Central Bank (ECB) outlined a plan to
make additional sovereign bond purchases in conjunction with the European Financial Stability Facility and the European Stability Mechanism. Spreads
of shorter-term yields on peripheral euro-area sovereign bonds over those on comparable-maturity German bunds declined substantially over the period.
The staff’s broad nominal index of the foreign
exchange value of the dollar declined and benchmark
sovereign yields in the major advanced foreign economies increased as safe-haven demands eased with the
lessening of concerns about the European situation.
Most global benchmark indexes for equity prices
moved up, and the equity prices of European banks
rose sharply. Funding conditions for euro-area banks
improved, although these conditions remained fragile, and draws on the Federal Reserve’s liquidity swap
facility with the ECB fell.
The staff also reported on potential risks to financial
stability, including those owing to the developments
in Europe and to the current environment of low
interest rates. Although the support for economic
activity provided by low interest rates enhances
financial stability, low interest rates also could eventually contribute to excessive borrowing or risktaking and possibly leave some aspects of the financial system vulnerable to a future rise in interest rates.
The staff surveyed a wide range of asset markets and
financial institutions for signs of excessive valuations,
leverage, or risk-taking that could pose systemic risks.
Valuations for broad asset classes did not appear
stretched, or supported by excessive leverage. The
staff also did not find evidence that excessive risktaking was widespread, although such behavior had
appeared in a few smaller and less liquid markets.

Staff Economic Outlook
In the economic projection prepared by the staff for
the September FOMC meeting, the forecast for real
GDP growth in the near term was broadly similar, on
balance, to the previous projection. The near-term
forecast incorporated a larger negative effect of the
drought on farm output in the second half of this
year than the staff previously anticipated, but this
effect was mostly offset by the staff’s expectation of a

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99th Annual Report | 2012

smaller drag from net exports. The staff’s mediumterm projection for real GDP growth, which was conditioned on the assumption of no changes in monetary policy, was revised up a little, mostly reflecting
a slight improvement in the outlook for the European
situation and a somewhat higher projected path for
equity prices. Nevertheless, with fiscal policy assumed
to be tighter next year than this year, the staff
expected that increases in real GDP would not materially exceed the growth of potential output in 2013.
In 2014, economic activity was projected to accelerate gradually, supported by an easing in fiscal policy
restraint, increases in consumer and business confidence, further improvements in financial conditions
and credit availability, and accommodative monetary
policy. The expansion in economic activity was
expected to narrow the significant margin of slack in
labor and product markets only slowly over the projection period, and the unemployment rate was
anticipated to still be elevated at the end of 2014.
The staff’s near-term forecast for inflation was
revised up from the projection prepared for the
August FOMC meeting, reflecting increases in consumer energy prices that were greater than anticipated. However, the staff’s projection for inflation
over the medium term was little changed. With crude
oil prices expected to gradually decline from their
current levels, the boost to retail food prices from the
drought anticipated to be only temporary and comparatively small, long-run inflation expectations
assumed to remain stable, and substantial resource
slack persisting over the projection period, the staff
continued to forecast that inflation would be subdued
through 2014.
The staff viewed the uncertainty around the forecast
for economic activity as elevated and the risks skewed
to the downside, largely reflecting concerns about the
situation in Europe and the possibility of a more
severe tightening in U.S. fiscal policy than anticipated. Although the staff saw the outlook for inflation as uncertain, the risks were viewed as balanced
and not unusually high.

Participants’ Views on Current Conditions
and the Economic Outlook
In conjunction with this FOMC meeting, meeting
participants—the 7 members of the Board of Governors and the presidents of the 12 Federal Reserve
Banks, all of whom participate in the deliberations of
the FOMC—submitted their assessments of real output growth, the unemployment rate, inflation, and

the target federal funds rate for each year from 2012
through 2015 and over the longer run, under each
participants’ judgment of appropriate monetary
policy. The longer-run projections represent each
participant’s assessment of the rate to which each
variable would be expected to converge, over time,
under appropriate monetary policy and in the
absence of further shocks to the economy. These economic projections and policy assessments are
described in the Summary of Economic Projections,
which is attached as an addendum to these minutes.
In their discussion of the economic situation and
outlook, meeting participants regarded the information received during the intermeeting period as indicating that economic activity had continued to
expand at a moderate pace in recent months. However, recent gains in employment were small and the
unemployment rate remained high. Although consumer spending had continued to advance, growth in
business fixed investment appeared to have slowed.
The housing sector showed some further signs of
improvement, albeit from a depressed level. Consumer price inflation had been subdued despite
recent increases in the prices of some key commodities, and longer-term inflation expectations had
remained stable.
Regarding the economic outlook, participants generally agreed that the pace of the economic recovery
would likely remain moderate over coming quarters
but would pick up over the 2013–15 period. In the
near term, the drought in the Midwest was expected
to weigh on economic growth. Moreover, participants observed that the pace of economic recovery
would likely continue to be held down for some time
by persistent headwinds, including continued weakness in the housing market, ongoing household sector deleveraging, still-tight credit conditions for some
households and businesses, and fiscal consolidation
at all levels of government. Many participants also
noted that a high level of uncertainty regarding the
European fiscal and banking crisis and the outlook
for U.S. fiscal and regulatory policies was weighing
on confidence, thereby restraining household and
business spending. However, others questioned the
role of uncertainty about policy as a factor constraining aggregate demand. In addition, participants
still saw significant downside risks to the outlook for
economic growth. Prominent among these risks were
a possible intensification of strains in the euro zone,
with potential spillovers to U.S. financial markets
and institutions and thus to the broader U.S.
economy; a larger-than-expected U.S. fiscal tighten-

Minutes of Federal Open Market Committee Meetings | September

233

ing; and the possibility of a further slowdown in
global economic growth. A few participants, however,
mentioned the possibility that economic growth
could be more rapid than currently anticipated, particularly if major sources of uncertainty were
resolved favorably or if faster-than-expected
advances in the housing sector led to improvements
in household balance sheets, increased confidence,
and easier credit conditions. Participants’ forecasts
for economic activity, which in most cases were conditioned on an assumption of additional, near-term
monetary policy accommodation, were also associated with an outlook for the unemployment rate to
remain close to recent levels through 2012 and then
to decline gradually toward levels judged to be consistent with the Committee’s mandate.

production and reduced profits on livestock. The
drought was expected to reduce farm inventories and
have a transitory impact on broader measures of
economic growth.

In the household sector, incoming data on retail sales
were somewhat stronger than expected. Participants
noted, however, that households were still in the process of deleveraging, confidence was low, and consumers appeared to remain particularly pessimistic
about the prospects for the future, raising doubts that
the somewhat stronger pace of spending would persist. Although the level of activity in the housing sector remained low, the somewhat faster pace of home
sales and construction provided some encouraging
signs of improvement. A number of participants also
observed that house prices were rising. It was noted
that such increases, coupled with historically low
mortgage rates, could lead to a stronger upturn in
housing activity, although constraints on the capacity
for loan origination and still-tight credit terms for
some borrowers continued to weigh on mortgage
lending.

The available indicators pointed to continued weakness in overall labor market conditions. Growth in
employment had been disappointing, with the average monthly increases in payrolls so far this year
below last year’s pace and below the pace that would
be required to make significant progress in reducing
the unemployment rate. The unemployment rate
declined around the turn of the year but had not
fallen significantly since then. In addition, the labor
force participation rate and employment-topopulation ratios were at or near post-recession lows.

Business contacts in many parts of the country were
reported to be highly uncertain about the outlook for
the economy and for fiscal and regulatory policies.
Although firms’ balance sheets were generally strong,
these uncertainties had led them to be particularly
cautious and to remain reluctant to hire or expand
capacity. Reports on manufacturing activity were
mixed, with production related to autos and housing
the most notable areas of relative strength. In one
District, business surveys pointed to further growth;
however, readings on forward-looking indicators of
orders around the country were less positive. In addition, business contacts noted that export demand was
showing signs of weakness as a result of the slowdown in economic activity in Europe. The energy sector continued to expand. In the agricultural sector,
high grain prices and crop insurance payments were
supporting farm incomes, helping offset declines in

Participants generally expected that fiscal policy
would continue to be a drag on economic activity
over coming quarters. In addition to ongoing weakness in spending at the federal, state, and local government levels, uncertainties about tax and spending
policies reportedly were restraining business decisionmaking. Participants also noted that if an agreement
was not reached to tackle the expiring tax cuts and
scheduled spending reductions, a sharp consolidation
of fiscal policy would take place at the beginning of
2013.

Meeting participants again discussed the extent of
slack in labor markets. A few participants reiterated
their view that the persistently high level of unemployment reflected the effect of structural factors,
including mismatches across and within sectors
between the skills of the unemployed and those
demanded in sectors in which jobs were currently
available. It was also suggested that there was an
ongoing process of polarization in the labor market,
with the share of job opportunities in middle-skill
occupations continuing to decline while the shares of
low and high skill occupations increased. Both of
these views would suggest a lower level of potential
output and thus reduced scope for combating unemployment with additional monetary policy stimulus.
Several participants, while acknowledging some evidence of structural changes in the labor market,
stated again that weak aggregate demand was the
principal reason for the high unemployment rate.
They saw slack in resource utilization as remaining
wide, indicating an important role for additional
policy accommodation. Several participants noted
the risk that continued high levels of unemployment,
even if initially cyclical, might ultimately induce
adverse structural changes. In particular, they

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99th Annual Report | 2012

The incoming information on inflation over the intermeeting period was largely in line with participants’
expectations. Despite recent increases in the prices of
some key commodities, consumer price inflation
remained subdued. With longer-term inflation expectations stable and the unemployment rate elevated,
participants generally anticipated that inflation over
the medium run would likely run at or below the
2 percent rate that the Committee judges to be most
consistent with its mandate. Most participants saw
the risks to the outlook for inflation as roughly balanced. A few participants felt that maintaining a
highly accommodative stance of monetary policy
over an extended period could unmoor longer-term
inflation expectations and, against a backdrop of
higher energy and commodity prices, posed upside
risks to inflation. Other participants, by contrast, saw
inflation risks as tilted to the downside, given their
expectations for sizable and persistent resource slack.

tive financial conditions. A number of participants
also indicated that it could lift consumer and business
confidence by emphasizing the Committee’s commitment to continued progress toward its dual mandate.
In addition, it was noted that additional purchases
could reinforce the Committee’s forward guidance
regarding the federal funds rate. Participants discussed the effectiveness of purchases of Treasury
securities relative to purchases of agency MBS in easing financial conditions. Some participants suggested
that, all else being equal, MBS purchases could be
preferable because they would more directly support
the housing sector, which remains weak but has
shown some signs of improvement of late. One participant, however, objected that purchases of MBS,
when compared to purchases of longer-term Treasury securities, would likely result in higher interest
rates for many borrowers in other sectors. A number
of participants highlighted the uncertainty about the
overall effects of additional purchases on financial
markets and the real economy. Some participants
thought past purchases were useful because they were
conducted during periods of market stress or heightened deflation risk and were less confident of the
efficacy of additional purchases under present circumstances. A few expressed skepticism that additional policy accommodation could help spur an
economy that they saw as held back by uncertainties
and a range of structural issues. In discussing the
costs and risks that such a program might entail, several participants reiterated their concern that additional purchases might complicate the Committee’s
efforts to withdraw monetary policy accommodation
when it eventually became appropriate to do so, raising the risk of undesirably high inflation in the future
and potentially unmooring inflation expectations.
One participant noted that an extended period of
accommodation resulting from additional asset purchases could lead to excessive risk-taking on the part
of some investors and so undermine financial stability over time. The possible adverse effects of large
purchases on market functioning were also noted.
However, most participants thought these risks could
be managed since the Committee could make adjustments to its purchases, as needed, in response to economic developments or to changes in its assessment
of their efficacy and costs.

Participants again exchanged views on the likely benefits and costs of a new large-scale asset purchase
program. Many participants anticipated that such a
program would provide support to the economic
recovery by putting downward pressure on longerterm interest rates and promoting more accommoda-

Participants also discussed issues related to the provision of forward guidance regarding the future path of
the federal funds rate. It was noted that clear communication and credibility allow the central bank to help
shape the public’s expectations about policy, which is
crucial to managing monetary policy when the fed-

expressed concerns about the risk that the exceptionally high level of long-term unemployment and the
depressed level of labor participation could ultimately lead to permanent negative effects on the
skills and prospects of those without jobs, thereby
reducing the longer-run normal level of employment
and potential output.
Sentiment in financial markets improved notably during the intermeeting period. Participants indicated
that recent decisions by the ECB helped ease investors’ anxiety about the near-term prospects for the
euro. However, participants also observed that significant risks related to the euro-area banking and
fiscal crisis remained, and that a number of important issues would have to be resolved in order to
achieve further progress toward a comprehensive
solution to the crisis. Participants noted that indicators of financial stress in the United States were not
especially high and overall conditions in U.S. financial markets remained favorable. Longer-term interest
rates were low and supportive of economic growth,
while equity prices had risen. One participant noted
that, while there were few current signs of excessive
risk-taking, low interest rates could ultimately lead to
financial imbalances that would be challenging to
detect before they became serious problems.

Minutes of Federal Open Market Committee Meetings | September

eral funds rate is at its effective lower bound. A number of participants questioned the effectiveness of
continuing to use a calendar date to provide forward
guidance, noting that a change in the calendar date
might be interpreted pessimistically as a downgrade
of the Committee’s economic outlook rather than as
conveying the Committee’s determination to support
the economic recovery. If the public interpreted the
statement pessimistically, consumer and business
confidence could fall rather than rise. Many participants indicated a preference for replacing the calendar date with language describing the economic factors that the Committee would consider in deciding
to raise its target for the federal funds rate. Participants discussed the benefits of such an approach,
including the potential for enhanced effectiveness of
policy through greater clarity regarding the Committee’s future behavior. That approach could also bolster the stimulus provided by the System’s holdings
of longer-term securities. It was noted that forward
guidance along these lines would allow market expectations regarding the federal funds rate to adjust
automatically in response to incoming data on the
economy. Many participants thought that moreeffective forward guidance could be provided by
specifying numerical thresholds for labor market and
inflation indicators that would be consistent with
maintaining the federal funds rate at exceptionally
low levels. However, reaching agreement on specific
thresholds could be challenging given the diversity of
participants’ views, and some were reluctant to
specify explicit numerical thresholds out of concern
that such thresholds would necessarily be too simple
to fully capture the complexities of the economy and
the policy process or could be incorrectly interpreted
as triggers prompting an automatic policy response.
In addition, numerical thresholds could be confused
with the Committee’s longer-term objectives, and so
undermine the Committee’s credibility. At the conclusion of the discussion, most participants agreed
that the use of numerical thresholds could be useful
to provide more clarity about the conditionality of
the forward guidance but thought that further work
would be needed to address the related communications challenges.

Committee Policy Action
Committee members saw the information received
over the intermeeting period as suggesting that economic activity had continued to expand at a moderate pace in recent months. However, growth in
employment had been slow, and almost all members
saw the unemployment rate as still elevated relative to

235

levels that they viewed as consistent with the Committee’s mandate. Members generally judged that
without additional policy accommodation, economic
growth might not be strong enough to generate sustained improvement in labor market conditions.
Moreover, while the sovereign and banking crisis in
Europe had eased some recently, members still saw
strains in global financial conditions as posing significant downside risks to the economic outlook. The
possibility of a larger-than-expected fiscal tightening
in the United States and slower global growth were
also seen as downside risks. Inflation had been subdued, even though the prices of some key commodities had increased recently. Members generally continued to anticipate that, with longer-term inflation
expectations stable and given the existing slack in
resource utilization, inflation over the medium term
would run at or below the Committee’s longer-run
objective of 2 percent.
In their discussion of monetary policy for the period
ahead, members generally expressed concerns about
the slow pace of improvement in labor market conditions and all members but one agreed that the outlook for economic activity and inflation called for
additional monetary accommodation. Members
agreed that such accommodation should be provided
through both a strengthening of the forward guidance regarding the federal funds rate and purchases
of additional agency MBS at a pace of $40 billion
per month. Along with the ongoing purchases of
$45 billion per month of longer-term Treasury securities under the maturity extension program
announced in June, these purchases will increase the
Committee’s holdings of longer-term securities by
about $85 billion each month through the end of the
year, and should put downward pressure on longerterm interest rates, support mortgage markets, and
help make broader financial conditions more accommodative. Members also agreed to maintain the
Committee’s existing policy of reinvesting principal
payments from its holdings of agency debt and
agency MBS into agency MBS. The Committee
agreed that it would closely monitor incoming information on economic and financial developments in
coming months, and that if the outlook for the labor
market did not improve substantially, it would continue its purchases of agency MBS, undertake additional asset purchases, and employ its other policy
tools as appropriate until such improvement is
achieved in a context of price stability. This flexible
approach was seen as allowing the Committee to tailor its policy response over time to incoming information while incorporating conditional features that

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99th Annual Report | 2012

clarified the Committee’s intention to improve labor
market conditions, thereby enhancing the effectiveness of the action by helping to bolster business and
consumer confidence. While members generally
viewed the potential risks associated with these purchases as manageable, the Committee agreed that in
determining the size, pace, and composition of its
asset purchases, it would, as always, take appropriate
account of the likely efficacy and costs of such purchases. With regard to the forward guidance, the
Committee agreed on an extension through mid2015, in conjunction with language in the statement
indicating that it expects that a highly accommodative stance of policy will remain appropriate for a
considerable time after the economic recovery
strengthens. That new language was meant to clarify
that the maintenance of a very low federal funds rate
over that period did not reflect an expectation that
the economy would remain weak, but rather reflected
the Committee’s intention to support a stronger economic recovery. One member dissented from the
policy decision, on the grounds that he opposed additional asset purchases and preferred to omit the calendar date from the forward guidance; in his view, it
would be better to use qualitative language to
describe the factors that would influence the Committee’s decision to increase the target federal funds
rate.
At the conclusion of the discussion, the Committee
voted to authorize and direct the Federal Reserve
Bank of New York, until it was instructed otherwise,
to execute transactions in the System Account in
accordance with the following domestic policy
directive:
“The Federal Open Market Committee seeks
monetary and financial conditions that will foster price stability and promote sustainable
growth in output. To further its long-run objectives, the Committee seeks conditions in reserve
markets consistent with federal funds trading in
a range from 0 to ¼ percent. The Committee
directs the Desk to continue the maturity extension program it announced in June to purchase
Treasury securities with remaining maturities of
6 years to 30 years with a total face value of
about $267 billion by the end of December 2012, and to sell or redeem Treasury securities with remaining maturities of approximately
3 years or less with a total face value of about
$267 billion. For the duration of this program,
the Committee directs the Desk to suspend its
policy of rolling over maturing Treasury securi-

ties into new issues. The Committee directs the
Desk to maintain its existing policy of reinvesting principal payments on all agency debt and
agency mortgage-backed securities in the System
Open Market Account in agency mortgagebacked securities. The Desk is also directed to
begin purchasing agency mortgage-backed securities at a pace of about $40 billion per month.
The Committee directs the Desk to engage in
dollar roll and coupon swap transactions as necessary to facilitate settlement of the Federal
Reserve’s agency MBS transactions. The System
Open Market Account Manager and the Secretary will keep the Committee informed of ongoing developments regarding the System’s balance sheet that could affect the attainment over
time of the Committee’s objectives of maximum
employment and price stability.”
The vote encompassed approval of the statement
below to be released at 12:30 p.m.:
“Information received since the Federal Open
Market Committee met in August suggests that
economic activity has continued to expand at a
moderate pace in recent months. Growth in
employment has been slow, and the unemployment rate remains elevated. Household spending
has continued to advance, but growth in business fixed investment appears to have slowed.
The housing sector has shown some further
signs of improvement, albeit from a depressed
level. Inflation has been subdued, although the
prices of some key commodities have increased
recently. Longer-term inflation expectations
have remained stable.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment
and price stability. The Committee is concerned
that, without further policy accommodation,
economic growth might not be strong enough to
generate sustained improvement in labor market
conditions. Furthermore, strains in global financial markets continue to pose significant downside risks to the economic outlook. The Committee also anticipates that inflation over the
medium term likely would run at or below its
2 percent objective.
To support a stronger economic recovery and to
help ensure that inflation, over time, is at the
rate most consistent with its dual mandate, the
Committee agreed today to increase policy

Minutes of Federal Open Market Committee Meetings | September

accommodation by purchasing additional
agency mortgage-backed securities at a pace of
$40 billion per month. The Committee also will
continue through the end of the year its program to extend the average maturity of its holdings of securities as announced in June, and it is
maintaining its existing policy of reinvesting
principal payments from its holdings of agency
debt and agency mortgage-backed securities in
agency mortgage-backed securities. These
actions, which together will increase the Committee’s holdings of longer-term securities by
about $85 billion each month through the end of
the year, should put downward pressure on
longer-term interest rates, support mortgage
markets, and help to make broader financial
conditions more accommodative.
The Committee will closely monitor incoming
information on economic and financial developments in coming months. If the outlook for the
labor market does not improve substantially, the
Committee will continue its purchases of agency
mortgage-backed securities, undertake additional asset purchases, and employ its other
policy tools as appropriate until such improvement is achieved in a context of price stability.
In determining the size, pace, and composition
of its asset purchases, the Committee will, as
always, take appropriate account of the likely
efficacy and costs of such purchases.
To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative
stance of monetary policy will remain appropriate for a considerable time after the economic
recovery strengthens. In particular, the Committee also decided today to keep the target range
for the federal funds rate at 0 to ¼ percent and
currently anticipates that exceptionally low levels
for the federal funds rate are likely to be warranted at least through mid-2015.”
Voting for this action: Ben Bernanke, William C.
Dudley, Elizabeth Duke, Dennis P. Lockhart, Sandra
Pianalto, Jerome H. Powell, Sarah Bloom Raskin,
Jeremy C. Stein, Daniel K. Tarullo, John C. Williams,
and Janet L. Yellen.
Voting against this action: Jeffrey M. Lacker.
Mr. Lacker dissented because he believed that additional monetary stimulus at this time was unlikely to

237

result in a discernible improvement in economic
growth without also causing an unwanted increase in
inflation. Moreover, he expressed his opposition to
the purchase of more MBS, because he viewed it as
inappropriate for the Committee to choose a particular sector of the economy to support; purchases of
Treasury securities instead would have avoided this
effect. Finally, he preferred to omit the description of
the time period over which exceptionally low levels
for the federal funds rate were likely to be warranted.

Consensus Forecast Experiment
In light of the discussion at the previous FOMC
meeting, the subcommittee on communications
developed a second experimental exercise intended to
shed light on the feasibility and desirability of constructing an FOMC consensus forecast. At this meeting, participants discussed possible formulations of
the monetary policy assumptions on which to condition an FOMC consensus forecast and alternative
approaches for participants to express their endorsement of the consensus forecast. In conclusion, participants agreed to have a broad discussion of the
experiences gathered from the two experimental exercises in conjunction with the October FOMC
meeting.
It was agreed that the next meeting of the Committee
would be held on Tuesday–Wednesday, October 23–
24, 2012. The meeting adjourned at 12:10 p.m. on
September 13, 2012.

Notation Vote
By notation vote completed on August 21, 2012, the
Committee unanimously approved the minutes of the
FOMC meeting held on July 31–August 1, 2012.
William B. English
Secretary

Addendum:
Summary of Economic Projections
In conjunction with the September 12−13, 2012, Federal Open Market Committee (FOMC) meeting,
meeting participants—the 7 members of the Board
of Governors and the 12 presidents of the Federal
Reserve Banks, all of whom participate in the deliberations of the FOMC—submitted their assessments,
under each participant’s judgment of appropriate
monetary policy, of real output growth, the unemployment rate, inflation, and the target federal funds

238

99th Annual Report | 2012

As shown in figure 2, most participants judged that
highly accommodative monetary policy was likely to
be warranted over the next few years. In particular,
13 participants thought that it would be appropriate
for the first increase in the target federal funds rate to
occur during 2015 or later. The majority of participants judged that appropriate monetary policy would
involve a decision by the Committee, at the September meeting or before long, to undertake significant
additional asset purchases.

rate for each year from 2012 through 2015 and over
the longer run. These assessments were based on
information available at the time of the meeting and
participants’ individual assumptions about the factors likely to affect economic outcomes. The longerrun projections represent each participant’s judgment
of the rate to which each variable would be expected
to converge, over time, under appropriate monetary
policy and in the absence of further shocks to the
economy. “Appropriate monetary policy” is defined
as the future path of policy that participants deem
most likely to foster outcomes for economic activity
and inflation that best satisfy their individual interpretations of the Federal Reserve’s objectives of
maximum employment and stable prices.

As in June, participants in September judged the
uncertainty associated with the outlook for real activity and the unemployment rate to be unusually high
compared with historical norms, with the risks
weighted mainly toward slower economic growth and
a higher unemployment rate. While a number of participants viewed the uncertainty surrounding their
projections for inflation to be unusually high in comparison with historical norms, many judged it to be
broadly similar to historical norms, and most considered the risks to inflation to be roughly balanced.

Overall, the assessments that FOMC participants
submitted in September indicated that, under appropriate monetary policy, the pace of economic recovery over the 2012−15 period would gradually pick up
and inflation would remain subdued (table 1 and figure 1). Participants judged that the growth rate of
real gross domestic product (GDP) would increase
somewhat in 2013 and that economic growth in 2014
and 2015 would modestly exceed participants’ estimates of the longer-run sustainable rate of growth,
while the unemployment rate would decline gradually
through 2015. Participants projected that inflation,
as measured by the annual change in the price index
for personal consumption expenditures (PCE), would
run close to or below the FOMC’s longer-run inflation objective of 2 percent.

The Outlook for Economic Activity
Conditional on their individual assumptions about
appropriate monetary policy, participants judged
that the economy would grow at a moderate pace
over coming quarters and then pick up somewhat in
2013 before expanding in 2014 and 2015 at a rate
modestly above what participants saw as the longerrun rate of output growth. The central tendency of
their projections for the change in real GDP in 2012

Table 1. Economic projections of Federal Reserve Board members and Federal Reserve Bank presidents, September 2012
Percent
Central tendency1

Range2

Variable
2012
Change in real GDP
June projection
Unemployment rate
June projection
PCE inflation
June projection
Core PCE inflation3
June projection

2013

2014

2015

Longer run

2012

2013

2014

2015

Longer run

1.7 to 2.0
1.9 to 2.4
8.0 to 8.2
8.0 to 8.2
1.7 to 1.8
1.2 to 1.7
1.7 to 1.9
1.7 to 2.0

2.5 to 3.0
2.2 to 2.8
7.6 to 7.9
7.5 to 8.0
1.6 to 2.0
1.5 to 2.0
1.7 to 2.0
1.6 to 2.0

3.0 to 3.8
3.0 to 3.5
6.7 to 7.3
7.0 to 7.7
1.6 to 2.0
1.5 to 2.0
1.8 to 2.0
1.6 to 2.0

3.0 to 3.8
n.a.
6.0 to 6.8
n.a.
1.8 to 2.0
n.a.
1.9 to 2.0
n.a.

2.3 to 2.5
2.3 to 2.5
5.2 to 6.0
5.2 to 6.0
2.0
2.0

1.6 to 2.0
1.6 to 2.5
8.0 to 8.3
7.8 to 8.4
1.5 to 1.9
1.2 to 2.0
1.6 to 2.0
1.7 to 2.0

2.3 to 3.5
2.2 to 3.5
7.0 to 8.0
7.0 to 8.1
1.5 to 2.1
1.5 to 2.1
1.6 to 2.0
1.4 to 2.1

2.7 to 4.1
2.8 to 4.0
6.3 to 7.5
6.3 to 7.7
1.6 to 2.2
1.5 to 2.2
1.6 to 2.2
1.5 to 2.2

2.5 to 4.2
n.a.
5.7 to 6.9
n.a.
1.8 to 2.3
n.a.
1.8 to 2.3
n.a.

2.2 to 3.0
2.2 to 3.0
5.0 to 6.3
4.9 to 6.3
2.0
2.0

Note: Projections of change in real gross domestic product (GDP) and projections for both measures of inflation are from the fourth quarter of the previous year to the fourth
quarter of the year indicated. PCE inflation and core PCE inflation are the percentage rates of change in, respectively, the price index for personal consumption expenditures
(PCE) and the price index for PCE excluding food and energy. Projections for the unemployment rate are for the average civilian unemployment rate in the fourth quarter of the
year indicated. Each participant’s projections are based on his or her assessment of appropriate monetary policy. Longer-run projections represent each participant’s
assessment of the rate to which each variable would be expected to converge under appropriate monetary policy and in the absence of further shocks to the economy. The June
projections were made in conjunction with the meeting of the Federal Open Market Committee on June 19–20, 2012.
1
The central tendency excludes the three highest and three lowest projections for each variable in each year.
2
The range for a variable in a given year includes all participants’ projections, from lowest to highest, for that variable in that year.
3
Longer-run projections for core PCE inflation are not collected.

Minutes of Federal Open Market Committee Meetings | September

239

Figure 1. Central tendencies and ranges of economic projections, 2012–15 and over the longer run
Percent

Change in real GDP

5

Central tendency of projections
Range of projections

4
3
2
1
+
0
1

Actual

2
3

2007

2008

2009

2010

2011

2012

2013

2014

2015

Longer
run
Percent

Unemployment rate

10
9
8
7
6
5

2007

2008

2009

2010

2011

2012

2013

2014

2015

Longer
run
Percent

PCE inflation
3

2

1

2007

2008

2009

2010

2011

2012

2013

2014

2015

Longer
run
Percent

Core PCE inflation
3

2

1

2007

2008

2009

2010

2011

2012

2013

Note: Definitions of variables are in the general note to table 1. The data for the actual values of the variables are annual.

2014

2015

Longer
run

240

99th Annual Report | 2012

Figure 2. Overview of FOMC participants’ assessments of appropriate monetary policy, September 2012
Number of participants

Appropriate timing of policy firming
13
12

12
11
10
9
8
7
6
5
4

3

3
2

2

1

2012

1

2013

2014

2015

1

2016

Appropriate pace of policy firming

Percent

Target federal funds rate at year-end
6

5

4

3

2

1

0

2012

2013

2014

2015

Longer run

Note: In the upper panel, the height of each bar denotes the number of FOMC participants who judge that, under appropriate monetary policy, the first increase in the target federal funds rate from its current range of 0 to ¼ percent will occur in the specified calendar year. In June 2012, the numbers of FOMC participants who judged that the first
increase in the target federal funds rate would occur in 2012, 2013, 2014, and 2015 were, respectively, 3, 3, 7, and 6. In the lower panel, each shaded circle indicates the value
(rounded to the nearest ¼ percentage point) of an individual participant’s judgment of the appropriate level of the target federal funds rate at the end of the specified calendar
year or over the longer run.

Minutes of Federal Open Market Committee Meetings | September

was 1.7 to 2.0 percent, somewhat lower than in June.
Many participants characterized the incoming data
as having been to the weak side of their expectations
at the time of the June meeting; several participants
also cited the severe drought as a factor causing them
to mark down their projections for economic growth
in 2012. However, participants’ projections for 2013
and 2014 were generally slightly higher than in June;
this reflected, in part, a greater assumed amount of
monetary policy accommodation than in their June
submissions as well as some improvement since then
in the outlook for economic activity in Europe. The
central tendency of participants’ projections for real
GDP growth in 2013 was 2.5 to 3.0 percent, followed
by central tendencies for both 2014 and 2015 of
3.0 to 3.8 percent. The central tendency for the
longer-run rate of increase of real GDP remained at
2.3 to 2.5 percent, unchanged from June. While most
participants noted that the increased degree of monetary policy accommodation assumed in their projections would help promote a faster recovery, participants cited several headwinds that would be likely to
hold back the pace of economic expansion over the
forecast period, including slower growth abroad, a
still-weak housing market, the difficult fiscal and
financial situation in Europe, and fiscal restraint in
the United States.
Participants projected the unemployment rate at the
end of 2012 to remain close to recent levels, with a
central tendency of 8.0 to 8.2 percent, the same as in
their June submissions. Participants anticipated
gradual improvement from 2013 through 2015; even
so, they generally thought that the unemployment
rate at the end of 2015 would still lie well above their
individual estimates of its longer-run normal level.
The central tendencies of participants’ forecasts for
the unemployment rate were 7.6 to 7.9 percent at the
end of 2013, 6.7 to 7.3 percent at the end of 2014,
and 6.0 to 6.8 percent at the end of 2015. The central
tendency of participants’ estimates of the longer-run
normal rate of unemployment that would prevail
under the assumption of appropriate monetary
policy and in the absence of further shocks to the
economy was 5.2 to 6.0 percent, unchanged from
June. Most participants projected that the gap
between the current unemployment rate and their
estimates of its longer-run normal rate would be
closed in five or six years, while a few judged that less
time would be needed.
Figures 3.A and 3.B provide details on the diversity
of participants’ views regarding the likely outcomes
for real GDP growth and the unemployment rate
over the next three years and over the longer run.
The dispersion in these projections reflects differ-

241

ences in participants’ assessments of many factors,
including appropriate monetary policy and its effects
on the economy, the rate of improvement in the
housing sector, the spillover effects of the fiscal and
financial situation in Europe, the prospective path for
U.S. fiscal policy, the extent of structural dislocations
in the labor market, the likely evolution of credit and
financial market conditions, and longer-term trends
in productivity and the labor force. With much of the
data for the first eight months of 2012 now in hand,
the dispersion of participants’ projections of real
GDP growth and the unemployment rate this year
narrowed in September compared with June. The
range of participants’ forecasts for the change in real
GDP in 2013 and 2014, however, was little changed
from June, on balance. The distribution of projections for the unemployment rate was not much
altered for 2013, while for 2014 it narrowed a bit and
shifted down slightly. The range for the unemployment rate for 2015 was 5.7 to 6.9 percent. As in June,
the dispersion of estimates for the longer-run rate of
output growth was fairly narrow, with the values
being mostly from 2.2 to 2.7 percent. The range of
participants’ estimates of the longer-run rate of
unemployment was 5.0 to 6.3 percent, a similar range
to that in June; this range reflected different judgments among participants about several factors,
including the outlook for labor force participation
and the structure of the labor market.
The Outlook for Inflation
Participants’ views on the broad outlook for inflation
under the assumption of appropriate monetary
policy were little changed from June. For 2012 as a
whole, most anticipated that overall inflation would
be only slightly above its average annual rate of
1.6 percent over the first half of the year; a number
of participants pointed to higher food prices in
response to the drought, along with recent increases
in oil prices, as temporary sources of upward pressure on the headline rate. Almost all participants
judged that both headline and core inflation would
remain subdued over the 2013–15 period, running at
rates at or below the FOMC’s longer-run objective of
2 percent. In pointing to factors likely to restrain
price pressures, several participants cited sizable
resource slack and stable inflation expectations, while
a few noted the subdued behavior of labor compensation. Specifically, the central tendency of participants’ projections for inflation, as measured by the
PCE price index, moved up and tightened to 1.7 to
1.8 percent for 2012 and was little changed for 2013
and 2014 at 1.6 to 2.0 percent. For 2015, the central
tendency was 1.8 to 2.0 percent. The central tendencies of the forecasts for core inflation were broadly

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99th Annual Report | 2012

Figure 3.A. Distribution of participants’ projections for the change in real GDP, 2012–15 and over the longer run
Number of participants

20
18
16
14
12
10
8
6
4
2

2012
September projections
June projections

1.6 1.7

1.8 1.9

2.0 2.1

2.2 2.3

2.4 2.5

2.6 2.7

2.8 2.9

3.0 3.1

3.2 3.3

3.4 3.5

3.6 3.7

3.8 3.9

4.0 4.1

4.2 4.3

Percent range
Number of participants

20
18
16
14
12
10
8
6
4
2

2013

1.6 1.7

1.8 1.9

2.0 2.1

2.2 2.3

2.4 2.5

2.6 2.7

2.8 2.9

3.0 3.1

3.2 3.3

3.4 3.5

3.6 3.7

3.8 3.9

4.0 4.1

4.2 4.3

Percent range
Number of participants

20
18
16
14
12
10
8
6
4
2

2014

1.6 1.7

1.8 1.9

2.0 2.1

2.2 2.3

2.4 2.5

2.6 2.7

2.8 2.9

3.0 3.1

3.2 3.3

3.4 3.5

3.6 3.7

3.8 3.9

4.0 4.1

4.2 4.3

Percent range
Number of participants

20
18
16
14
12
10
8
6
4
2

2015

1.6 1.7

1.8 1.9

2.0 2.1

2.2 2.3

2.4 2.5

2.6 2.7

2.8 2.9

3.0 3.1

3.2 3.3

3.4 3.5

3.6 3.7

3.8 3.9

4.0 4.1

4.2 4.3

Percent range
Number of participants

20
18
16
14
12
10
8
6
4
2

Longer run

1.6 1.7

1.8 1.9

2.0 2.1

2.2 2.3

2.4 2.5

2.6 2.7

2.8 2.9

3.0 3.1

Percent range
Note: Definitions of variables are in the general note to table 1.

3.2 3.3

3.4 3.5

3.6 3.7

3.8 3.9

4.0 4.1

4.2 4.3

Minutes of Federal Open Market Committee Meetings | September

243

Figure 3.B. Distribution of participants’ projections for the unemployment rate, 2012–15 and over the longer run
Number of participants

20
18
16
14
12
10
8
6
4
2

2012
September projections
June projections

4.8 4.9

5.0 5.1

5.2 5.3

5.4 5.5

5.6 5.7

5.8 5.9

6.0 6.1

6.2 6.3

6.4 6.5

6.6 6.7

6.8 6.9

7.0 7.1

7.2 7.3

7.4 7.5

7.6 7.7

7.8 7.9

8.0 8.1

8.2 8.3

8.4 8.5

Percent range
Number of participants

20
18
16
14
12
10
8
6
4
2

2013

4.8 4.9

5.0 5.1

5.2 5.3

5.4 5.5

5.6 5.7

5.8 5.9

6.0 6.1

6.2 6.3

6.4 6.5

6.6 6.7

6.8 6.9

7.0 7.1

7.2 7.3

7.4 7.5

7.6 7.7

7.8 7.9

8.0 8.1

8.2 8.3

8.4 8.5

Percent range
Number of participants

20
18
16
14
12
10
8
6
4
2

2014

4.8 4.9

5.0 5.1

5.2 5.3

5.4 5.5

5.6 5.7

5.8 5.9

6.0 6.1

6.2 6.3

6.4 6.5

6.6 6.7

6.8 6.9

7.0 7.1

7.2 7.3

7.4 7.5

7.6 7.7

7.8 7.9

8.0 8.1

8.2 8.3

8.4 8.5

Percent range
Number of participants

20
18
16
14
12
10
8
6
4
2

2015

4.8 4.9

5.0 5.1

5.2 5.3

5.4 5.5

5.6 5.7

5.8 5.9

6.0 6.1

6.2 6.3

6.4 6.5

6.6 6.7

6.8 6.9

7.0 7.1

7.2 7.3

7.4 7.5

7.6 7.7

7.8 7.9

8.0 8.1

8.2 8.3

8.4 8.5

Percent range
Number of participants

20
18
16
14
12
10
8
6
4
2

Longer run

4.8 4.9

5.0 5.1

5.2 5.3

5.4 5.5

5.6 5.7

5.8 5.9

6.0 6.1

6.2 6.3

6.4 6.5

6.6 6.7

6.8 6.9

Percent range
Note: Definitions of variables are in the general note to table 1.

7.0 7.1

7.2 7.3

7.4 7.5

7.6 7.7

7.8 7.9

8.0 8.1

8.2 8.3

8.4 8.5

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99th Annual Report | 2012

similar to those for the headline measure for 2013
through 2015.

about the longer-run equilibrium level of the real federal funds rate.

Figures 3.C and 3.D provide information about the
diversity of participants’ views about the outlook for
inflation. Participants’ projections for headline inflation for 2012, which in June had ranged from 1.2 to
2 percent, narrowed in September to the range of
1.5 to 1.9 percent; about three-fourths of participants’ projections took values of 1.7 to 1.8 percent,
broadly in line with recent inflation readings. The distributions of participants’ projections for headline
inflation in 2013 and 2014 were very similar to those
for June, while the range of projections for core inflation narrowed slightly for both years. The distributions for core and overall inflation in 2015 were concentrated near the Committee’s longer-run inflation
objective of 2 percent.

Participants also provided qualitative information on
their views regarding the appropriate path of the
Federal Reserve’s balance sheet. Eleven participants
indicated that appropriate policy would involve a
decision by the Committee, at the September meeting
or soon thereafter, to undertake significant additional
asset purchases. Several participants envisioned this
program as entailing purchases of agency mortgagebacked securities. Almost all participants assumed
that, at the appropriate time, the Committee would
carry out the normalization of the balance sheet
according to the principles approved at the June 2011
FOMC meeting. In general, participants linked their
preferred start dates for the normalization process to
their views for the appropriate timing of the first
increase in the target federal funds rate.

Appropriate Monetary Policy
As indicated in figure 2, most participants judged
that exceptionally low levels of the federal funds rate
would remain appropriate for several more years. In
particular, 12 participants thought that the first
increase in the target federal funds rate would not be
warranted until 2015, and 1 viewed a start to firming
in 2016 as appropriate (upper panel). The 12 participants who expected that the target federal funds rate
would not move above its effective lower bound until
2015 thought the federal funds rate would be 1.6 percent or lower at the end of that year, while the one
participant who expected that policy firming would
commence in 2016 saw the funds rate target at
75 basis points at the end of that year. Six participants judged that policy firming in 2012, 2013, or
2014 would be consistent with the Committee’s statutory mandate. Those participants judged that the
appropriate value for the federal funds rate would
range from 1½ to 3 percent at the end of 2014 and
from 2½ to 4½ percent at the end of 2015. In total,
14 participants judged that appropriate monetary
policy called for a more-accommodative path for the
federal funds rate than in their June submissions,
involving either a lower target for the federal funds
rate at the end of the initial year of policy firming, or
a shift out in the first year of firming.
All participants reported levels for the appropriate
target federal funds rate at the end of 2014 that were
well below their estimates of the level expected to
prevail in the longer run, and most saw the appropriate target federal funds rate as still well below its
longer-run value at the end of 2015. Estimates of the
longer-run target federal funds rate ranged from 3 to
4½ percent, reflecting the Committee’s inflation
objective of 2 percent and participants’ judgments

The key factors informing participants’ individual
assessments of the appropriate setting for monetary
policy included their judgments regarding labor market conditions that would be consistent with the
maximum level of employment, the extent to which
employment currently deviated from the maximum
level of employment, the extent to which inflation
deviated from the Committee’s longer-term objective
of 2 percent, and participants’ projections of the
likely time horizon necessary to return employment
and inflation to mandate-consistent levels. Several
participants noted that their assessments of appropriate monetary policy reflected the subpar pace of
labor market improvement and the persistent shortfall of output from potential since the 2007–09 recession. A few participants noted that their settings of
appropriate federal funds rate policy took into
account unusual factors prevailing in recent years,
such as the likelihood that the neutral level of the
federal funds rate was somewhat below its historical
norm and the fact that policy rate setting had been
constrained by the effective lower bound on nominal
interest rates. Two participants expressed concern
that a protracted period of very accommodative
monetary policy could lead to imbalances in the
financial system. Participants also noted that because
the appropriate stance of monetary policy is conditional on the evolution of real activity and inflation
over time, their assessments of the appropriate future
path of the federal funds rate and the balance sheet
could change if economic conditions were to evolve
in an unexpected manner.
Figure 3.E details the distribution of participants’
judgments regarding the appropriate level of the target federal funds rate at the end of each calendar year

Minutes of Federal Open Market Committee Meetings | September

245

Figure 3.C. Distribution of participants’ projections for PCE inflation, 2012–15 and over the longer run
Number of participants

20
18
16
14
12
10
8
6
4
2

2012
September projections
June projections

1.1 1.2

1.3 1.4

1.5 1.6

1.7 1.8

1.9 2.0

2.1 2.2

2.3 2.4

Percent range
Number of participants

20
18
16
14
12
10
8
6
4
2

2013

1.1 1.2

1.3 1.4

1.5 1.6

1.7 1.8

1.9 2.0

2.1 2.2

2.3 2.4

Percent range
Number of participants

20
18
16
14
12
10
8
6
4
2

2014

1.1 1.2

1.3 1.4

1.5 1.6

1.7 1.8

1.9 2.0

2.1 2.2

2.3 2.4

Percent range
Number of participants

20
18
16
14
12
10
8
6
4
2

2015

1.1 1.2

1.3 1.4

1.5 1.6

1.7 1.8

1.9 2.0

2.1 2.2

2.3 2.4

Percent range
Number of participants

20
18
16
14
12
10
8
6
4
2

Longer run

1.1 1.2

1.3 1.4

1.5 1.6

1.7 1.8

Percent range
Note: Definitions of variables are in the general note to table 1.

1.9 2.0

2.1 2.2

2.3 2.4

246

99th Annual Report | 2012

Figure 3.D. Distribution of participants’ projections for core PCE inflation, 2012–15
Number of participants

2012

20
18
16
14
12
10
8
6
4
2

September projections
June projections

1.3 1.4

1.5 1.6

1.7 1.8

1.9 2.0

2.1 2.2

2.3 2.4

Percent range
Number of participants

2013

20
18
16
14
12
10
8
6
4
2
1.3 1.4

1.5 1.6

1.7 1.8

1.9 2.0

2.1 2.2

2.3 2.4

Percent range
Number of participants

2014

20
18
16
14
12
10
8
6
4
2
1.3 1.4

1.5 1.6

1.7 1.8

1.9 2.0

2.1 2.2

2.3 2.4

Percent range
Number of participants

2015

20
18
16
14
12
10
8
6
4
2
1.3 1.4

1.5 1.6

1.7 1.8

1.9 2.0

Percent range
Note: Definitions of variables are in the general note to table 1.

2.1 2.2

2.3 2.4

Minutes of Federal Open Market Committee Meetings | September

247

Figure 3.E. Distribution of participants’ projections for the target federal funds rate, 2012–15 and over the longer run
Number of participants

2012
September projections
June projections

0.00 0.37

0.38 0.62

0.63 0.87

0.88 1.12

1.13 1.37

1.38 1.62

1.63 1.87

1.88 2.12

2.13 2.37

2.38 2.62

2.63 2.87

2.88 3.12

3.13 3.37

3.38 3.62

3.63 3.87

3.88 4.12

4.13 4.37

20
18
16
14
12
10
8
6
4
2

4.38 4.62

Percent range
Number of participants

2013
20
18
16
14
12
10
8
6
4
2

0.00 0.37

0.38 0.62

0.63 0.87

0.88 1.12

1.13 1.37

1.38 1.62

1.63 1.87

1.88 2.12

2.13 2.37

2.38 2.62

2.63 2.87

2.88 3.12

3.13 3.37

3.38 3.62

3.63 3.87

3.88 4.12

4.13 4.37

4.38 4.62

Percent range
Number of participants

2014
20
18
16
14
12
10
8
6
4
2

0.00 0.37

0.38 0.62

0.63 0.87

0.88 1.12

1.13 1.37

1.38 1.62

1.63 1.87

1.88 2.12

2.13 2.37

2.38 2.62

2.63 2.87

2.88 3.12

3.13 3.37

3.38 3.62

3.63 3.87

3.88 4.12

4.13 4.37

4.38 4.62

Percent range
Number of participants

2015
20
18
16
14
12
10
8
6
4
2

0.00 0.37

0.38 0.62

0.63 0.87

0.88 1.12

1.13 1.37

1.38 1.62

1.63 1.87

1.88 2.12

2.13 2.37

2.38 2.62

2.63 2.87

2.88 3.12

3.13 3.37

3.38 3.62

3.63 3.87

3.88 4.12

4.13 4.37

4.38 4.62

Percent range
Number of participants

Longer run
20
18
16
14
12
10
8
6
4
2

0.00 0.37

0.38 0.62

0.63 0.87

0.88 1.12

1.13 1.37

1.38 1.62

1.63 1.87

1.88 2.12

2.13 2.37

2.38 2.62

2.63 2.87

2.88 3.12

3.13 3.37

3.38 3.62

Percent range
Note: The target federal funds rate is measured as the level of the target rate at the end of the calendar year or in the longer run.

3.63 3.87

3.88 4.12

4.13 4.37

4.38 4.62

248

99th Annual Report | 2012

from 2012 to 2015 and over the longer run. As previously noted, most participants judged that economic
conditions would warrant maintaining the current
low level of the federal funds rate through the end of
2014. Views on the appropriate level of the federal
funds rate at the end of 2015 were more widely dispersed, with 10 participants seeing the appropriate
level of the federal funds rate as 1 percent or lower
and 6 of them seeing the appropriate rate as 2½ percent or higher. Those who judged that a longer
period of very accommodative monetary policy
would be appropriate generally were participants
who projected a sizable gap between the unemployment rate and the longer-run normal level of the
unemployment rate until 2015 or later. In contrast,
the 6 participants who judged that policy firming
should begin in 2012, 2013, or 2014 indicated that the
Committee would need to act relatively soon in order
to keep inflation near the FOMC’s longer-run objective of 2 percent and to prevent a rise in inflation
expectations.
Uncertainty and Risks
Nearly all participants judged that their current level
of uncertainty about real GDP growth and unemployment was higher than was the norm during the
previous 20 years (figure 4).5 Eight participants
judged the level of uncertainty associated with their
forecasts of total PCE inflation to be higher as well,
while another 10 participants viewed uncertainty
about inflation as broadly similar to historical norms.
The main factors cited as contributing to the elevated
uncertainty about economic outcomes were the
ongoing fiscal and financial situation in Europe, the
outlook for fiscal policy in the United States, and a
general slowdown in global economic growth, including the possibility of a significant slowdown in
China. As in June, participants noted the difficulties
associated with forecasting the path of the U.S. economic recovery following a financial crisis and recession that differed markedly from recent historical
experience. A number of participants commented
that in the aftermath of the financial crisis, they were
more uncertain about the level of potential output
and its rate of growth. A couple of participants
noted that some of the uncertainty about potential
5

Table 2 provides estimates of the forecast uncertainty for the
change in real GDP, the unemployment rate, and total consumer price inflation over the period from 1991 to 2011. At the
end of this summary, the box “Forecast Uncertainty” discusses
the sources and interpretation of uncertainty in the economic
forecasts and explains the approach used to assess the uncertainty and risks attending the participants’ projections.

Table 2. Average historical projection error ranges
Percentage points
Variable
Change in real GDP1
Unemployment rate1
Total consumer prices2

2012

2013

2014

2015

±0.6
±0.2
±0.5

±1.4
±0.9
±0.9

±1.7
±1.5
±1.1

±1.7
±1.9
±1.0

Note: Error ranges shown are measured as plus or minus the root mean squared
error of projections for 1992 through 2011 that were released in the fall by
various private and government forecasters. As described in the box “Forecast
Uncertainty,” under certain assumptions, there is about a 70 percent probability
that actual outcomes for real GDP, unemployment, and consumer prices will be in
ranges implied by the average size of projection errors made in the past. Further
information may be found in David Reifschneider and Peter Tulip (2007), “Gauging
the Uncertainty of the Economic Outlook from Historical Forecasting Errors,”
Finance and Economics Discussion Series 2007-60 (Washington: Board of
Governors of the Federal Reserve System, November).
1
Definitions of variables are in the general note to table 1.
2
Measure is the overall consumer price index, the price measure that has been
most widely used in government and private economic forecasts. Projection
is percent change, fourth quarter of the previous year to the fourth quarter of
the year indicated.

output arose from the risk that continuation of longterm unemployment might impair the skill level of
the labor force or cause some workers to retire earlier
than would otherwise have been the case, thereby
reducing potential output in the medium term.
A majority of participants reported that they saw the
risks to their forecasts of real GDP growth as
weighted toward the downside and, accordingly, the
risks to their projections of the unemployment rate
as tilted to the upside. The most frequently identified
sources of risk were the situation in Europe, which
many participants thought had the potential to slow
global economic activity further, particularly over the
near term, and issues associated with fiscal policy in
the United States.
Most participants continued to judge the risks to
their projections for inflation as broadly balanced,
with several highlighting the recent stability of inflation expectations. However, four participants saw the
risks to inflation as tilted to the downside, with a
couple of them noting that slack in resource markets
could turn out to be greater than they were anticipating. Three participants saw the risks to inflation as
weighted to the upside in light of concerns about
U.S. fiscal imbalances, the current highly accommodative stance of monetary policy, and uncertainty
about the Committee’s ability to shift to a less
accommodative policy stance when it becomes
appropriate to do so.

Minutes of Federal Open Market Committee Meetings | September

Figure 4. Uncertainty and risks in economic projections
Number of participants

Uncertainty about GDP growth

20
18
16
14
12
10
8
6
4
2

September projections
June projections

Lower

Broadly
similar

Number of participants

Higher

Risks to GDP growth

Weighted to
downside

Broadly
balanced

Number of participants

Uncertainty about the unemployment rate

Lower

Broadly
similar

Risks to the unemployment rate

Weighted to
downside

Higher

Broadly
balanced

Number of participants

Lower

Broadly
similar

Broadly
similar

Weighted to
downside

Higher

20
18
16
14
12
10
8
6
4
2

Broadly
balanced

Weighted to
upside
Number of participants

20
18
16
14
12
10
8
6
4
2

Higher

Weighted to
upside

Risks to PCE inflation

Number of participants

Lower

20
18
16
14
12
10
8
6
4
2

Number of participants

20
18
16
14
12
10
8
6
4
2

Uncertainty about core PCE inflation

Weighted to
upside
Number of participants

20
18
16
14
12
10
8
6
4
2

Uncertainty about PCE inflation

20
18
16
14
12
10
8
6
4
2

September projections
June projections

Risks to core PCE inflation

Weighted to
downside

Broadly
balanced

20
18
16
14
12
10
8
6
4
2

Weighted to
upside

Note: For definitions of uncertainty and risks in economic projections, see the box “Forecast Uncertainty.” Definitions of variables are in the general note to table 1.

249

250

99th Annual Report | 2012

Forecast Uncertainty
The economic projections provided by the members
of the Board of Governors and the presidents of the
Federal Reserve Banks inform discussions of monetary policy among policymakers and can aid public
understanding of the basis for policy actions. Considerable uncertainty attends these projections, however. The economic and statistical models and relationships used to help produce economic forecasts
are necessarily imperfect descriptions of the real
world, and the future path of the economy can be
affected by myriad unforeseen developments and
events. Thus, in setting the stance of monetary
policy, participants consider not only what appears to
be the most likely economic outcome as embodied in
their projections, but also the range of alternative
possibilities, the likelihood of their occurring, and the
potential costs to the economy should they occur.
Table 2 summarizes the average historical accuracy
of a range of forecasts, including those reported in
past Monetary Policy Reports and those prepared by
the Federal Reserve Board’s staff in advance of
meetings of the Federal Open Market Committee.
The projection error ranges shown in the table illustrate the considerable uncertainty associated with
economic forecasts. For example, suppose a participant projects that real gross domestic product (GDP)
and total consumer prices will rise steadily at annual
rates of, respectively, 3 percent and 2 percent. If the
uncertainty attending those projections is similar to
that experienced in the past and the risks around the
projections are broadly balanced, the numbers
reported in table 2 would imply a probability of about
70 percent that actual GDP would expand within a
range of 2.4 to 3.6 percent in the current year, 1.6 to
4.4 percent in the second year, and 1.3 to 4.7 percent
in the third and fourth years. The corresponding

70 percent confidence intervals for overall inflation
would be 1.5 to 2.5 percent in the current year, 1.1 to
2.9 percent in the second year, 0.9 to 3.1 percent in
the third year, and 1.0 to 3.0 percent in the fourth
year.
Because current conditions may differ from those
that prevailed, on average, over history, participants
provide judgments as to whether the uncertainty
attached to their projections of each variable is
greater than, smaller than, or broadly similar to typical levels of forecast uncertainty in the past, as
shown in table 2. Participants also provide judgments
as to whether the risks to their projections are
weighted to the upside, are weighted to the downside, or are broadly balanced. That is, participants
judge whether each variable is more likely to be
above or below their projections of the most likely
outcome. These judgments about the uncertainty
and the risks attending each participant’s projections
are distinct from the diversity of participants’ views
about the most likely outcomes. Forecast uncertainty
is concerned with the risks associated with a particular projection rather than with divergences across a
number of different projections.
As with real activity and inflation, the outlook for the
future path of the federal funds rate is subject to considerable uncertainty. This uncertainty arises primarily
because each participant’s assessment of the appropriate stance of monetary policy depends importantly
on the evolution of real activity and inflation over
time. If economic conditions evolve in an unexpected
manner, then assessments of the appropriate setting
of the federal funds rate would change from that
point forward.

Minutes of Federal Open Market Committee Meetings | October

Meeting Held
on October 23–24, 2012
A meeting of the Federal Open Market Committee
was held in the offices of the Board of Governors of
the Federal Reserve System in Washington, D.C., on
Tuesday, October 23, 2012, at 1:00 p.m. and continued on Wednesday, October 24, 2012, at 9:00 a.m.

Present
Ben Bernanke
Chairman
William C. Dudley
Vice Chairman
Elizabeth Duke
Jeffrey M. Lacker
Dennis P. Lockhart
Sandra Pianalto
Jerome H. Powell
Sarah Bloom Raskin
Jeremy C. Stein
Daniel K. Tarullo
John C. Williams
Janet L. Yellen
James Bullard, Charles L. Evans,
Esther L. George, and Eric Rosengren
Alternate Members of the Federal Open Market
Committee
Richard W. Fisher, Narayana Kocherlakota, and
Charles I. Plosser
Presidents of the Federal Reserve Banks of Dallas,
Minneapolis, and Philadelphia, respectively
William B. English
Secretary and Economist
Deborah J. Danker
Deputy Secretary
Matthew M. Luecke
Assistant Secretary
David W. Skidmore
Assistant Secretary
Michelle A. Smith
Assistant Secretary
Scott G. Alvarez
General Counsel

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Thomas C. Baxter
Deputy General Counsel
Steven B. Kamin
Economist
David W. Wilcox
Economist
David Altig, Thomas A. Connors, Michael P. Leahy,
William Nelson, David Reifschneider,
Mark S. Sniderman, and William Wascher
Associate Economists
Simon Potter
Manager, System Open Market Account
Michael S. Gibson
Director, Division of Banking Supervision and
Regulation, Board of Governors
James A. Clouse
Deputy Director, Division of Monetary Affairs,
Board of Governors
Andreas Lehnert
Deputy Director, Office of Financial Stability Policy
and Research, Board of Governors
Linda Robertson
Assistant to the Board, Office of Board Members,
Board of Governors
Thomas Laubach
Senior Adviser, Division of Research and Statistics,
Board of Governors
Ellen E. Meade, Stephen A. Meyer, and
Joyce K. Zickler
Senior Advisers, Division of Monetary Affairs,
Board of Governors
Eric M. Engen, Michael T. Kiley, and
Michael G. Palumbo
Associate Directors, Division of Research and
Statistics, Board of Governors
Joshua Gallin
Deputy Associate Director, Division of Research and
Statistics, Board of Governors
Marnie Gillis DeBoer
Assistant Director, Division of Monetary Affairs,
Board of Governors
David H. Small
Project Manager, Division of Monetary Affairs,
Board of Governors
Jeremy B. Rudd
Senior Economist, Division of Research and
Statistics, Board of Governors

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99th Annual Report | 2012

Helen E. Holcomb
First Vice President, Federal Reserve Bank of Dallas
Jeff Fuhrer and Loretta J. Mester
Executive Vice Presidents, Federal Reserve Banks of
Boston and Philadelphia, respectively
Troy Davig, Spencer Krane, and Kevin Stiroh
Senior Vice Presidents, Federal Reserve Banks of
Kansas City, Chicago, and New York, respectively
William Gavin, Evan F. Koenig,
Lorie K. Logan, and Paolo A. Pesenti
Vice Presidents, Federal Reserve Banks of St. Louis,
Dallas, New York, and New York, respectively
Thomas D. Tallarini, Jr.
Assistant Vice President, Federal Reserve Bank of
Minneapolis
Andreas L. Hornstein
Senior Advisor, Federal Reserve Bank of Richmond
Eric T. Swanson
Senior Research Advisor, Federal Reserve Bank of
San Francisco

Thresholds and Forward Guidance
A staff presentation focused on the potential effects
of using specific threshold values of inflation and the
unemployment rate to provide forward guidance
regarding the timing of the initial increase in the federal funds rate. The presentation reviewed simulations from a staff macroeconomic model to illustrate
the implications for policy and the economy of
announcing various threshold values that would need
to be attained before the Federal Open Market Committee (FOMC) would consider increasing its target
for the federal funds rate. Meeting participants discussed whether such thresholds might usefully
replace or perhaps augment the date-based guidance
that had been provided in the policy statements since
August 2011. Participants generally favored the use
of economic variables, in place of or in conjunction
with a calendar date, in the Committee’s forward
guidance, but they offered different views on whether
quantitative or qualitative thresholds would be most
effective. Many participants were of the view that
adopting quantitative thresholds could, under the
right conditions, help the Committee more clearly
communicate its thinking about how the likely timing
of an eventual increase in the federal funds rate
would shift in response to unanticipated changes in

economic conditions and the outlook. Accordingly,
thresholds could increase the probability that market
reactions to economic developments would move
longer-term interest rates in a manner consistent with
the Committee’s view regarding the likely future path
of short-term rates. A number of other participants
judged that communicating a careful qualitative
description of the indicators influencing the Committee’s thinking about current and future monetary
policy, or providing more information about the
Committee’s policy reaction function, would be more
informative than either quantitative thresholds or
date-based forward guidance. Several participants
were concerned that quantitative thresholds could
confuse the public by giving the impression that the
FOMC focuses on a small number of economic variables in setting monetary policy, when the Committee
in fact uses a wide range of information. Some other
participants worried that the public might mistakenly
interpret quantitative thresholds as equivalent to the
Committee’s longer-run objectives or as triggers that,
when reached, would prompt an immediate rate
increase; but it was noted that the Chairman’s postmeeting press conference and other venues could be
used to explain the distinction between thresholds
and these other concepts.
Participants generally agreed that the Committee
would need to resolve a number of practical issues
before deciding whether to adopt quantitative thresholds to communicate its thinking about the timing of
the initial increase in the federal funds rate. These
issues included whether to specify such thresholds in
terms of realized or projected values of inflation and
the unemployment rate and, in either case, what values for those thresholds would best balance the Committee’s objectives of promoting maximum employment and price stability. Another open question was
whether to supplement thresholds expressed in terms
of the unemployment rate and inflation with additional indicators of economic and financial conditions that might signal a need either to raise the federal funds rate before a threshold is crossed or to
delay until well afterward. A final question was
whether the statement should also provide forward
guidance about the likely path of the federal funds
rate after the initial increase. It was noted that such
guidance could have significant effects on financial
conditions and the economy. At the conclusion of
the discussion, the Chairman asked the staff to pro-

Minutes of Federal Open Market Committee Meetings | October

vide additional background material, taking into
account the range of participants’ views.

Developments in Financial Markets and
the Federal Reserve’s Balance Sheet
The Manager of the System Open Market Account
(SOMA) reported on developments in domestic and
foreign financial markets during the period since the
FOMC met on September 12–13, 2012. The Manager also reported on System open market operations
over the intermeeting period, focusing on the ongoing reinvestment into agency-guaranteed mortgagebacked securities (MBS) of principal payments
received on SOMA holdings of agency debt and
agency-guaranteed MBS and the purchases of MBS
authorized at the September FOMC meeting. By
unanimous vote, the Committee ratified the Desk’s
domestic transactions over the intermeeting period.
There were no intervention operations in foreign currencies for the System’s account over the intermeeting period.

Staff Review of the Economic Situation
The information reviewed at the October 23–24 meeting suggested that economic activity continued to
increase at a moderate pace in recent months. The
unemployment rate declined but was still elevated.
Consumer price inflation picked up, reflecting higher
consumer energy costs, but longer-run inflation
expectations remained stable.
Private nonfarm employment expanded modestly in
September, and government employment increased.
The unemployment rate fell to 7.8 percent, and the
labor force participation rate rose slightly. The share
of workers employed part time for economic reasons
increased somewhat and continued to be elevated,
while the rate of long-duration unemployment edged
down further but remained high. Other indicators of
labor market conditions, such as surveys of firms’
job openings and hiring plans and initial claims for
unemployment insurance, did not show decided
improvement over the intermeeting period.
Manufacturing production declined in the third
quarter, and the rate of manufacturing capacity utilization edged down. Automakers’ schedules pointed
to a similar rate of motor vehicle assemblies in the
fourth quarter as in the third quarter. Broader indicators of factory production, such as the diffusion
indexes of new orders from the national and regional

253

manufacturing surveys, remained subdued in recent
months at levels consistent with only tepid increases
in manufacturing output in the near term.
Real personal consumption expenditures rose at a
solid pace in August. In September, nominal retail
sales, excluding purchases at motor vehicle and parts
outlets, increased considerably. Light motor vehicle
sales also expanded. Recent data on factors that tend
to support household spending were mixed. Real disposable income declined in August, largely reflecting
the effect of higher consumer energy prices. In contrast, consumer sentiment rose in September and
early October, and continued modest increases in
house prices added to households’ net worth.
Housing market conditions improved more generally
in recent months. Starts and permits of both new
single-family homes and multifamily units picked up
in August and September. However, construction
activity remained at a relatively low level, reflecting
the restraint imposed by tight credit standards for
mortgage borrowing and by the large inventory of
foreclosed and distressed properties. Sales of existing
homes continued to expand, on balance, in recent
months, but new home sales were flat.
Real business expenditures on equipment and software appeared to edge down in the third quarter.
Nominal shipments for nondefense capital goods
excluding aircraft continued to decrease in August;
the backlog of unfilled orders for these capital goods
also declined. Other forward-looking indicators, such
as subdued readings from surveys of business conditions and capital spending plans, also pointed toward
roughly flat real expenditures for business equipment
in the near term. Nominal business spending for new
nonresidential construction decreased further in
August. Meanwhile, inventories in most industries
were about in line with sales. In the farm sector, however, drought conditions likely reduced inventory
accumulation last quarter and subtracted from overall economic growth.
Real federal government purchases appeared to edge
up in the third quarter, as data for nominal federal
spending in August and September pointed to a
slight increase in real defense expenditures. Real state
and local government purchases likely moved essentially sideways in the third quarter. State and local
government payrolls expanded, but nominal construction spending continued to decline in recent
months.

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99th Annual Report | 2012

The U.S. international trade deficit widened in
August, as imports fell less than exports. Imports
edged down, on net, with higher purchases of services and petroleum products more than offset by
declines in all of the other major categories. Across
export categories, exports of industrial supplies
posted a particularly large decline, as the volume of
petroleum product exports dropped sharply.
Consumer prices picked up in August and September, primarily reflecting sharp increases in retail gasoline prices. However, survey data indicated that retail
gasoline prices were about flat in early October. Consumer food prices rose modestly in recent months.
The somewhat better-than-expected crop harvest
caused spot and futures prices of farm commodities
to retrace some of their rise during the summer; however, farm commodity prices remained elevated and
continued to point toward some temporary upward
pressures on retail food prices later this year.
Increases in consumer prices excluding food and
energy were subdued in August and September.
Near-term inflation expectations from the Thomson
Reuters/University of Michigan Surveys of Consumers declined in September and early October, while
longer-term inflation expectations in the survey
moved down to near the lower end of the narrow
range where they have remained for some time.
Available measures of labor compensation indicated
that increases in nominal wages stayed relatively
modest. The gains in average hourly earnings for all
employees in the third quarter were subdued.
Foreign economic growth remained sluggish,
restrained by weak activity in Europe and the associated spillovers—including through trade—to the rest
of the world. Euro-area production indicators signaled continued contraction, and the area’s unemployment rate in August stayed at a historical high.
In Japan, exports and output declined in the summer
months, and growth of real gross domestic product
(GDP) for the first half of the year was revised down
significantly. Data for exports from emerging market
economies, especially in Asia, showed a drop,
although recently released data for China indicated a
pickup in economic activity in the third quarter. Foreign inflation rose slightly in some emerging market
economies in response to higher food prices but was
still generally well contained. Monetary policy
remained accommodative in most advanced and
emerging market economies.

Staff Review of the Financial Situation
Market participants reportedly read the September
FOMC statement as pointing to a significant
increase in monetary policy accommodation. As a
result, financial conditions generally eased appreciably early in the intermeeting period. However, toward
the end of the period investor sentiment deteriorated
somewhat, in part because of concerns about corporate profitability.
Short- and medium-term nominal Treasury yields
ended the intermeeting period up slightly, and longterm yields were about unchanged on net. At the
same time, real yields on Treasury inflation-protected
securities (TIPS) decreased somewhat, leaving inflation compensation higher. In part, the rise in inflation compensation may have reflected upward pressure on nominal Treasury yields associated with some
unwinding of safe-haven demands.
The expected path of the federal funds rate based on
money market futures was little changed between the
September and October FOMC meetings. Marketbased measures of uncertainty about the path of the
federal funds rate over medium-to-long horizons
declined over the period. The survey of primary dealers conducted prior to the October meeting showed
that the expected size of the SOMA at the end of
2013 had risen significantly.
Indicators of the condition of domestic financial
institutions were mixed over the intermeeting period.
Indexes of equity prices for those institutions were
modestly lower. But spreads on credit default swaps
for large financial institutions declined in recent
months, and third-quarter earnings of large bank
holding companies that had reported by the time of
the FOMC meeting were generally in line with
expectations.
Conditions in unsecured dollar funding markets
appeared to improve some. In secured funding markets, rates on repurchase agreements spiked around
quarter-end but subsequently more than retraced
that move, ending the intermeeting period down
slightly.
Broad equity price indexes were a little lower, on balance, as gains following the September FOMC meeting and generally better-than-expected economic data
releases were more than offset by concerns about cor-

Minutes of Federal Open Market Committee Meetings | October

porate profitability. Option-implied volatility for the
S&P 500 index fell noticeably following the September FOMC meeting but increased, on net, over the
intermeeting period.
Yields on investment-grade corporate bonds reached
a record low level, and their spreads to yields on
comparable-maturity Treasury securities narrowed
on net. Yields and spreads on speculative-grade corporate bonds also decreased.
The pace of investment- and speculative-grade bond
issuance by nonfinancial firms picked up significantly in September from the already robust pace in
previous months. In the syndicated leveraged loan
market, issuance through the first three quarters of
2012 lagged that of the same period in 2011 but
nonetheless remained solid. The pace of gross public
equity issuance by nonfinancial firms moved up some
in September from the subdued levels observed in
prior months, but overall issuance in the third quarter stayed low compared with the first half of 2012.
Financial conditions in the commercial real estate
sector remained weak amid elevated vacancy and
delinquency rates. However, some indicators pointed
to modest improvement in this sector, and issuance of
commercial mortgage-backed securities was solid in
the third quarter.
Residential mortgage rates declined over the intermeeting period. The decline in mortgage rates
reflected a sizable drop in MBS yields following the
September FOMC statement. Refinancing activity
increased further in September and early October.
House prices continued to rise, and some indicators
of credit quality on residential real estate loans
improved. The fraction of seriously delinquent existing mortgages remained elevated, but the rate at
which mortgages entered delinquency continued to
trend down in July.
Consumer credit expanded briskly in August. Nonrevolving credit continued to increase at a robust pace,
mainly reflecting growth in student and auto loans.
Revolving credit also rose in August but was little
changed, on balance, over the past few months.
Delinquency rates for consumer credit remained low,
and issuance of consumer asset-backed securities was
strong in the third quarter, close to the pace seen earlier this year.
Bank credit continued to expand at a moderate rate
in the third quarter, with further growth in loans aug-

255

mented by larger gains in securities holdings. Results
from the October Senior Loan Officer Opinion Survey on Bank Lending Practices indicated that modest
fractions of domestic banks, on net, continued to
report having eased their lending standards on some
categories of business and household loans. In addition, for the second straight quarter, reports of
stronger demand were relatively widespread for many
types of loans.
M2 growth picked up somewhat in September, as
strong growth in liquid deposits and currency offset
ongoing declines in small time deposits and retail
money market funds.
The staff’s broad nominal index of the foreign
exchange value of the dollar was little changed, on
net, over the intermeeting period. The dollar rose
against the currencies of most advanced economies
but declined against the euro and most Asian emerging market currencies. Of note, the Chinese renminbi
appreciated further against the dollar. A number of
central banks eased monetary policy during the
period, including those of Australia, Brazil, Japan,
Korea, and Thailand. Foreign equity indexes, which
generally rose following the September FOMC statement, ended the intermeeting period higher in most
markets, although stock prices in the euro area were
down on net. Ten-year sovereign yields in Germany
and the United Kingdom moved down just a few
basis points. After declining significantly between
late July and early September, the yield spread of
10-year sovereign debt in Italy over comparable German bunds declined only slightly further over the
intermeeting period, and the Spanish sovereign
spread edged up.

Staff Economic Outlook
In the economic forecast prepared by the staff for the
October FOMC meeting, real GDP growth in the
near term was revised up relative to the previous projection. The upward revision to the near-term forecast primarily reflected better-than-expected incoming information for consumer spending, residential
construction, and labor market conditions that more
than offset the recent data for business fixed investment and industrial production that were weaker
than anticipated. The staff’s medium-term projection
for real GDP growth also was revised up, mostly
reflecting the monetary policy actions announced by
the FOMC after the September meeting and the
resulting improved outlook for financial conditions.
Nonetheless, with fiscal policy assumed to be tighter

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99th Annual Report | 2012

next year than this year, the staff anticipated that real
GDP growth would not materially exceed increases in
potential output in 2013. In 2014, economic activity
was projected to accelerate gradually, supported by a
lessening in fiscal policy restraint, gains in consumer
and business confidence, further improvements in
financial conditions and credit availability, and
accommodative monetary policy. Progress in reducing unemployment over the projection period was
expected to be relatively slow.
The staff’s near-term forecast for inflation was little
changed, on balance, from the projection prepared
for the September FOMC meeting, notwithstanding
recent increases in consumer energy prices. The
staff’s projection for inflation over the medium term
was also essentially unchanged. Crude oil prices were
anticipated to decline slowly from their current levels,
the boost to retail food prices from the drought was
expected to be only temporary and relatively small,
long-run inflation expectations were assumed to
remain stable, and significant resource slack was projected to persist over the projection period. As a
result, the staff continued to forecast that inflation
would be subdued through 2014.

Participants’ Views on Current Conditions
and the Economic Outlook
In their discussion of the economic situation and the
outlook, meeting participants viewed the information
received since the Committee met in September as
indicating that economic activity continued to
expand at a moderate pace. Employment was still rising slowly, and the unemployment rate remained
elevated. Household spending advanced more
quickly in recent months than during the spring, and
housing activity showed further signs of improvement. However, business fixed investment slowed
noticeably. Inflation recently picked up somewhat,
reflecting higher energy prices, while longer-run inflation expectations remained stable.
Participants generally saw the economic outlook as
little changed, on balance, from their projections prepared for the September Summary of Economic Projections (SEP), agreeing that the pace of the economic recovery was likely to stay moderate over coming quarters. The recent news on household
spending, consumer sentiment, and the housing market was encouraging, and most participants expected
that highly accommodative monetary policy would

provide support for the recovery in the period ahead.
However, many participants saw the uncertainty
attending the unresolved U.S. fiscal situation and the
ongoing fiscal and financial strains in the euro area
as factors likely to restrain the pace of economic
growth in coming months. Moreover, many participants cited significant downside risks to the outlook
that might arise from more widespread weakness in
global economic activity or an intensification of
strains in global financial markets. Regarding inflation, the recent run-up in consumer energy prices was
expected to subside over the next few months, while
the effects of the drought were likely to show through
to retail food prices. Over the medium term, most
participants anticipated that inflation would run at
or below the Committee’s 2 percent objective.
Concerning developments in the household sector,
participants observed that the recent news on consumer spending and confidence had been positive,
with surveys reporting that households had become
noticeably more optimistic about the outlook for
unemployment and income. Sales of motor vehicles
remained an area of strength, in part due to favorable credit conditions. The increase in consumer
spending appeared to be relatively broadly based
across the country, although retailers in a few areas
reported that they had seen slower sales recently and
expressed concerns about the near-term outlook.
Among the factors mentioned that might support
consumer confidence and a continuation of the
somewhat stronger pace of spending were an
expected decline in retail energy prices and continued
gradual improvement in labor market conditions. In
addition, lower mortgage rates had spurred a rise in
refinancing activity, which, along with the increases
in household wealth attributable to higher home values and equity prices, would provide support for consumer spending going forward.
Participants generally agreed that a recovery in housing activity now appeared to be under way, citing
increases in house prices, sales, and construction in
many areas. Most saw the low levels of mortgage
interest rates as an important factor contributing to
increased housing demand. Although the recovery in
the housing sector appeared to be taking hold, several participants cited obstacles to more rapid
improvement. For example, several participants
reported that lenders’ capacity for processing homepurchase mortgages was tight and backlogs were
long, in part due to the current heavy pace of refi-

Minutes of Federal Open Market Committee Meetings | October

nancings. These participants also noted that underwriting standards remained quite tight, particularly
for borrowers with lower credit quality.
In contrast to the more favorable news on consumer
spending and housing, contacts generally reported
slower activity in the business sector. Some participants expressed concern about weaker manufacturing
output and new orders in recent months, particularly
in capital goods industries, although several pointed
out that manufacturers’ expectations for future
orders and production were more positive. A few participants noted that shipping activity was down, and
one participant added that energy production had
decelerated. In contrast, a few participants had
received reports of a pickup in nonresidential construction, and one indicated that high-tech firms
were expecting gains in business going forward. In
many instances, participants’ business contacts stated
that they were delaying or cutting back on hiring and
capital spending because of the uncertain outlook for
government spending, taxes, or regulatory policies.
One participant, however, reported that contacts said
that insufficient demand remained their principal
concern. Several participants mentioned that the cautious posture of businesses was apparent in national
and regional surveys of plans of both large and small
firms. Some participants noted that the outlook for
business spending would likely be difficult to assess
until the direction of U.S. fiscal policy becomes
clearer. A few suggested the possibility that a nearterm resolution of the fiscal situation might lead to a
significant increase in spending as projects now being
deferred were undertaken; another worried that the
uncertainty attending the outlook for fiscal policy
might weigh on business planning for some time. In
addition to the uncertainty about the fiscal outlook,
manufacturing contacts attributed the weakness in
orders and production to softer export demand; one
participant added that agricultural exports had also
softened. Several participants noted that their contacts were concerned not only about the economic
slowdown in Europe, but also about whether the
recent slowing in economic activity in Asia might
persist.
In their comments on labor market developments,
participants generally viewed the recent decline in the
unemployment rate and continued modest gains in
payroll employment, taken together, as consistent
with a gradually improving job market. However,
with economic growth anticipated to stay moderate,
some participants expressed concern that the pace of
job creation would generate only a slow decline in

257

joblessness. Several pointed to a steep drop in the
index of hiring plans by small businesses. A couple of
participants mentioned that some firms planned to
increase their use of part-time or temporary workers
rather than full-time permanent employees, at least
partly in order to limit health insurance costs.
Participants saw recent price developments as consistent with inflation remaining at or below the Committee’s 2 percent objective over the medium run.
Although energy prices had risen sharply in recent
months, reflecting earlier increases in crude oil costs
and supply disruptions, gasoline prices were anticipated to move back down in coming months as those
pressures eased. Similarly, effects of the drought were
expected to show through to retail food prices over
the next few quarters but then subside. By various
estimates, underlying inflation trends remained subdued, and indicators of longer-term inflation expectations were generally viewed as stable.
In their discussion of financial developments over the
intermeeting period, participants commented on the
effects of the policy actions taken at the September
meeting to strengthen the Committee’s forward guidance and to purchase additional MBS. The initial
effects were generally viewed as consistent with a
marked easing in financial conditions. For example,
yields on MBS dropped noticeably, leading to a
decline in mortgage interest rates, and corporate
bond yields generally moved lower. Yields on nominal Treasury securities were little changed. Some participants suggested that more time would be required
to assess the ultimate effects of the additional MBS
purchases on primary mortgage rates and on financial conditions more broadly. The stability in nominal
Treasury yields, paired with a decline in TIPS yields,
implied a modest increase in inflation compensation,
on net, over the intermeeting period. A couple of
participants saw this increase as a sign that the openended asset purchases posed a risk to the stability of
longer-term inflation expectations. However, others
saw the effect on expected inflation as relatively
muted or likely the result of reduced risks of undesirably low inflation. Participants remained concerned
about risks to financial markets associated with the
situation in the euro area and uncertain U.S. fiscal
prospects, but a couple noted that measures of financial market uncertainty were still relatively low. Several participants pointed out that recent policy
announcements by the European Central Bank were
received favorably in markets. A number of participants mentioned other signs of greater optimism in
financial markets, including a rise in merger and

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99th Annual Report | 2012

acquisition activity and a moderation in pressures on
large U.S. financial institutions. A few participants
observed that low interest rates had increased
demand for riskier financial products, and a couple
of participants saw a risk that holding interest rates
low for a prolonged period could lead to financial
imbalances and imprudent risk-taking. One participant, however, commented that risk aversion still
seemed quite high, citing the very low yields on
longer-term TIPS and a large estimated risk premium
in equity markets.
Participants also discussed the efficacy and potential
costs of the Committee’s asset purchases. A number
of participants offered the assessment that the Committee’s policy actions, to date, had been effective in
making financial conditions more accommodative
and that lower interest rates were providing support
to aggregate spending, most notably in areas such as
housing, autos, and other consumer durables. In particular, some pointed out that the favorable developments in mortgage markets over the intermeeting
period suggested that the MBS purchases were likely
to reinforce the nascent recovery in the housing market. Several added that, based on the experience with
earlier asset purchases, the broader effects on economic activity from more-accommodative financial
conditions were likely to accrue over time. Looking
ahead, a number of participants indicated that additional asset purchases would likely be appropriate
next year after the conclusion of the maturity extension program in order to achieve a substantial
improvement in the labor market. In that regard, a
couple of participants noted the likely usefulness of
clarifying the range of indicators that would be
evaluated in assessing the outlook for the labor market. Participants generally agreed that in determining
the appropriate size, pace, and composition of further purchases, they would need to carefully assess
the efficacy of asset purchases in fostering stronger
economic activity and consider the potential risks
and costs of such purchases. Several participants
questioned the effectiveness of the current purchases
or whether a continuation of them would be warranted if the recent moderate pace of economic
recovery were sustained. In addition, several participants expressed concerns that sizable asset purchases
might eventually have adverse consequences for the
functioning of asset markets or that they might complicate the Committee’s ability to remove policy
accommodation at the appropriate time and normalize the size and composition of the Federal Reserve’s
balance sheet. A couple of participants noted that an

extended period of policy accommodation posed an
upside risk to inflation.

Committee Policy Action
Members viewed the information on U.S. economic
activity received over the intermeeting period as suggesting that the economy was, on balance, expanding
moderately, with a pickup in household spending and
further improvement in housing markets offset to
some extent by a slowdown in the business sector.
Although the unemployment rate declined in recent
months, monthly gains in nonfarm payroll jobs
remained modest, and many members noted that,
without sufficient policy accommodation, economic
growth might not be strong enough to generate sustained improvement in the labor market. Inflation
rose recently because of a temporary run-up in
energy prices. However, longer-term inflation expectations were stable, and over the medium run, inflation was anticipated to run at or below the Committee’s 2 percent objective.
In their discussion of monetary policy for the period
ahead, Committee members generally agreed that
their overall assessments of the economic outlook
were little changed since their previous meeting.
Accordingly, all but one member judged that maintaining the current, highly accommodative stance of
monetary policy was warranted in order to foster a
stronger economic recovery in a context of price stability. The Committee judged that continuing both
the purchases of MBS at a pace of $40 billion per
month and the existing program to extend the average maturity of its Treasury securities holdings
remained appropriate. The Committee also agreed to
maintain its policy of reinvesting principal payments
from its holdings of agency debt and agency MBS
into agency MBS. One member opposed further asset
purchases because he viewed them as unlikely to help
the Committee achieve its goals and because he
thought that purchases of MBS represented inappropriate credit allocation. Many members saw the
adjustments in the Committee’s forward guidance at
the September meeting as having been effective in
communicating its intention to maintain a highly
accommodative stance of monetary policy for a considerable time after the economic recovery strengthens and judged that the guidance remained appropriate at this meeting. However, one member continued
to object to the calendar-date-based forward guidance for the federal funds rate. With respect to the
statement to be released following the meeting, mem-

Minutes of Federal Open Market Committee Meetings | October

bers made only relatively small modifications to
update the description of recent developments in
consumer and business spending and in inflation.
With the economic outlook little changed, they
agreed that the remainder of the statement would
reiterate the policy actions and intentions adopted at
the September meeting.
At the conclusion of the discussion, the Committee
voted to authorize and direct the Federal Reserve
Bank of New York, until it was instructed otherwise,
to execute transactions in the System Account in
accordance with the following domestic policy
directive:
“The Federal Open Market Committee seeks
monetary and financial conditions that will foster price stability and promote sustainable
growth in output. To further its long-run objectives, the Committee seeks conditions in reserve
markets consistent with federal funds trading in
a range from 0 to ¼ percent. The Committee
directs the Desk to continue the maturity extension program it announced in June to purchase
Treasury securities with remaining maturities of
6 years to 30 years with a total face value of
about $267 billion by the end of December 2012, and to sell or redeem Treasury securities with remaining maturities of approximately
3 years or less with a total face value of about
$267 billion. For the duration of this program,
the Committee directs the Desk to suspend its
policy of rolling over maturing Treasury securities into new issues. The Committee directs the
Desk to maintain its existing policy of reinvesting principal payments on all agency debt and
agency mortgage-backed securities in the System
Open Market Account in agency mortgagebacked securities. The Desk is also directed to
continue purchasing agency mortgage-backed
securities at a pace of about $40 billion per
month. The Committee directs the Desk to
engage in dollar roll and coupon swap transactions as necessary to facilitate settlement of the
Federal Reserve’s agency MBS transactions. The
System Open Market Account Manager and the
Secretary will keep the Committee informed of
ongoing developments regarding the System’s
balance sheet that could affect the attainment
over time of the Committee’s objectives of
maximum employment and price stability.”
The vote encompassed approval of the statement
below to be released at 2:15 p.m.:

259

“Information received since the Federal Open
Market Committee met in September suggests
that economic activity has continued to expand
at a moderate pace in recent months. Growth in
employment has been slow, and the unemployment rate remains elevated. Household spending
has advanced a bit more quickly, but growth in
business fixed investment has slowed. The housing sector has shown some further signs of
improvement, albeit from a depressed level.
Inflation recently picked up somewhat, reflecting
higher energy prices. Longer-term inflation
expectations have remained stable.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment
and price stability. The Committee remains concerned that, without sufficient policy accommodation, economic growth might not be strong
enough to generate sustained improvement in
labor market conditions. Furthermore, strains in
global financial markets continue to pose significant downside risks to the economic outlook.
The Committee also anticipates that inflation
over the medium term likely would run at or
below its 2 percent objective.
To support a stronger economic recovery and to
help ensure that inflation, over time, is at the
rate most consistent with its dual mandate, the
Committee will continue purchasing additional
agency mortgage-backed securities at a pace of
$40 billion per month. The Committee also will
continue through the end of the year its program to extend the average maturity of its holdings of Treasury securities, and it is maintaining
its existing policy of reinvesting principal payments from its holdings of agency debt and
agency mortgage-backed securities in agency
mortgage-backed securities. These actions,
which together will increase the Committee’s
holdings of longer-term securities by about
$85 billion each month through the end of the
year, should put downward pressure on longerterm interest rates, support mortgage markets,
and help to make broader financial conditions
more accommodative.
The Committee will closely monitor incoming
information on economic and financial developments in coming months. If the outlook for the
labor market does not improve substantially, the
Committee will continue its purchases of agency
mortgage-backed securities, undertake addi-

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99th Annual Report | 2012

tional asset purchases, and employ its other
policy tools as appropriate until such improvement is achieved in a context of price stability.
In determining the size, pace, and composition
of its asset purchases, the Committee will, as
always, take appropriate account of the likely
efficacy and costs of such purchases.
To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative
stance of monetary policy will remain appropriate for a considerable time after the economic
recovery strengthens. In particular, the Committee also decided today to keep the target range
for the federal funds rate at 0 to ¼ percent and
currently anticipates that exceptionally low levels
for the federal funds rate are likely to be warranted at least through mid-2015.”
Voting for this action: Ben Bernanke, William C.
Dudley, Elizabeth Duke, Dennis P. Lockhart, Sandra
Pianalto, Jerome H. Powell, Sarah Bloom Raskin,
Jeremy C. Stein, Daniel K. Tarullo, John C. Williams,
and Janet L. Yellen.
Voting against this action: Jeffrey M. Lacker.
Mr. Lacker dissented for the same reasons he had
cited at the September FOMC meeting, including his
view of the likely ineffectiveness of asset purchases
and their potential inflationary effects, as well as the
inappropriateness of credit allocation inherent in
purchasing MBS. He also continued to disagree with
the description of the time period over which a
highly accommodative stance of monetary policy
would remain appropriate and exceptionally low levels for the federal funds rate were likely to be
warranted.

Discussion of Communications regarding
Economic Projections
A staff presentation reviewed the results of the consensus forecast experiments that the Committee con-

ducted in conjunction with its August and September
meetings. The briefing highlighted the important role
of the assumed path for monetary policy in constructing a consensus forecast and reviewed several
alternative approaches for setting such a path. As a
possible alternative to a consensus forecast, the staff
presentation also discussed potential enhancements
to the SEP. In their discussion, participants agreed
that FOMC communications could be enhanced by
clarifying the linkage between participants’ economic
forecasts, including the underlying policy assumptions, and the Committee’s policy decision as
expressed in the postmeeting statement. However,
most participants judged that, given the diversity of
their views about the economy’s structure and
dynamics, it would be difficult for the Committee to
agree on a fully specified longer-term path for monetary policy to incorporate into a quantitative consensus forecast in a timely manner, especially under
present conditions in which the policy decision comprises several elements. Participants agreed to continue to explore ways to increase transparency and
clarity in the Committee’s policy communications,
and they indicated a willingness to look into modifications to the SEP. At the end of the discussion, the
Chairman asked the subcommittee on communications to explore potential approaches to providing
more information about the Committee’s collective
judgment regarding the economic outlook and
appropriate monetary policy through the SEP.
It was agreed that the next meeting of the Committee
would be held on Tuesday–Wednesday, December 11–12, 2012. The meeting adjourned at 12:50
p.m. on October 24, 2012.

Notation Vote
By notation vote completed on October 3, 2012, the
Committee unanimously approved the minutes of the
FOMC meeting held on September 12–13, 2012.
William B. English
Secretary

Minutes of Federal Open Market Committee Meetings | December

Meeting Held
on December 11–12, 2012
A meeting of the Federal Open Market Committee
was held in the offices of the Board of Governors of
the Federal Reserve System in Washington, D.C., on
Tuesday, December 11, 2012, at 11:00 a.m. and continued on Wednesday, December 12, 2012, at
8:30 a.m.

Present
Ben Bernanke
Chairman
William C. Dudley
Vice Chairman
Elizabeth Duke
Jeffrey M. Lacker
Dennis P. Lockhart
Sandra Pianalto
Jerome H. Powell
Sarah Bloom Raskin
Jeremy C. Stein
Daniel K. Tarullo
John C. Williams
Janet L. Yellen
James Bullard, Christine Cumming, Charles L. Evans,
Esther L. George, and Eric Rosengren
Alternate Members of the Federal Open Market
Committee
Richard W. Fisher, Narayana Kocherlakota, and
Charles I. Plosser
Presidents of the Federal Reserve Banks of Dallas,
Minneapolis, and Philadelphia, respectively
William B. English
Secretary and Economist
Deborah J. Danker
Deputy Secretary
Matthew M. Luecke
Assistant Secretary
Michelle A. Smith
Assistant Secretary
Scott G. Alvarez
General Counsel

261

Steven B. Kamin
Economist
David W. Wilcox
Economist
David Altig, Thomas A. Connors,
Michael P. Leahy, William Nelson,
David Reifschneider, and William Wascher
Associate Economists
Simon Potter
Manager, System Open Market Account
Nellie Liang
Director, Office of Financial Stability Policy and
Research, Board of Governors
Jon W. Faust
Special Advisor to the Board, Office of Board
Members, Board of Governors
James A. Clouse and Stephen A. Meyer
Deputy Directors, Division of Monetary Affairs,
Board of Governors
Maryann F. Hunter
Deputy Director, Division of Banking Supervision
and Regulation, Board of Governors
Linda Robertson
Assistant to the Board, Office of Board Members,
Board of Governors
Ellen E. Meade and Joyce K. Zickler
Senior Advisers, Division of Monetary Affairs,
Board of Governors
Eric M. Engen, Thomas Laubach, and
David E. Lebow
Associate Directors, Division of Research and
Statistics, Board of Governors
Michael T. Kiley1
Associate Director, Office of Financial Stability
Policy and Research, Board of Governors
Joshua Gallin
Deputy Associate Director, Division of Research and
Statistics, Board of Governors
Jane E. Ihrig
Deputy Associate Director, Division of Monetary
Affairs, Board of Governors
Beth Anne Wilson
Deputy Associate Director, Division of International
Finance, Board of Governors
1

Attended Tuesday’s session only.

262

99th Annual Report | 2012

David H. Small
Project Manager, Division of Monetary Affairs,
Board of Governors
Jennifer E. Roush
Senior Economist, Division of Monetary Affairs,
Board of Governors
Marie Gooding
First Vice President, Federal Reserve Bank of Atlanta
Loretta J. Mester and Daniel G. Sullivan
Executive Vice Presidents, Federal Reserve Banks of
Philadelphia and Chicago, respectively
Troy Davig, Mark E. Schweitzer, Geoffrey Tootell,
Christopher J. Waller, and Kei-Mu Yi
Senior Vice Presidents, Federal Reserve Banks of
Kansas City, Cleveland, Boston, St. Louis, and
Minneapolis, respectively
Mary Daly
Group Vice President, Federal Reserve Bank of
San Francisco
Evan F. Koenig, Lorie K. Logan, Julie Ann Remache,
Alexander L. Wolman, and Nathaniel Wuerffel
Vice Presidents, Federal Reserve Banks of Dallas,
New York, New York, Richmond, and New York,
respectively
Argia M. Sbordone
Assistant Vice President, Federal Reserve Bank of
New York

Developments in Financial Markets and
the Federal Reserve’s Balance Sheet
The Manager of the System Open Market Account
(SOMA) reported on developments in domestic and
foreign financial markets during the period since the
Federal Open Market Committee (FOMC) met on
October 23–24, 2012. He also reported on System
open market operations over the intermeeting period,
including the ongoing reinvestment into agencyguaranteed mortgage-backed securities (MBS) of
principal payments received on SOMA holdings of
agency debt and agency-guaranteed MBS; the operations related to the maturity extension program
authorized at the June 19–20, 2012, FOMC meeting;
and the purchases of MBS authorized at the September 12–13, 2012, FOMC meeting. By unanimous
vote, the Committee ratified the Open Market Desk’s
domestic transactions over the intermeeting period.
There were no intervention operations in foreign currencies for the System’s account over the intermeeting period.

The Committee considered a proposal to extend its
liquidity swap arrangements with foreign central
banks past February 1, 2013. All but one member
approved the following resolution:
“The Federal Open Market Committee directs
the Federal Reserve Bank of New York to
extend the existing temporary dollar liquidity
swap arrangements with the Bank of Canada,
the Bank of England, the Bank of Japan, the
European Central Bank, and the Swiss National
Bank through February 1, 2014. In addition, the
Federal Open Market Committee directs the
Federal Reserve Bank of New York to extend
the existing temporary foreign currency liquidity
swap arrangements with the Bank of Canada,
the Bank of England, the Bank of Japan, the
European Central Bank, and the Swiss National
Bank through February 1, 2014.”
Mr. Lacker dissented because of his opposition to
arrangements that support Federal Reserve lending
in foreign currencies, which he viewed as amounting
to fiscal policy.

Options for the Continuation of Asset
Purchases
The staff reviewed several options for purchasing
longer-term securities after the planned completion
at the end of the month of the maturity extension
program. The presentation focused on the potential
effects for the U.S. economy, based in part on simulations of a staff macroeconomic model, and for the
Federal Reserve’s balance sheet and income of continuing to buy MBS and longer-term Treasury securities over various time frames. In their discussion of
the staff presentation, some participants asked about
the possible consequences of the alternative purchase
programs for the expected path of Federal Reserve
remittances to the Treasury Department, and a few
indicated the need for additional consideration of the
implications of such purchases for the eventual normalization of the stance of monetary policy and the
size and composition of the Federal Reserve’s balance sheet.

Staff Review of the Economic Situation
The information reviewed at the December 11–12
meeting indicated that economic activity continued
to increase at a moderate pace in recent months.
Employment expanded further, and the unemployment rate declined slightly, on balance, from Septem-

Minutes of Federal Open Market Committee Meetings | December

ber to November but was still elevated. Consumer
price inflation slowed as consumer energy costs fell,
while measures of longer-run inflation expectations
remained stable.
Private nonfarm employment increased at a slightly
faster rate in October and November than in the
third quarter, but government employment decreased
somewhat. The unemployment rate declined to
7.7 percent in November, and the labor force participation rate in that month was at the same level as in
the third quarter. The relatively large share of workers employed part time for economic reasons trended
up a bit, on net, while the share of long-duration
unemployment in total unemployment was essentially
flat and remained elevated. Indicators of firms’ job
openings and hiring plans were little changed on balance. Initial claims for unemployment insurance were
boosted in early November by the effects of Hurricane Sandy but returned within weeks to a level that
was about the same as before the hurricane.
Manufacturing production declined in October, as
output was held down at the end of the month by the
disruptions and damage caused by Hurricane Sandy;
the rate of manufacturing capacity utilization also
declined. Automakers’ schedules indicated that the
pace of motor vehicle assemblies would rise somewhat in the coming months. Broader indicators of
factory output, such as the diffusion indexes of new
orders from the national and regional manufacturing
surveys, continued to be subdued at levels consistent
with only small gains in production in the near term.
Real personal consumption expenditures rose at a
modest pace in the third quarter, but spending
declined in October, likely in response in part to some
disruptions caused by the hurricane. Probably reflecting those disruptions, sales of light motor vehicles fell
in October but then increased notably in November.
Some factors that tend to influence household spending became less supportive: Real disposable personal
income moved up only slightly in the third quarter
and declined in October. Moreover, consumer sentiment fell back in early December to about its level
during the summer. In contrast, household net worth
increased in the third quarter, partially a result of
higher equity and home values.
Conditions in the housing market continued to
improve gradually, but construction activity was still
at a low level, restrained by the considerable inventory of foreclosed and distressed homes and the tight
credit standards for mortgages. Starts and permits of

263

new single-family homes were essentially flat in October after rising significantly in the preceding month.
Starts of new multifamily units rose in October,
although permits declined somewhat following their
brisk increase in the previous month. Meanwhile,
home prices advanced further and sales of existing
homes continued to expand, but new home sales were
little changed.
Real business expenditures on equipment and software decreased in the third quarter. In October,
nominal new orders for nondefense capital goods
excluding aircraft moved up a little, but shipments of
these capital goods edged down and the level of
orders remained below that of shipments. In addition, other forward-looking indicators of equipment
investment by firms, such as surveys of business conditions and capital spending plans, were still subdued. Real business expenditures for nonresidential
structures also decreased in the third quarter,
although nominal construction spending by firms
increased in October. Inventories in most industries
appeared to be roug