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101st Annual Report 2014 BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM 101st Annual Report 2014 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. June 2015 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 101st annual report of the Board of Governors of the Federal Reserve System. This report covers operations of the Board during calendar year 2014. Sincerely, Janet L. Yellen Chair v Contents Overview ..................................................................................................................................... 1 About This Report ....................................................................................................................... 1 About the Federal Reserve System .............................................................................................. 2 Monetary Policy and Economic Developments ............................................................ 5 Monetary Policy Report of February 2015 .................................................................................... 5 Monetary Policy Report of July 2014 .......................................................................................... 22 Financial Stability .................................................................................................................. 37 Monitoring Risks to Financial Stability ........................................................................................ 38 Macroprudential Supervision of Large, Complex Financial Institutions ......................................... 43 Domestic and International Cooperation and Coordination .......................................................... 44 Supervision and Regulation ................................................................................................ 47 2014 Developments .................................................................................................................. 47 Supervision .............................................................................................................................. 49 Regulation ................................................................................................................................ 71 Consumer and Community Affairs ................................................................................. 75 Supervision and Examinations ................................................................................................... 75 Consumer Laws and Regulations ............................................................................................... 86 Consumer Research and Emerging-Issues and Policy Analysis ................................................... 88 Community Development .......................................................................................................... 91 Federal Reserve Banks .......................................................................................................... 95 Federal Reserve Priced Services ................................................................................................ 95 Currency and Coin .................................................................................................................... 98 Fiscal Agency and Government Depository Services ................................................................... 99 Use of Federal Reserve Intraday Credit .................................................................................... 102 FedLine Access to Reserve Bank Services ............................................................................... 102 Information Technology ........................................................................................................... 103 Examinations of the Federal Reserve Banks ............................................................................. 103 Income and Expenses ............................................................................................................. 104 SOMA Holdings and Loans ...................................................................................................... 105 Federal Reserve Bank Premises ............................................................................................... 108 Pro Forma Financial Statements for Federal Reserve Priced Services ...................................... 109 vi Other Federal Reserve Operations .................................................................................. 115 Regulatory Developments: Dodd-Frank Act Implementation ...................................................... 115 The Board of Governors and the Government Performance and Results Act .............................. 119 Record of Policy Actions of the Board of Governors ............................................. 121 Rules and Regulations ............................................................................................................. 121 Policy Statements and Other Actions ....................................................................................... 125 Discount Rates for Depository Institutions in 2014 .................................................................... 126 Minutes of Federal Open Market Committee Meetings ......................................... 129 Meeting Held on January 28–29, 2014 ...................................................................................... 130 Meeting Held on March 18–19, 2014 ........................................................................................ 149 Meeting Held on April 29–30, 2014 ........................................................................................... 174 Meeting Held on June 17–18, 2014 .......................................................................................... 184 Meeting Held on July 29–30, 2014 ........................................................................................... 210 Meeting Held on September 16–17, 2014 ................................................................................. 222 Meeting Held on October 28–29, 2014 ..................................................................................... 248 Meeting Held on December 16–17, 2014 .................................................................................. 261 Litigation ................................................................................................................................. 285 Statistical Tables .................................................................................................................... 287 Federal Reserve System Audits ........................................................................................ 317 Board of Governors Financial Statements ................................................................................. 318 Federal Reserve Banks Combined Financial Statements ........................................................... 340 Office of Inspector General Activities ........................................................................................ 398 Government Accountability Office Reviews ............................................................................... 399 Federal Reserve System Budgets ..................................................................................... 401 System Budgets Overview ....................................................................................................... 401 Board of Governors Budgets ................................................................................................... 404 Federal Reserve Banks Budgets .............................................................................................. 408 Currency Budget ..................................................................................................................... 412 Federal Reserve System Organization ........................................................................... 417 Board of Governors ................................................................................................................. 417 Federal Open Market Committee ............................................................................................. 422 Board of Governors Advisory Councils ..................................................................................... 424 Federal Reserve Banks and Branches ...................................................................................... 427 Index ......................................................................................................................................... 443 1 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 2,745-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 2014. The report includes the following sections: • Monetary policy and economic developments. Section 2 provides adapted versions of the Board’s semiannual monetary policy reports to Congress. • Federal Reserve operations. Section 3 provides a summary of Board and System activities in the areas of financial stability policy and research; section 4, in supervision and regulation; section 5, in consumer and community affairs; and section 6, in Reserve Bank operations. • Dodd-Frank Act implementation and other requirements. Section 7 summarizes the Board’s efforts in 2014 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. 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/ publications/annual-report/default.htm. • Policy actions and litigation. Section 8 and section 9 provide accounts of policy actions taken by the Board in 2014, including new or amended rules and regulations and other actions as well as the deliberations and decisions of the Federal Open Market Committee (FOMC);1section 10 summarizes litigation involving the Board. • Statistical tables. Section 11 includes 14 statistical tables that provide updated historical data concerning Board and System operations and activities. • Federal Reserve System audits. Section 12 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 budgets. Section 13 presents information on the 2014 budget performance of the Board and Reserve Banks, as well as their 2015 budgets, budgeting processes, and trends in their expenses and employment. • Federal Reserve System organization. Section 14 provides listings of key officials at the Board and in the Federal Reserve System, including the Board of 1 For more information on the FOMC, see the Board’s website at www.federalreserve.gov/monetarypolicy/fomc.htm. 2 101st Annual Report | 2014 Governors, its officers, FOMC members, several System councils, and Federal Reserve Bank and Branch officers and directors. About the Federal Reserve System 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. ■ Federal Reserve Bank city ■ N Board of Governors of the Federal Reserve System, Washington, D.C. 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 following maps identify Federal Reserve Districts by their official number, city, and letter designation. Overview ■ Federal Reserve Bank city ● Federal Reserve Branch city ■ N Board of Governors of the Federal Reserve System, Washington, D.C. — Branch boundary 3 5 2 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 Chair. The following discussion is a review of U.S. monetary policy and economic developments in 2014, excerpted from the Monetary Policy Reports published in February 2015 and July 2014. Those complete reports are available on the Board’s website at www .federalreserve.gov/monetarypolicy/files/20150224_ mprfullreport.pdf (February 2015) and www .federalreserve.gov/monetarypolicy/files/20140715_ mprfullreport.pdf (July 2014). Other materials in this annual report related to the conduct of monetary policy can be found in section 9, “Minutes of Federal Open Market Committee Meetings,” and section 11, “Statistical Tables” (see tables 1–4). Monetary Policy Report of February 2015 Summary The labor market improved further during the second half of last year and into early 2015, and labor market conditions moved closer to those the Federal Open Market Committee (FOMC) judges consistent with its maximum employment mandate. Since the middle of last year, monthly payrolls have expanded by about 280,000, on average, and the unemployment rate has declined nearly ½ percentage point on net. Nevertheless, a range of labor market indicators suggest that there is still room for improvement. In particular, at 5.7 percent, the unemployment rate is still above most FOMC participants’ estimates of its longer-run normal level, the labor force participation rate remains below most assessments of its trend, an unusually large number of people continue to work part time when they would prefer full-time employment, and wage growth has continued to be slow. A steep drop in crude oil prices since the middle of last year has put downward pressure on overall inflation. As of December 2014, the price index for personal consumption expenditures was only ¾ percent higher than a year earlier, a rate of increase that is well below the FOMC’s longer-run goal of 2 percent. Even apart from the energy sector, price increases have been subdued. Indeed, the prices of items other than food and energy products rose at an annual rate of only about 1 percent over the last six months of 2014, noticeably less than in the first half of the year. The slow pace of price increases during the second half was likely associated, in part, with falling import prices and perhaps also with some pass-through of lower oil prices. Survey-based measures of longerterm inflation expectations have remained stable; however market-based measures of inflation compensation have declined since last summer. Economic activity expanded at a strong pace in the second half of last year. Notably reflecting solid gains in consumer spending, real gross domestic product (GDP) is estimated to have increased at an annual rate of 3¾ percent after a reported increase of just 1¼ percent in the first half of the year. The growth in GDP was supported by accommodative monetary policy, a reduction in the degree of restraint imparted by fiscal policy, and the increase in households’ purchasing power arising from the drop in oil prices. The gains in GDP have occurred despite continued sluggish growth abroad and a sizable appreciation of the U.S. dollar, both of which have weighed on net exports. Financial conditions in the United States have generally remained supportive of economic growth. Longer-term interest rates in the United States and 6 101st Annual Report | 2014 other advanced economies have continued to move down, on net, since the middle of 2014 amid disappointing economic growth and low inflation abroad as well as the associated anticipated and actual monetary policy actions by foreign central banks. Broad indexes of U.S. equity prices have risen moderately, on net, since the end of June. Credit flows to nonfinancial businesses largely remained solid in the second half of last year. Overall borrowing conditions for households eased further, but mortgage lending standards are still tight for many potential borrowers. The vulnerability of the U.S. financial system to financial instability has remained moderate, primarily reflecting low-to-moderate levels of leverage and maturity transformation. Asset valuation pressures have eased a little, on balance, but continue to be notable in some sectors. The capital and liquidity positions of the banking sector have improved further. Over the second half of 2014, the Federal Reserve and other agencies finalized or proposed several more rules related to the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, which were designed to further strengthen the resilience of the financial system. At the time of the FOMC meeting in late January of this year, the Committee saw the outlook as broadly similar to that at the time of its December meeting, when the most recent Summary of Economic Projections (SEP) was compiled. (The December SEP is included as Part 3 of the February 2015 Monetary Policy Report on pages 39–52; it is also included in section 9 of this annual report.) The FOMC expects that, with appropriate monetary policy accommodation, economic activity will expand at a moderate pace, and that labor market indicators will continue to move toward levels the Committee judges consistent with its dual mandate of maximum employment and price stability. In addition, the Committee continues to see the risks to the outlook for economic activity and the labor market as nearly balanced. Inflation is anticipated to decline further in the near term, mainly reflecting the pass-through of lower oil prices to consumer energy prices. However, the Committee expects inflation to rise gradually toward its 2 percent longer-run objective over the medium term as the labor market improves further and the transitory effects of lower energy prices and other factors dissipate. At the end of October, and after having made further measured reductions in the pace of its asset purchases at its July and September meetings, the FOMC concluded the asset purchase program that began in September 2012. The decision to end the purchase program reflected the substantial improvement in the outlook for the labor market since the program’s inception—the stated aim of the asset purchases—and a judgment that the underlying strength of the broader economy was sufficient to support ongoing progress toward the Committee’s policy objectives. Nonetheless, the Committee continued to judge that a high degree of policy accommodation remained appropriate. As a result, the FOMC has maintained the exceptionally low target range of 0 to ¼ percent for the federal funds rate and kept the Federal Reserve’s holdings of longer-term securities at sizable levels. The Committee has also continued to provide forward guidance bearing on the anticipated path of the federal funds rate. In particular, the FOMC has stressed that in deciding how long to maintain the current target range, it will consider a broad set of indicators to assess realized and expected progress toward its objectives. On the basis of its assessment, the Committee indicated in its two most recent postmeeting statements that it can be patient in beginning to normalize the stance of monetary policy. To further emphasize the data-dependent nature of its policy stance, the FOMC has stated that if incoming information indicates faster progress toward its policy objectives than the Committee currently expects, increases in the target range for the federal funds rate will likely occur sooner than the Committee anticipates. The FOMC has also indicated that in the case of slower-than-expected progress, increases in the target range will likely occur later than currently anticipated. Moreover, the Committee continues to expect that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run. As part of prudent planning, the Federal Reserve has continued to prepare for the eventual normalization of the stance and conduct of monetary policy. The FOMC announced updated principles and plans for the normalization process following its September meeting and has continued to test the operational readiness of its monetary policy tools. The Committee remains confident that it has the tools it needs to raise short-term interest rates when doing so becomes appropriate, despite the very large size of the Federal Reserve’s balance sheet. Monetary Policy and Economic Developments Part 1: Recent Economic and Financial Developments Figure 1. Net change in payroll employment 3-month moving averages The labor market continued to improve in the second half of last year and early this year. Job gains have averaged close to 280,000 per month since June, and the unemployment rate fell from 6.1 percent in June to 5.7 percent in January. Even so, the labor market likely has not yet fully recovered, and wage growth has remained slow. Since June, a steep drop in crude oil prices has exerted downward pressure on overall inflation, and non-energy price increases have been subdued as well. The price index for personal consumption expenditures (PCE) increased only ¾ percent during the 12 months ending in December, a rate that is well below the Federal Open Market Committee’s (FOMC) longer-run objective of 2 percent; the index excluding food and energy prices was up 1¼ percent over this period. Survey measures of longer-run inflation expectations have been stable, but measures of inflation compensation derived from financial market quotes have moved down. Meanwhile, real gross domestic product (GDP) increased at an estimated annual rate of 3¾ percent in the second half of the year, up from a reported rate of just 1¼ percent in the first half. The growth in GDP has been supported by accommodative monetary policy and generally favorable financial conditions, the boost to households’ purchasing power from lower oil prices, and improving consumer and business confidence. However, housing market activity has been advancing only slowly, and sluggish growth abroad and the higher foreign exchange value of the dollar have weighed on net exports. Longer-term interest rates in the United States and other advanced economies declined, on net, amid disappointing growth and low inflation abroad and the associated actual and anticipated accommodative monetary policy actions by foreign central banks. Domestic Developments The labor market has strengthened further . . . Employment rose appreciably and the unemployment rate fell in the second half of 2014 and early this year. Payroll employment has increased by an average of about 280,000 per month since June, almost 40,000 faster than in the first half of last year (figure 1). The gain in payroll employment for 2014 as a whole was the largest for any year since 1999. In addition, the unemployment rate continued to move down, declining from 6.1 percent in June to 5.7 percent in January of this year, a rate more than 4 percentage points below its peak in 2009. Furthermore, a substantial 7 Thousands of jobs 400 Private 200 + 0 _ Total nonfarm 200 400 600 800 2008 2009 2010 2011 2012 2013 2014 2015 Source: Department of Labor, Bureau of Labor Statistics. portion of the decline in unemployment over the past year came from a decrease in the number of individuals reporting unemployment spells longer than six months. The labor force participation rate has been roughly flat since late 2013 after having declined not only during the recession, but also during much of the recovery period when most other indicators of labor market health were improving. While much of that decline likely reflected ongoing demographic trends—such as the aging of members of the babyboom generation into their retirement years—some of the decline likely reflected workers’ perceptions of poor job opportunities. Judged against the backdrop of a declining trend, the recent stability of the participation rate likely represents some cyclical improvement. Nevertheless, the participation rate remains lower than would be expected given the unemployment rate, and thus it continues to suggest more cyclical weakness than is indicated by the unemployment rate. Another sign that the labor market remains weaker than indicated by the unemployment rate alone is the still-elevated share of workers who are employed part time but would like to work full time. This share of involuntary part-time employees has generally shown less improvement than the unemployment rate over the past few years; in part for this reason, the more comprehensive U-6 measure of labor underutilization remains quite elevated (figure 2). Nevertheless, most broad measures of labor market health have improved. With employment rising and the participation rate holding steady, the 8 101st Annual Report | 2014 Figure 2. Measures of labor underutilization Monthly Percent 16 U-6 U-4 14 12 U-5 10 8 Unemployment rate 6 4 2003 2005 2007 2009 2011 2013 2015 Note: U-4 measures total unemployed plus discouraged workers, as a percent of the labor force plus discouraged workers. Discouraged workers are a subset of marginally attached workers who are not currently looking for work because they believe no jobs are available for them. U-5 measures total unemployed plus all marginally attached to the labor force, as a percent of the labor force plus persons marginally attached to the labor force. Marginally attached workers are not in the labor force, want and are available for work, and have looked for a job in the past 12 months. U-6 measures total unemployed plus all marginally attached workers plus total employed part time for economic reasons, as a percent of the labor force plus all marginally attached workers. The shaded bar indicates a period of business recession as defined by the National Bureau of Economic Research. Source: Department of Labor, Bureau of Labor Statistics. employment-to-population ratio climbed noticeably higher in 2014 and early 2015 after having moved more or less sideways for much of the recovery. The quit rate, which is often perceived as a measure of worker confidence in labor market opportunities, has largely recovered to its pre-recession level. Moreover, an index constructed by Federal Reserve Board staff that aims to summarize movements in a wide array of labor market indicators also suggests that labor market conditions strengthened further in 2014, and that the gains have been quite strong in recent months.1 . . . while gains in compensation have been modest . . . Even as the labor market has been improving, most measures of labor compensation have continued to show only modest gains. The employment cost index (ECI) for private industry workers, which measures both wages and the cost of employer-provided ben1 For details on the construction of the labor market conditions index, see Hess Chung, Bruce Fallick, Christopher Nekarda, and David Ratner (2014), “Assessing the Change in Labor Market Conditions,” Finance and Economics Discussion Series 2014-109 (Washington: Board of Governors of the Federal Reserve System, December), www.federalreserve.gov/ econresdata/feds/2014/files/2014109pap.pdf. efits, rose 2¼ percent over the 12 months ending in December, only slightly faster than the gains of about 2 percent that had prevailed for several years. Two other prominent measures of compensation— average hourly earnings and business-sector compensation per hour—increased slightly less than the ECI over the past year and have shown fewer signs of acceleration. Over the past five years, the gains in all three of these measures of nominal compensation have fallen well short of their pre-recession averages and have only slightly outpaced inflation. That said, the drop in energy prices has pushed up real wages in recent months. . . . and productivity growth has been lackluster Over time, increases in productivity are the central determinant of improvements in living standards. Labor productivity in the private business sector has increased at an average annual pace of 1¼ percent since the recession began in late 2007. This pace is close to the average that prevailed between the mid1970s and the mid-1990s, but it is well below the pace of the earlier post–World War II period and the period from the mid-1990s to the eve of the financial crisis. In recent years, productivity growth has been Monetary Policy and Economic Developments Figure 3. Brent spot and futures prices 9 Figure 4. Change in the chain-type price index for personal consumption expenditures Daily Dollars per barrel Monthly Percent 140 Spot price 130 5 120 Dec. 2017 futures contracts 4 Total 110 100 3 90 2 80 1 + 0 _ Excluding food and energy 70 60 50 2011 2012 2013 2014 1 2015 2 Source: NYMEX. 2008 held down by, among other factors, the sharp drop in businesses’ capital expenditures over the recession and the moderate recovery in expenditures since then. Productivity gains may be better supported in the future as investment continues to strengthen. A plunge in crude oil prices has held down consumer prices . . . As discussed in the box “The Effect of the Recent Decline in Oil Prices on Economic Activity” on pages 8–9 of the February 2015 Monetary Policy Report, crude oil prices have plummeted since June 2014 (figure 3). This sharp drop has caused overall consumer price inflation to slow, mainly due to falling gasoline prices: The national average of retail gasoline prices moved down from about $3.75 per gallon in June to about $2.20 per gallon in January. Crude oil prices have turned slightly higher in recent weeks, and futures markets suggest that prices are expected to edge up further in coming years; nevertheless, oil prices are still expected to remain well below the levels that had prevailed through last June. Over the past six months, increases in food prices have moderated. Consumer food price increases had been somewhat elevated in early 2014 as a result of rising food commodity prices, but those commodity prices have since eased, and increases at the retail level have slowed accordingly. . . . but even outside of the energy and food categories, inflation has remained subdued Inflation for items other than food and energy (socalled core inflation) remains modest. Core PCE prices rose at an annual rate of only about 1 percent over the last six months of 2014 after having risen at a 1¾ percent rate in the first half of the year; for 2009 2010 2011 2012 2013 2014 Note: The data extend through December 2014; changes are from one year earlier. Source: Department of Commerce, Bureau of Economic Analysis. 2014 as a whole, core PCE prices were up a little more than 1¼ percent (figure 4). The trimmed mean PCE price index, an alternative indicator of underlying inflation constructed by the Federal Reserve Bank of Dallas, also increased more slowly in the second half of last year. Falling import prices likely held down core inflation in the second half of the year; lower oil prices, and easing prices for commodities more generally, may have played a role as well. In addition, ongoing resource slack has reinforced the low-inflation environment, though with the improving economy, downward pressure from this factor is likely waning. Looking at the overall basket of items that people consume, price increases remain muted and below the FOMC’s longer-run objective of 2 percent. In December, the PCE price index was only ¾ percent above its level from a year earlier. With retail surveys showing a further sharp decline in gasoline prices in January, overall consumer prices likely moved lower early this year. Survey-based measures of longer-term inflation expectations have remained stable, while market-based measures of inflation compensation have declined The Federal Reserve tracks indicators of inflation expectations because such expectations likely factor into wage- and price-setting decisions and so influence actual inflation. Survey-based measures of longer-term inflation expectations, including surveys of both households and professional forecasters, have 10 101st Annual Report | 2014 Figure 5. Median inflation expectations Figure 6. Change in real gross domestic product, gross domestic income, and private domestic final purchases Percent Percent, annual rate Michigan survey expectations for next 5 to 10 years Gross domestic product Gross domestic income Private domestic final purchases 4 H2* H1 3 5 4 3 2 1 + 0 _ 2 SPF expectations for next 10 years 1 1 2 3 4 2001 2003 2005 2007 2009 2011 2013 2015 Note: The Michigan survey data are monthly and extend through February 2015. The SPF data for inflation expectations for personal consumption expenditures are quarterly and extend from 2007:Q1 through 2015:Q1. Source: University of Michigan Surveys of Consumers; Survey of Professional Forecasters (SPF). been quite stable over the past 15 years; in particular, they have changed little, on net, over the past few years (figure 5). In contrast, measures of longer-term inflation compensation derived from financial market instruments have fallen noticeably during the past several months. As is discussed in more detail in the box “Challenges in Interpreting Measures of LongerTerm Inflation Expectations” on pages 12–13 of the February 2015 Monetary Policy Report, deducing the sources of changes in inflation compensation is difficult because such movements may be caused by factors other than shifts in market participants’ inflation expectations. Economic activity expanded at a strong pace in the second half of 2014 Real GDP is estimated to have increased at an annual rate of 3¾ percent in the second half of last year after a reported increase of just 1¼ percent in the first half, when output was likely restrained by severe weather and other transitory factors (figure 6). Private domestic final purchases—a measure of household and business spending that tends to exhibit less quarterly variation than GDP—also advanced at a substantial pace in the second half of last year. The second-half gains in GDP reflected solid advances in consumer spending and in business investment spending on equipment and intangibles (E&I) as well as subdued gains for both residential investment and nonresidential structures. More generally, the growth in GDP has been supported by accommodative financial conditions, including 2008 2009 2010 2011 2012 2013 2014 * Gross domestic income is not yet available for 2014:H2. Source: Department of Commerce, Bureau of Economic Analysis. declines in the cost of borrowing for many households and businesses; by a reduction in the restraint from fiscal policy relative to 2013; and by increases in spending spurred by continuing job gains and, more recently, by falling oil prices. The gains in GDP have occurred despite an appreciating U.S. dollar and concerns about global economic growth, which remain an important source of uncertainty for the economic outlook. Consumer spending was supported by continuing improvement in the labor market and falling oil prices, . . . Real PCE rose at an annual rate of 3¾ percent in the second half of 2014—a noticeable step-up from the sluggish rate of only about 2 percent in the first half (figure 7). The increases in spending have been supported by the improving labor market. In addition, the fall in gasoline and other energy prices has boosted purchasing power for consumers, especially those in lower- and middle-income brackets who spend a sizable share of their income on gasoline. Real disposable personal income—that is, income after taxes and adjusted for price changes—rose 3 percent at an annual rate in the second half of last year, roughly double the average rate recorded over the preceding five years. . . . further increases in household wealth and low interest rates, . . . Consumer spending growth was also likely supported by further increases in household net worth, as the stock market continued to rise and house prices moved up in the second half of last year. The value Monetary Policy and Economic Developments Figure 7. Change in real personal consumption expenditures and disposable personal income 11 Figure 8. Prices of existing single-family houses Monthly Peak = 100 Percent, annual rate Personal consumption expenditures Disposable personal income 6 H2 H1 100 5 Zillow 4 index 90 3 2 1 + 0 _ 80 CoreLogic price index 1 70 S&P/Case-Shiller 2 national index 3 2005 2008 2009 2010 2011 2012 2013 2014 Source: Department of Commerce, Bureau of Economic Analysis. of corporate equities rose about 10 percent in 2014, on top of the 30 percent gain seen in 2013. Although the gains in house prices slowed last year—for example, the CoreLogic national index increased only 5 percent after having risen more substantially in 2012 and 2013—these gains affected a larger share of the population than did the gains in equities, as more individuals own homes than own stocks (figure 8). Reflecting increases in home and equity prices, aggregate household net wealth has risen appreciably from its levels during the recession and its aftermath to more than six times the value of disposable personal income. Coupled with low interest rates, the rise in incomes has lowered debt payment burdens for many households. The household debt service ratio—that is, the ratio of required principal and interest payments on outstanding household debt to disposable personal income—has remained at a very low level by historical standards. . . . and increased credit availability for consumers Consumer credit continued to expand through late 2014, as auto and student loans have remained available even to borrowers with lower credit scores. In addition, credit cards have become somewhat more accessible to individuals on the lower end of the credit spectrum, and overall credit card debt increased moderately last year. Consumer confidence has moved up Consistent with the improvement in the labor market and the fall in energy prices, indicators of consumer 2008 2011 2014 Note: The data for the Zillow and S&P/Case-Shiller indexes extend through November 2014. The data for the CoreLogic index extend through December 2014. Each index has been normalized so that its peak is 100. The CoreLogic price index includes purchase transactions only and is adjusted by Federal Reserve Board staff. The S&P/Case-Shiller index reflects all arm’s-length sales transactions nationwide. Source: The S&P/Case-Shiller U.S. National Home Price Index (“Index”) is a product of S&P Dow Jones Indices LLC and/or its affiliates and has been licensed for use by the Board. Copyright © 2015 S&P Dow Jones Indices LLC, a subsidiary of the McGraw Hill Financial Inc., and/or its affiliates. All rights reserved. Redistribution, reproduction and/or photocopying in whole or in part are prohibited without written permission of S&P Dow Jones Indices LLC. For more information on any of S&P Dow Jones Indices LLC’s indices please visit www.spdji.com. S&P® is a registered trademark of Standard & Poor’s Financial Services LLC and Dow Jones® is a registered trademark of Dow Jones Trademark Holdings LLC. Neither S&P Dow Jones Indices LLC, Dow Jones Trademark Holdings LLC, their affiliates nor their third party licensors make any representation or warranty, express or implied, as to the ability of any index to accurately represent the asset class or market sector that it purports to represent and neither S&P Dow Jones Indices LLC, Dow Jones Trademark Holdings LLC, their affiliates nor their third party licensors shall have any liability for any errors, omissions, or interruptions of any index or the data included therein. sentiment moved up noticeably in the second half of last year. The University of Michigan Surveys of Consumers’ index of consumer sentiment—which incorporates households’ views about their own financial situations as well as broader economic conditions—has moved up strongly, on net, in recent months and is now close to its long-run average. The Michigan survey’s measure of households’ expectations of real income changes in the year ahead has also continued to trend up over the past several months, perhaps reflecting the fall in gasoline prices. However, this measure remains substantially below its historical average and suggests a more guarded outlook than the headline sentiment index. However, the pace of homebuilding has improved only slowly After advancing reasonably well in 2012 and early 2013, the recovery in residential construction activity has slowed markedly. Single-family housing starts only edged up in 2014, and multifamily construction 12 101st Annual Report | 2014 Figure 9. Private housing starts and permits Figure 10. Change in real business fixed investment Percent, annual rate Millions of units, annual rate Monthly Structures Equipment and intangible capital 30 2.2 20 1.8 Single-family starts Single-family permits Multifamily starts 2001 2003 2005 2007 2009 2011 2013 H1 H2 1.4 10 + 0 _ 1.0 10 .6 20 .2 30 2015 Source: Department of Commerce, Bureau of the Census. 2007 2008 2009 2010 2011 2012 2013 2014 Source: Department of Commerce, Bureau of Economic Analysis. activity was also little changed (figure 9). And sales of both new and existing homes were flat, on net, last year. In all, real residential investment rose only 2½ percent in 2014, and it remains well below its prerecession peak. The weak recovery in construction likely relates to the rate of household formation, which, notwithstanding tentative signs of a recent pickup, has generally stayed very low despite the improvement in the labor market. since retraced much of those increases. The 30-year fixed mortgage rate declined roughly 60 basis points in 2014, and it has edged down further, on net, this year to a level not far from its all-time low in 2012. Likely related to the most recent decline in mortgage rates, refinancing activity rose modestly in January. Lending policies for home purchases remained tight overall, although there are some indications that mortgage credit has started to become more widely accessible. Over the course of 2014, the fraction of home-purchase mortgages issued to borrowers with credit scores on the lower end of the spectrum edged up. Additionally, in the Senior Loan Officer Opinion Survey on Bank Lending Practices (SLOOS), several large banks reported having eased lending standards on prime home-purchase loans in the third and fourth quarters of last year.2 In January, the Federal Housing Administration reduced its mortgage insurance premiums by about one-third of the level that had prevailed during the past four years—a step that may lower the cost of credit for households with small down payments and low credit scores. Even so, mortgages have remained difficult to obtain for many households. Business fixed investment rose at an annual rate of 5¼ percent in the second half of 2014, close to the rate of increase seen in the first half. Spending on E&I capital rose at an annual rate of about 6 percent, while spending on nonresidential structures moved up about 4 percent (figure 10). Business investment has been supported by strengthening final demand as well as by low interest rates and generally accommodative financial conditions. Regarding nonresidential structures, vacancy rates for existing properties have been declining, and financing conditions for new construction have eased further—both factors that bode well for future construction. More recently, however, the steep decline in the number of drilling rigs in operation suggests that a sharp falloff in the drilling and mining component of investment in nonresidential structures may be under way. Meanwhile, for borrowers who can qualify for a mortgage, the cost of credit is low. After rising appreciably around mid-2013, mortgage interest rates have 2 The SLOOS is available on the Board’s website at www .federalreserve.gov/boarddocs/snloansurvey. Overall business investment has moved up, but investment in the energy sector is starting to be affected by the drop in oil prices Corporate financing conditions were generally favorable The financial condition of large nonfinancial firms generally remained solid in the second half of last year; profitability stayed high, and default rates on nonfinancial corporate bonds were generally very low. Nonfinancial firms have continued to raise funds Monetary Policy and Economic Developments through capital markets at a robust pace, given sturdy corporate credit quality, historically low interest rates on corporate bonds, and highly accommodative lending conditions for most firms. Bond issuance by investment-grade nonfinancial firms, and syndicated lending to those firms, have both been particularly strong. However, speculative-grade issuance in those markets, which had remained elevated for most of 2014, diminished late in the year, because volatility increased and spreads widened and perhaps also because of greater scrutiny by regulators of syndicated leveraged loans with weaker credit quality and lower repayment capacity. Credit also was readily available to most bankdependent businesses. According to the October 2014 and January 2015 SLOOS reports, banks generally continued to ease price and nonprice terms on commercial and industrial (C&I) loans to firms of all sizes in the second half of 2014. That said, in the fourth quarter, several banks reported having tightened lending policies for oil and gas firms or, more broadly, in response to legislative, supervisory, or accounting changes. In addition, although overall C&I loans on banks’ books registered substantial increases in the second half of 2014, loans to businesses in amounts of $1 million or less—a proxy for lending to small businesses—increased only modestly. The weak growth in these small loans appears largely due to sluggish demand; however, bank lending standards to small businesses are still reportedly somewhat tighter than the midpoint of their range over the past decade despite considerable loosening over the past few years. Net exports held down second-half real GDP growth slightly Exports increased at a modest pace in the second half of 2014, held back by lackluster growth abroad as well as the appreciation of the dollar. Import growth was also relatively subdued, despite the impetus from the stronger dollar, and was well below the pace observed in the first half (figure 11). All told, real net trade was a slight drag on real GDP growth in the second half of 2014. The current account deficit was little changed in the third quarter of 2014 and, at 2¼ percent of nominal GDP, was near its narrowest reading since the late 1990s. The current account deficit in the first three quarters of 2014 was financed mainly by purchases of Treasury and corporate securities by foreign private investors. In contrast, the pace of foreign official purchases in the first three quarters of the year was 13 Figure 11. Change in real imports and exports of goods and services Percent, annual rate Imports Exports 12 9 H1 H2 6 3 + 0 _ 3 6 2008 2009 2010 2011 2012 2013 2014 Source: Department of Commerce, Bureau of Economic Analysis. the slowest in more than a decade, reflecting a significant slowdown in reserve accumulation by emerging market economies (EMEs). Federal fiscal policy was less of a drag on GDP . . . Fiscal policy at the federal level had been a factor restraining GDP growth for several years, especially in 2013. In 2014, however, the contractionary effects of tax and spending changes eased appreciably as the restraining effects of the 2013 tax increases abated and there was a slowing in the declines in federal purchases due to sequestration and the Budget Control Act of 2011 (figure 12). Moreover, some of the over- Figure 12. Change in real government expenditures on consumption and investment Percent, annual rate Federal State and local 9 6 H1 H2 3 + 0 _ 3 6 9 2008 2009 2010 2011 2012 2013 Source: Department of Commerce, Bureau of Economic Analysis. 2014 14 101st Annual Report | 2014 all drag on demand was offset in 2014 by an increase in transfers resulting from the Affordable Care Act. Figure 13. Yields on nominal Treasury securities Daily Percent The federal unified deficit narrowed further last year, reflecting both the previous years’ spending cuts and an increase in tax receipts resulting from the ongoing economic expansion. The budget deficit was 2¾ percent of GDP for fiscal year 2014, and the Congressional Budget Office projects that it will be about 2½ percent in 2015. As a result, overall federal debt held by the public stabilized as a share of GDP in 2014, albeit at a relatively high level. . . . and state and local government expenditures are also turning up The expansion of economic activity has also led to continued slow improvements in the fiscal position of most state and local governments. Consistent with improving finances, states and localities expanded employment rolls in 2014. Furthermore, state and local expenditures on construction projects rose a touch last year following several years of declines. 7 6 10-year 30-year 5 4 3 5-year 2 1 0 2001 2003 2005 2007 2009 2011 2013 2015 Note: The Treasury ceased publication of the 30-year constant maturity series on February 18, 2002, and resumed that series on February 9, 2006. Source: Department of the Treasury. tainty based on interest rate derivatives edged higher, on net, from their mid-2014 levels. Financial Developments Longer-term Treasury yields and other sovereign benchmark yields declined The expected path for the federal funds rate flattened Yields on longer-term Treasury securities have continued to move down since the middle of last year on net (figure 13). In particular, the yields on 10- and 30-year nominal Treasury securities declined about 40 basis points and 60 basis points, respectively, from their levels at the end of June 2014. The decreases in longer-term yields were driven especially by reductions in longer-horizon forward rates. For example, the 5-year forward rate 5 years ahead dropped about 80 basis points over the same period. Long-term benchmark sovereign yields in advanced foreign economies (AFEs) have also moved down significantly in response to disappointing growth and very low and declining rates of inflation in a number of foreign countries as well as the associated actual and anticipated changes in monetary policy abroad. Market participants seemed to judge the incoming domestic economic data since the middle of last year, especially the employment reports, as supporting expectations for continued economic expansion in the United States; however, concerns about the foreign economic outlook weighed on investor sentiment. On balance, market-based measures of the expected (or mean) path of the federal funds rate through late 2017 have flattened, but the expected timing of the initial increase in the federal funds rate from its current target range was about unchanged. In addition, according to the results of the most recent Survey of Primary Dealers and the Survey of Market Participants, both conducted by the Federal Reserve Bank of New York just prior to the January FOMC meeting, respondents judged that the initial increase in the target federal funds rate was most likely to occur around mid-2015, little changed from the results of those surveys from last June.3 Meanwhile, in part because the passage of time brought the anticipated date of the initial increase in the federal funds rate closer, measures of policy rate uncer3 The results of the Survey of Primary Dealers and of the Survey of Market Participants are available on the Federal Reserve Bank of New York’s website at www.newyorkfed.org/markets/ primarydealer_survey_questions.html and www.newyorkfed.org/ markets/survey_market_participants.html, respectively. The declines in longer-term Treasury yields and longhorizon forward rates seem to largely reflect reductions in term premiums—the extra return investors expect to obtain from holding longer-term securities as opposed to holding and rolling over a sequence of short-term securities for the same period. Market participants pointed to several factors that may help to explain the reduction in term premiums. First, very low and declining AFE yields and safe-haven flows associated with the deterioration in the foreign economic outlook likely have increased demand for Treasury securities. Second, the weaker foreign eco- Monetary Policy and Economic Developments nomic outlook coupled with the steep decline in oil prices may have led investors to put higher odds on scenarios in which U.S. inflation remains quite low for an extended period. Investors may see nominal long-term Treasury securities as an especially good hedge against such risks. Finally, market participants may have increased the probability they attach to outcomes in which U.S. economic growth is persistently subdued. Indeed, the 5-year forward real yield 5 years ahead, obtained from yields on Treasury Inflation-Protected Securities, has declined further, on net, since the middle of last year and stands well below levels commonly cited as estimates of the longer-run real short rate. Consistent with moves in the yields on longer-term Treasury securities, yields on 30-year agency mortgage-backed securities (MBS)—an important determinant of mortgage interest rates—decreased about 30 basis points, on balance, over the second half of 2014 and early 2015. Liquidity conditions in Treasury and agency MBS markets were generally stable . . . On balance, indicators of Treasury market functioning remained stable over the second half of 2014 even as the Federal Reserve trimmed the pace of its asset purchases and ultimately brought the purchase program to a close at the end of October. The Treasury market experienced a sharp drop in yields and significantly elevated volatility on October 15, as technical factors reportedly amplified price movements following the release of the somewhat weaker-thanexpected September U.S. retail sales data. However, market conditions recovered quickly and liquidity measures, such as bid-asked spreads, have been generally stable since then. Moreover, Treasury auctions generally continued to be well received by investors. As in the Treasury market, liquidity conditions in the agency MBS market were generally stable, with the exception of mid-October. Dollar-roll-implied financing rates for production coupon MBS—an indicator of the scarcity of agency MBS for settlement— suggested limited settlement pressures in these markets over the second half of 2014 and early 2015. . . . and short-term funding markets also continued to function well as rates moved slightly higher overall Conditions in short-term dollar funding markets also remained stable during the second half of 2014 and early 2015. Both unsecured and secured money mar- 15 Figure 14. Equity prices Daily December 31, 2007 = 100 140 Dow Jones bank index 120 100 80 60 S&P 500 index 40 20 1994 1997 2000 2003 2006 2009 2012 2015 Source: Dow Jones bank index and Standard & Poor’s 500 index via Bloomberg. ket rates moved modestly higher late in 2014 but remained close to their averages since the federal funds rate reached its effective lower bound. Unsecured offshore dollar funding markets generally did not exhibit signs of stress, and the repurchase agreement, or repo, market functioned smoothly with modest year-end pressures. Money market participants continued to focus on the ongoing testing of the Federal Reserve’s monetary policy tools. The offering rate in the overnight reverse repurchase agreement (ON RRP) exercise has continued to provide a soft floor for other rates on secured borrowing, and the term RRP testing operations that were conducted in December and matured in early January seemed to help alleviate year-end pressures in money markets. For a detailed discussion of the testing of monetary policy tools, see the box “Additional Testing of Monetary Policy Tools” on pages 36–37 of the February 2015 Monetary Policy Report. Broad equity price indexes rose despite higher volatility, while risk spreads on corporate debt widened Over the second half of 2014 and early 2015, broad measures of U.S. equity prices increased further, on balance, but stock prices for the energy sector declined substantially, reflecting the sharp drops in oil prices (figure 14). Although increased concerns about the foreign economic outlook seemed to weigh on risk sentiment, the generally positive tone of U.S. economic data releases as well as declining longerterm interest rates appeared to provide support for equity prices. Overall equity valuations by some conventional measures are somewhat higher than their historical average levels, and valuation metrics in 16 101st Annual Report | 2014 Figure 15. Ratio of total commercial bank credit to nominal gross domestic product Quarterly Percent 75 Measures of bank profitability were little changed in the second half of 2014, on net, and remained below their historical averages. Equity prices of large domestic bank holding companies (BHCs) have increased moderately, on net, since the middle of last year. Credit default swap (CDS) spreads for large BHCs were about unchanged. 70 65 60 55 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Source: Federal Reserve Board, Statistical Release H.8, “Assets and Liabilities of Commercial Banks in the United States”; Department of Commerce, Bureau of Economic Analysis. The M2 measure of the money stock has increased at an average annualized rate of about 5½ percent since last June, below the pace registered in the first half of 2014 and about in line with the pace of nominal GDP. The deceleration was driven by a moderation in the growth rate of liquid deposits in the banking sector relative to the first half of 2014. Although demand for currency weakened in the third quarter of 2014 relative to the first half of the year, currency growth has been strong since November. Municipal bond markets functioned smoothly, but some issuers remained strained some sectors continue to appear stretched relative to historical norms. Implied volatility for the S&P 500 index, as calculated from options prices, increased moderately, on net, from low levels over the summer. Corporate credit spreads, particularly those for speculative-grade bonds, widened from the fairly low levels of last summer, in part because of the underperformance of energy firms. Overall, corporate bond spreads across the credit spectrum have been near their historical median levels recently. For further discussion of asset prices and other financial stability issues, see the box “Developments Related to Financial Stability” on pages 24–25 of the February 2015 Monetary Policy Report. Credit conditions in municipal bond markets have generally remained stable since the middle of last year. Over that period, the MCDX—an index of CDS spreads for a broad portfolio of municipal bonds—and ratios of yields on 20-year general obligation municipal bonds to those on longer-term Treasury securities increased slightly. Nevertheless, significant financial strains were still evident for some issuers. Puerto Rico, with speculative-grade-rated general obligation bonds, continued to face challenges from subdued economic performance, severe indebtedness, and other fiscal pressures. Meanwhile, the City of Detroit emerged from bankruptcy late in 2014 after its debt restructuring plan was approved by a federal judge. Bank credit and the M2 measure of the money stock continued to expand International Developments Aggregate credit provided by commercial banks increased at a solid pace in the second half of 2014 (figure 15). The expansion in bank credit was mainly driven by moderate loan growth coupled with continued robust expansion of banks’ holdings of U.S. Treasury securities, which was reportedly influenced by efforts of large banks to meet the new Basel III Liquidity Coverage Ratio requirements. The growth of loans on banks’ books was generally consistent with the SLOOS reports of increased loan demand and further easing of lending standards for many loan categories over the second half of 2014. Meanwhile, delinquency and charge-off rates fell across most major loan types. Bond yields in the advanced foreign economies continued to decline . . . As noted previously, long-term sovereign yields in the AFEs moved down further during the second half of 2014 and into early 2015 on continued low inflation readings abroad and heightened concerns over the strength of foreign economic growth as well as amid substantial monetary policy accommodation (figure 16). German yields fell to record lows, as the European Central Bank (ECB) implemented new liquidity facilities, purchased covered bonds and asset-backed securities, and announced it would begin buying euro-area sovereign bonds. Specifically, the ECB said that it would purchase €60 billion per Monetary Policy and Economic Developments Figure 16. 10-year nominal benchmark yields in advanced foreign economies Figure 17. U.S. dollar exchange rate against broad index and selected major currencies Percent Daily United Kingdom Daily January 4, 2012 = 100 160 155 150 145 140 135 130 125 120 115 110 105 100 95 90 3.0 2.5 Germany 2.0 Yen 1.5 1.0 Japan Broad .5 Euro 0 2013 2014 17 2015 Source: Bloomberg. 2012 2013 2014 2015 Note: The data are in foreign currency units per dollar. Source: Federal Reserve Board, Statistical Release H.10, “Foreign Exchange Rates.” month of euro-area public and private bonds through at least September 2016. Japanese yields also declined, reflecting the expansion by the Bank of Japan (BOJ) of its asset purchase program. In the United Kingdom, yields fell as data showed declining inflation and some moderation in economic growth, although they have retraced a little of that move in recent weeks, in part as market sentiment toward the U.K. outlook appears to have improved somewhat. In emerging markets, yields were mixed—falling, for the most part, in Asia and generally rising modestly in Latin America—as CDS spreads widened amid growing credit concerns, particularly in some oilexporting countries. Foreign equity indexes were mixed over the period. Japanese equities outperformed other AFE indexes, helped by the BOJ’s asset purchase expansion. Euroarea equities are up modestly from their mid-2014 levels, boosted recently by monetary easing. However, euro-area bank shares substantially underperformed broader indexes, partly reflecting low profitability, weak operating environments, and lingering vulnerabilities to economic and financial shocks. EME equities indexes were mixed, with most emerging Asian indexes rising and some of the major Latin American indexes moving down. . . . while the dollar has strengthened markedly Economic growth in the advanced foreign economies, while still generally weak, firmed toward the end of the year The broad nominal value of the dollar has increased markedly since the middle of 2014, with the U.S. dollar appreciating against almost all currencies (figure 17). The increase in the value of the dollar was largely driven by additional monetary easing abroad and rising concerns about foreign growth—forces similar to those that drove benchmark yields lower—in the face of expectations of solid U.S. growth and the anticipated start of monetary tightening in the United States later this year. Both the euro and the yen have depreciated about 20 percent against the dollar since mid-2014. Notwithstanding the sharp nominal appreciation of the dollar since mid-2014, the real value of the dollar, measured against a broad basket of currencies, is currently somewhat below its historical average since 1973 and well below the peak it reached in early 1985. Economic growth in the AFEs, which was weak in the first half of 2014, firmed toward the end of the second half of the year, supported in part by lower oil prices and more accommodative monetary policies. The euro-area economy barely grew in the third quarter and unemployment remained near record highs, but the pace of economic activity moved up in the fourth quarter. Notwithstanding more supportive monetary policy and the recent pickup in euro-area growth, negotiations over additional financial assistance for Greece have the potential to trigger adverse market reactions and resurrect financial stresses that might impair growth in the broader euro-area economy. Japanese real GDP contracted again in the third quarter, following a tax hike–induced plunge in the second quarter, but it rebounded toward the end 18 101st Annual Report | 2014 of the year as exports and household spending increased. In contrast, economic activity in the United Kingdom and Canada was robust in the third quarter but moderated in the fourth quarter. The fall in oil prices and other commodity prices pushed down headline inflation across the major AFEs. Most notably, 12-month euro-area inflation continued to trend down, falling to negative 0.6 percent in January. Declines in inflation and in marketbased measures of inflation expectations since mid2014 prompted the ECB to increase its monetary stimulus. Similar considerations led the BOJ to step up its pace of asset purchases in October. The Bank of Canada lowered its target for the overnight rate in January in light of the depressing effect of lower oil prices on Canadian inflation and economic activity, as oil exports are nearly 20 percent of total goods exports. Several other foreign central banks lowered their policy rates, either reaching or pushing further into negative territory, including in Denmark, Sweden, and Switzerland—the last of which did so in the context of removing its floor on the euro-Swiss franc exchange rate. Growth in the emerging market economies improved but remained subdued Following weak growth earlier last year, overall economic activity in the EMEs improved a bit in the second half of 2014, but performance varied across economies. Growth in Asia was generally solid, supported by external demand, particularly from the United States, and improved terms of trade due to the sharp decline in commodity prices. In contrast, the decline in commodity prices, along with macroeconomic policy challenges, weighed on economic activity in several South American countries. In China, exports expanded rapidly in the second half of last year, but fixed investment softened, as real estate investment slowed amid a weakening property market. Responding to increased concerns over the strength of growth, the authorities announced additional targeted stimulus measures in an effort to prevent the economy from slowing abruptly. In much of the rest of emerging Asia, exports, particularly to the United States, supported a step-up in growth from the first half of the year. The Mexican economy continued to grow at a moderate pace in the second half of 2014, with solid exports to the United States but lingering softness in household demand. In Brazil, economic activity remained lackluster amid falling commodity prices, diminished business confidence, and tighter macroeconomic policy. Declining oil prices were especially disruptive for several economies with heavy dependence on oil exports, including Russia and Venezuela. Inflation continued to be subdued in most EMEs. The fall in the price of oil contributed to a moderation of headline inflation in several EMEs, including China. However, this contribution was limited in many EMEs due to the prevalence of administered energy prices, which lower the pass-through of changes in oil prices to consumer prices. In several countries, including Indonesia and Malaysia, the fall in energy prices prompted governments to cut fuel subsidies, leading to a rise in domestic prices of fuel and in inflation late in 2014. With inflation low or declining, some central banks, including those of China, Korea, and Chile, loosened monetary policy to support growth. In other EMEs, including Brazil and Malaysia, inflationary pressures stemming from depreciating currencies or from reductions in fuel subsidies prompted central banks to raise policy rates. The central bank of Russia sharply tightened monetary policy to combat inflationary pressures and stabilize its financial markets, which came under considerable pressure in late 2014. Part 2: Monetary Policy The Federal Open Market Committee (FOMC) concluded its asset purchase program at the end of October in light of the substantial improvement in the outlook for the labor market since the inception of the program. To support further progress toward maximum employment and price stability, the FOMC has kept the target federal funds rate at its effective lower bound and maintained the Federal Reserve’s holdings of longer-term securities at sizable levels. To give greater clarity to the public about its policy outlook, the Committee has also continued to provide qualitative guidance regarding the future path of the federal funds rate. In particular, the Committee indicated at its two most recent meetings that it can be patient in beginning to normalize the stance of monetary policy and continued to emphasize the data-dependent nature of its policy stance. Following its September meeting, and as part of prudent planning, the Committee announced updated principles and plans for the eventual normalization of monetary policy. The FOMC concluded its asset purchases at the end of October in light of substantial improvement in the outlook for the labor market At the end of October, the FOMC ended the asset purchase program that began in September 2012 Monetary Policy and Economic Developments after having made further measured reductions in the pace of its asset purchases at the prior meetings in July and September.4 The decision to end the purchase program reflected the substantial improvement in the outlook for the labor market since the program’s inception—which had been the goal of the asset purchases—and the Committee’s judgment that the overall recovery was sufficiently strong to support ongoing progress toward the Committee’s policy objectives. However, the Committee judged that a high degree of policy accommodation still remained appropriate and maintained its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities (MBS) in agency MBS and of rolling over maturing Treasury securities at auction. By keeping the Federal Reserve’s holdings of longer-term securities at sizable levels, this policy is expected to help maintain accommodative financial conditions by putting downward pressure on longer-term interest rates and supporting mortgage markets. In turn, those effects are expected to contribute to progress toward both the maximum employment and price stability objectives of the FOMC. To support further progress toward its objectives, the Committee has kept the target federal funds rate at its lower bound and updated its forward rate guidance The Committee has maintained the exceptionally low target range of 0 to ¼ percent for the federal funds rate to support further progress toward its objectives of maximum employment and price stability. In addition, the FOMC has provided guidance about the likely future path of the federal funds rate in an effort to give greater clarity to the public about its policy outlook. In particular, the Committee has reiterated that, in determining how long to maintain this target range, it will assess realized and expected progress toward its objectives. This assessment will continue to take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. Based on its assessment of these factors, before updating its guidance in December, the Committee had been indicating that it likely would be appropriate to maintain the current target range 4 See Board of Governors of the Federal Reserve System (2014), “Federal Reserve Issues FOMC Statement,” press release, October 29, www.federalreserve.gov/newsevents/press/monetary/ 20141029a.htm. 19 for the federal funds rate for a considerable time following the end of the asset purchase program, especially if projected inflation continued to run below the Committee’s 2 percent longer-run goal and provided that longer-term inflation expectations remained well anchored. In light of the conclusion of the asset purchase program at the end of October and the further progress that the economy had made toward the Committee’s objectives, the FOMC updated its forward guidance at its December meeting. In particular, the Committee stated that it can be patient in beginning to normalize the stance of monetary policy, but it also emphasized that the Committee saw the revised language as consistent with the guidance in its previous statement.5 The Committee restated the updated forward guidance following its January meeting based on its assessment of the economic information available at that time.6 In her December press conference, Chair Yellen emphasized that the update to the forward guidance did not signify a change in the Committee’s policy intentions, but rather was a better reflection of the Committee’s focus on the economic conditions that would make an increase in the federal funds rate appropriate.7 Chair Yellen additionally indicated that, consistent with the new language, the Committee was unlikely to begin the normalization process for at least the following two meetings. There are a range of views within the Committee regarding the appropriate timing of the first increase in the federal funds rate, in part reflecting differences in participants’ expectations for how the economy would evolve. By the time of liftoff, the Committee expects some further decline in the unemployment rate and additional improvement in labor market conditions. In addition, the Committee anticipates that, on the basis of incoming data, it will be reasonably confident that inflation will move back over the medium term to its 2 percent objective. 5 6 7 See Board of Governors of the Federal Reserve System (2014), “Federal Reserve Issues FOMC Statement,” press release, December 17, www.federalreserve.gov/newsevents/press/ monetary/20141217a.htm. See Board of Governors of the Federal Reserve System (2015), “Federal Reserve Issues FOMC Statement,” press release, January 28, www.federalreserve.gov/newsevents/press/monetary/ 20150128a.htm. See Board of Governors of the Federal Reserve System (2014), “Transcript of Chair Yellen’s FOMC Press Conference,” December 17, www.federalreserve.gov/mediacenter/files/ FOMCpresconf20141217.pdf. 20 101st Annual Report | 2014 Figure 18. Federal Reserve assets and liabilities Trillions of dollars Weekly Assets — — — — — — — — — — — — — — — — — — — Other assets Agency debt and mortgage-backed securities holdings Credit and liquidity facilities Treasury securities held outright Federal Reserve notes in circulation Deposits of depository institutions Capital and other liabilities Liabilities and capital 2008 2009 2010 2011 2012 2013 2014 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 .5 0 .5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 2015 Note: “Credit and liquidity facilities” consists of primary, secondary, and seasonal credit; term auction credit; central bank liquidity swaps; support for Maiden Lane, Bear Stearns, and AIG; and other credit facilities, including the Primary Dealer Credit Facility, the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility, the Commercial Paper Funding Facility, and the Term Asset-Backed Securities Loan Facility. “Other assets” includes unamortized premiums and discounts on securities held outright. “Capital and other liabilities” includes reverse repurchase agreements, the U.S. Treasury General Account, and the U.S. Treasury Supplementary Financing Account. Data extend through February 18, 2015. Source: Federal Reserve Board, Statistical Release H.4.1, “Factors Affecting Reserve Balances.” The Committee has reiterated that, when it decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent. In addition, the Committee continues to anticipate that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run. As emphasized by Chair Yellen in her recent press conferences, FOMC participants provide a number of explanations for this view, with many citing the residual effects of the financial crisis. These effects are expected to ease gradually, but they are seen as likely to continue to constrain household spending for some time. The FOMC has stressed the data-dependent nature of its policy stance and indicated that if incoming information signals faster progress than the Committee expects, increases in the target range for the federal funds rate will likely occur sooner than the Committee anticipates. The FOMC also stated that in the case of slower-than-expected progress, increases in the target range will likely occur later than anticipated. The size of the Federal Reserve’s balance sheet stabilized with the conclusion of the asset purchase program After the conclusion of the large-scale asset purchase program at the end of October, the Federal Reserve’s total assets stabilized at around $4.5 trillion (fig- ure 18). As a result of the asset purchases over the second half of 2014, before the completion of the program, holdings of U.S. Treasury securities in the System Open Market Account (SOMA) increased $56 billion to $2.5 trillion, and holdings of agency debt and agency MBS increased $78 billion to $1.8 trillion on net. On the liability side of the balance sheet, the increase in the Federal Reserve’s assets was largely matched by increases in currency in circulation and reverse repurchase agreements. Given the Federal Reserve’s large securities holdings, interest income on the SOMA portfolio continued to support substantial remittances to the U.S. Treasury Department. Preliminary estimates suggest that the Federal Reserve provided more than $98 billion of such distributions to the Treasury in 2014 and about $500 billion on a cumulative basis since 2008.8 The FOMC continued to plan for the eventual normalization of monetary policy . . . FOMC meeting participants have had ongoing discussions of issues associated with the eventual normalization of the stance and conduct of monetary policy as part of prudent planning.9 The discussions 8 9 See Board of Governors of the Federal Reserve System (2015), “Reserve Bank Income and Expense Data and Transfers to the Treasury for 2014,” press release, January 9, www.federalreserve .gov/newsevents/press/other/20150109a.htm. See Board of Governors of the Federal Reserve System (2014), “Minutes of the Federal Open Market Committee, July 29–30, 2014,” press release, August 20, www.federalreserve.gov/ newsevents/press/monetary/20140820a.htm. Monetary Policy and Economic Developments involved various tools that could be used to control the level of short-term interest rates, even while the balance sheet of the Federal Reserve remains very large, as well as approaches to normalizing the size and composition of the Federal Reserve’s balance sheet. To inform the public about its approach to normalization and to convey the Committee’s confidence in its plans, the FOMC issued a statement regarding its intentions for the eventual normalization of policy following its September meeting. (That statement is reproduced in the box “Policy Normalization Principles and Plans” on page 35 of the February 2015 Monetary Policy Report.) As was the case before the crisis, the Committee intends to adjust the stance of monetary policy during normalization primarily through actions that influence the level of the federal funds rate and other short-term interest rates. Regarding the balance sheet, the Committee intends to reduce securities holdings in a gradual and predictable manner primarily by ceasing to reinvest repayments of principal on securities held in the SOMA. The Committee noted that economic and financial conditions 21 could change, and that it was prepared to make adjustments to its normalization plans if warranted. . . . including by testing the policy tools to be used The Federal Reserve has continued to test the operational readiness of its policy tools, conducting daily overnight reverse repurchase agreement (ON RRP) operations, a series of term RRP operations, and several tests of the Term Deposit Facility. To date, testing has progressed smoothly, and short-term market rates have generally traded above the ON RRP rate, which suggests that the facility will be a useful supplementary tool for the FOMC to use in addition to the interest rate it pays on excess reserves (the IOER rate) to control the federal funds rate during the normalization process. Overall, testing operations reinforced the Federal Reserve’s confidence in its view that it has the tools necessary to tighten policy at the appropriate time. (For more discussion of the Federal Reserve’s preparations for the eventual normalization of monetary policy, see the box “Additional Testing of Monetary Policy Tools” on pages 36–37 of the February 2015 Monetary Policy Report.) 22 101st Annual Report | 2014 Monetary Policy Report of July 2014 Summary The overall condition of the labor market continued to improve during the first half of 2014. Gains in payroll employment picked up to an average monthly pace of about 230,000, and the unemployment rate fell to 6.1 percent in June, nearly 4 percentage points below its peak in 2009. Notwithstanding those improvements, a broad array of labor market indicators—such as labor force participation, hiring and quit rates, and the number of people working part time for economic reasons—generally suggests that significant slack remains in the labor market. Continued slow increases in most measures of labor compensation also corroborate the view that labor resources are not being fully utilized. Inflation has moved up this year following unusually low readings in 2013, but it has remained somewhat below the Federal Open Market Committee’s (FOMC) longer-run goal of 2 percent. The price index for personal consumption expenditures (PCE) rose 1¾ percent over the 12 months ending in May, up from an increase of only 1 percent a year earlier. The PCE price index excluding food and energy items rose 1½ percent over the past 12 months. Meanwhile, both survey- and market-based measures of longer-term inflation expectations have remained stable. Real gross domestic product is reported to have declined in the first quarter of this year, but a number of recent indicators suggest that economic activity rebounded in the second quarter. The pace of economic growth abroad also appears to have quickened in the second quarter following weakness earlier this year, which should provide support for export sales. Moreover, expansion in economic activity continues to be supported by ongoing job gains, a waning drag from fiscal policy, and accommodative financial conditions. However, the housing sector has shown little recent progress. While it has recovered notably from its earlier trough, activity in the sector leveled off in the wake of last year’s increase in mortgage rates, and readings this year have, overall, continued to be disappointing. The Committee expects that, with appropriate policy accommodation, economic activity will expand at a moderate pace and labor market conditions will con- tinue to move gradually toward levels that the Committee judges consistent with its dual mandate of maximum employment and price stability. In addition, the Committee anticipates that with stable inflation expectations and strengthening economic activity, inflation will, over time, return to the Committee’s 2 percent objective. Those expectations are reflected in the June Summary of Economic Projections, which is included as Part 3 of this report. (The June SEP is included as Part 3 of the July 2014 Monetary Policy Report on pages 41–54; it is also included in section 9 of this annual report.) Financial conditions have generally remained supportive of economic growth. Longer-term interest rates have continued to be low by historical standards, and over the first half of the year those interest rates moved down significantly in the United States as well as in most other advanced economies. Overall, borrowing conditions for households have continued to slowly improve amid rising house and equity prices and the faster pace of employment growth so far this year. Credit flows to large nonfinancial businesses have remained strong, and small business lending activity has shown signs of improvement in recent months. With respect to financial stability, signs of risk-taking that could leave segments of the U.S. financial sector vulnerable to possible adverse events have increased modestly this year, albeit from a subdued level. Prices for real estate, equities, and corporate debt have risen and valuation measures have increased, but valuations remain roughly in line with historical norms. Signs of excesses that could lead to higher future defaults and losses have emerged in some sectors, including for speculative-grade corporate bonds and leveraged loans. At the same time, financial firms’ use of short-term wholesale funding has not increased materially and the capital and liquidity position of the banking sector continued to improve. The Federal Reserve and other agencies took further supervisory and regulatory steps to improve resilience, including conducting the 2014 stress tests of the largest bank holding companies (BHCs); finalizing rules to strengthen prudential standards for the largest domestic BHCs and for the U.S. operations of foreign banking firms; and raising leverage ratio standards for the largest, most interconnected firms. To support continued progress toward maximum employment and price stability, the FOMC has maintained a highly accommodative stance of monetary policy. Specifically, the Committee has kept its target Monetary Policy and Economic Developments range for the federal funds rate at 0 to ¼ percent; updated its forward guidance regarding the path of the federal funds rate; and continued to increase its sizable holdings of longer-term securities, though at a gradually diminishing pace. In particular, the Committee made additional measured reductions at each of its first four rebegularly scheduled meetings in 2014 in the monthly pace of its asset purchases. The FOMC also stated at each meeting that, if incoming information continued to broadly support the Committee’s assessment of the economic outlook, the Committee would likely reduce the pace of asset purchases in further measured steps at future meetings. However, the Committee also noted that its asset purchases are not on a preset course, and that decisions about their pace will remain contingent on the economic outlook. The FOMC has provided forward guidance for the federal funds rate based on its assessment of economic and financial conditions. As 2014 began, the Committee’s forward rate guidance included quantitative thresholds relating to the unemployment rate and inflation. However, with the unemployment rate having neared its 6½ percent threshold, the Committee decided at its March meeting to replace the numerical thresholds with a qualitative characterization of its approach to determining how long to maintain the current 0 to ¼ percent target range for the federal funds rate. Specifically, the Committee stated that it will assess progress—both realized and expected—toward its objectives of maximum employment and 2 percent inflation, taking into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends. The Committee additionally stated its anticipation that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run. As part of prudent planning, the Federal Reserve has continued to prepare for the eventual normalization of the stance and conduct of monetary policy. The FOMC remains confident that it has the tools it needs to raise short-term interest rates when the time is right and to achieve the desired level of short-term 23 interest rates thereafter, even while the Federal Reserve is holding a very large balance sheet. The Committee intends to continue its discussions about policy normalization at upcoming meetings while it proceeds with testing the operational readiness of its tools; it expects to provide to the public more information about its normalization plans later this year. Part 1: Recent Economic and Financial Developments Labor market conditions continued to improve over the first half of this year. Gains in payroll employment since the start of the year have averaged about 230,000 jobs per month, up a little from the average pace in 2013, and the unemployment rate declined to 6.1 percent in June, the lowest rate recorded in more than five years. Nevertheless, the jobless rate is still above Federal Open Market Committee (FOMC) participants’ estimates of the longer-run normal rate. Other measures of labor utilization, as well as the continued slow increases in most measures of labor compensation, generally corroborate the view that significant slack remains in the labor market. Inflation, as measured by the price index for personal consumption expenditures (PCE), averaged 1¾ percent over the 12 months ending in May, higher than the unusually low level over the preceding 12 months but still somewhat below the Committee’s 2 percent objective. Meanwhile, both survey- and market-based measures of longer-term inflation expectations have remained quite stable. Real gross domestic product (GDP) was reported to have decreased in the first quarter of this year, but the available information for the second quarter suggests that the decline was transitory. One area of concern, however, is the housing sector, where activity softened by more, relative to its earlier trajectory, than would have been expected based on last year’s rise in mortgage interest rates. Financial conditions have generally remained supportive of economic growth. Longer-term interest rates in the United States as well as in most other advanced economies have partially reversed last year’s increases, and borrowing conditions for households and small businesses have slowly improved, while credit flows to large nonfinancial corporations have remained strong. Domestic Developments Labor market conditions have strengthened further . . . The labor market continued to improve in the first half of 2014. Payroll employment has increased by 24 101st Annual Report | 2014 an average of about 230,000 per month so far this year, higher than the average gain in 2013. The unemployment rate continued to trend down, declining from 6.7 percent in December 2013 to 6.1 percent in June of this year, while the labor force participation rate was little changed, on net, over the first half of this year after having moved down considerably in the second half of last year. The unemployment rate has declined nearly 4 percentage points from its peak in 2009, although it remains elevated when judged against FOMC participants’ estimates of the longerrun normal rate. Payrolls have reversed the cumulative job losses that occurred over the last recession, though that recovery has been achieved in the context of a larger population and labor force. An index constructed by Board staff that aims to summarize movements in a broad array of labor market indicators also suggests that labor market conditions have strengthened further this year.1 While increases in that index slowed a touch at the beginning of this year, partly reflecting the effects of the unseasonably cold and snowy weather this winter, the pace has picked up again in recent months. . . . but significant slack remains . . . Notwithstanding those improvements, various labor market indicators suggest that a significant degree of slack remains in labor utilization. For instance, measures of labor underutilization that incorporate broader definitions of unemployment are still well above their pre-recession levels, even though they have moved down further this year. The proportion of workers employed part time because they are unable to find full-time work has similarly declined but remains elevated, and hiring and quit rates are still below their pre-recession norms. Moreover, the median duration of unemployment is still well above its long-run average. The declines in the participation rate during the past few years, within the context of a strengthening labor market, also could be an indication of continuing labor market slack. To be sure, movements in the participation rate partly reflect the changing demographic composition of the population, most notably the increasing share of older persons, who have 1 For details on the construction of the labor market conditions index, see Hess Chung, Bruce Fallick, Christopher Nekarda, and David Ratner (2014), “Assessing the Change in Labor Market Conditions,” FEDS Notes (Washington: Board of Governors of the Federal Reserve System, May 22), www .federalreserve.gov/econresdata/notes/feds-notes/2014/assessingthe-change-in-labor-market-conditions-20140522.html. lower-than-average participation rates because they are more likely to be retired. As such, many of those exits from the labor force probably would have occurred even if the labor market had been stronger. However, some exits are likely occurring because the prolonged period of high unemployment has led some individuals to give up their job search, and such dynamics could have harmful consequences for economic activity in the long run. . . . and wage growth has remained tepid Continued slow increases in most measures of labor compensation offer further evidence of labor market slack. Compensation per hour in the nonfarm business sector is estimated to have risen at a modest pace of 2¼ percent over the four quarters ending in the first quarter of this year; the employment cost index for private industry workers rose at an annual rate of only 1¾ percent in the same period; and average hourly earnings rose about 2 percent over the 12 months ending in June, little changed from the average rate of increase in hourly earnings during the past several years. Over the past five years, the various measures of nominal hourly compensation have increased roughly 2 percent per year, on average, and after adjusting for inflation, growth of real compensation has fallen short of the gains in productivity over this period. Consumer price inflation has moved up . . . Inflation has moved higher this year following unusually low readings in 2013. The PCE price index rose 1¾ percent over the 12 months ending in May, up from the 1 percent increase recorded over the preceding 12 months. The PCE price index excluding food and energy items rose 1½ percent over the 12 months ending in May, slightly less than the overall index. The FOMC continues to judge that inflation at the rate of 2 percent, as measured by the annual change in the PCE price index, is most consistent over the longer run with the Federal Reserve’s statutory mandate. Thus, inflation remained somewhat below the Committee’s goal. Some of the factors that contributed to the unusually low inflation in 2013, such as the softness seen in non-oil import prices, have begun to unwind and are pushing up inflation a little this year. More generally, however, with wages growing slowly and raw materials prices generally flat or moving downward, firms are not facing much in the way of cost pressures that they might otherwise try to pass on. A portion of the recent increase in inflation reflects movements in energy and food prices that appear Monetary Policy and Economic Developments transitory. Consumer energy prices rose at an annual rate of nearly 6 percent over the 12 months ending in May, partly reflecting strong demand for electricity and natural gas during the cold winter. Global oil prices have been remarkably stable for much of the past year, with oil prices remaining mostly in a narrow range of between about $105 and $110 per barrel and moving above that range only temporarily in reaction to events in Iraq. Meanwhile, adverse growing conditions in both the United States and abroad have pushed up wholesale prices for various food commodities—including corn, wheat, and coffee— and these higher raw materials prices have led to somewhat larger increases in consumer food prices this year. . . . but inflation expectations have changed little Survey- and market-based measures of inflation expectations at medium- and longer-term horizons have remained quite stable throughout the recent period. Readings on inflation expectations 5 to 10 years ahead, as reported in the Thomson Reuters/ University of Michigan Surveys of Consumers, have continued to move within a narrow range. In the Survey of Professional Forecasters, conducted by the Federal Reserve Bank of Philadelphia, the median expectation in the second quarter for the annual rate of increase in the PCE price index over the next 10 years was 2 percent, similar to its level in recent years. Meanwhile, market-based measures of medium- (5-year) and longer-term (5-to-10-yearsahead) inflation compensation derived from differences between yields on nominal Treasury securities and Treasury Inflation-Protected Securities have also remained within their respective ranges observed over the past few years. The first-quarter decline in real GDP appears to have been transitory Measures of real aggregate output—that is, GDP and gross domestic income—were both reported to have declined in the first quarter of this year.2 Part of the weakness in output was likely related to severe weather early in the year.3 But much of the drop in first-quarter GDP reflected unusually large swings in inventories and net exports, two volatile categories 2 3 Gross domestic income measures the same economic concept as GDP, and the two estimates would be identical if they were measured without error Manufacturing output was held down by both snow and extreme cold in parts of the country in January and February. In March, output appears to have been boosted significantly by manufacturers making up for earlier production curtailments. Factory output subsequently dropped back in April, consistent with the view that this makeup production had been achieved. 25 for which the available monthly data point to a rebound in the second quarter. In addition, a number of recent indicators of second-quarter spending, including motor vehicle sales, retail sales, and shipments of capital goods, suggests that the overall pace of consumer and business spending also picked up in the second quarter. Expansion in real activity continues to be supported by ongoing job gains, a waning drag from fiscal policy, and accommodative financial conditions. However, activity in the housing sector has yet to show persistent gains since it slowed in the wake of last year’s rise in mortgage interest rates. Export declines weighed heavily on first-quarter GDP Real exports of goods and services declined at an annual rate of about 9 percent in the first quarter of 2014, coinciding with a global slowdown in trade. The decline partly reflected a retrenchment in two volatile categories, petroleum and agriculture, that had surged in the fourth quarter of 2013. With real imports of goods and services advancing in the first quarter, albeit slowly, net exports subtracted 1½ percentage points—an unusually large amount—from overall GDP growth. However, available data for April and May indicate that exports rebounded in the second quarter, and net exports will likely be more supportive of growth in the second quarter. The current account deficit widened somewhat in the first quarter of this year after having narrowed further over 2013; however, measured relative to nominal GDP, the deficit remains near its narrowest readings since the late 1990s. In the second half of 2013, the current account deficit continued to be financed mostly by purchases of Treasury and corporate securities by both foreign official investors and foreign private investors. Foreign private purchases remained strong in the first quarter of 2014, but official inflows weakened as conditions in emerging market economies (EMEs) worsened early in the quarter. Gains in wealth and income are supporting consumer spending Smoothing through weather-related fluctuations, consumer spending was reported to have risen at a modest annual rate of 1 percent over the first five months of this year, while disposable personal income advanced at a stronger pace of 2¼ percent over the same period.4 The faster pace of job gains so 4 In its third release of quarterly GDP, the Bureau of Economic Analysis reported that consumer spending on health-care services declined in the first quarter. This estimate reflected the incorporation of census data from the U.S. Census Bureau’s 26 101st Annual Report | 2014 far this year has helped improve the economic prospects of many households and has contributed to a pickup in the pace of aggregate income growth, though it is not yet clear how widely these income gains have been shared across the population. In addition, personal tax payments and social security contributions, which surged last year as a consequence of higher federal payroll and income taxes, are no longer weighing as heavily on income growth. Consumption growth this year also has been supported by ongoing gains in household net worth. House prices, which are of particular importance for the wealth position of many middle-income households, have continued to move higher, with the CoreLogic national index showing a rise of almost 9 percent over the 12 months ending in May. Meanwhile, the value of corporate equities has risen more than 15 percent over the past year and has added substantially to net wealth. Reflecting those solid gains, aggregate household net wealth is estimated to have approached 6½ times the value of disposable personal income in the first quarter of this year, the highest level observed for that ratio since 2007. Coupled with low interest rates, the rise in incomes has enabled many households to reduce their debt payment burdens. The household debt service ratio— that is, the ratio of required principal and interest payments on outstanding household debt to disposable personal income—dropped further in the first quarter of this year and stood at a very low level by historical standards. Borrowing conditions for households are slowly improving . . . The improvements in households’ balance sheets so far this year have been accompanied by a gradual easing in borrowing conditions. For example, large banks reported a net easing of standards for home purchase loans to prime borrowers in the Federal Reserve Board’s April 2014 Senior Loan Officer Opinion Survey on Bank Lending Practices (SLOOS).5 SLOOS responses also indicated a net easing in credit standards for consumer loans. Even 5 Quarterly Services Survey, which showed a decline in the revenues of health-care providers. By contrast, a variety of other indicators, including data on Medicaid payments as well as health-care exchange enrollments and subsidies related to the Affordable Care Act, are suggestive of greater strength in health-care spending. The SLOOS is available on the Board’s website at www .federalreserve.gov/boarddocs/snloansurvey. so, mortgage lending standards have remained tight for many households; indeed, standards on nontraditional mortgage loans were reported to have tightened further in the April survey. Likely reflecting, in part, the increased willingness to lend, the rate of decline in mortgage debt has slowed so far this year, and growth in other consumer credit has been robust. . . . but consumer confidence remains tepid Despite the strengthening in household incomes and wealth, indicators of consumer sentiment still appear somewhat depressed compared with their longer-run norms. The Michigan survey’s index of consumer sentiment—which incorporates households’ views about their own financial situations as well as broader economic conditions—has recovered noticeably from its recessionary low but has changed little, on net, over the past year. The responses to a separate survey question about income expectations display a similar pattern: Although an index of households’ expectations of real income changes in the year ahead has recovered somewhat since 2011, it remains substantially below the historical average and suggests a more guarded outlook than the headline index. Business investment has been lackluster, . . . After recording modest gains in 2013, business fixed investment ticked down in the first quarter of this year, as a large decline in spending on nonresidential structures was partly offset by a small increase in outlays for equipment and intangible (E&I) capital. Although the expiration of a tax provision allowing 50 percent bonus depreciation may have pulled some capital investment forward into late 2013, looking over a longer period, the pattern of investment outlays over the past year and a half appears broadly consistent with the sluggish pace of business output growth during the period. Nevertheless, various forward-looking indicators, such as business sentiment and earnings expectations of capital goods producers, paint a fairly upbeat picture and point to a pickup in the growth of E&I investment. Business investment in structures has been relatively weak this year, as demand for nonresidential buildings continues to be restrained by high vacancy rates for existing properties and tight financing conditions for new construction. However, the level of investment in drilling and mining structures is extremely high by historical standards, a reflection of the boom in oil and natural gas extraction. Monetary Policy and Economic Developments . . . even as corporate borrowing has expanded and loan terms and standards appear to be easing The financial condition of large nonfinancial firms has remained strong so far this year, with profitability high and the default rate on nonfinancial corporate bonds generally low. Nonfinancial firms have continued to raise funds at a robust pace, given strong corporate credit quality and historically low interest rates on corporate bonds. Indeed, bond issuance by both investment- and speculative-grade nonfinancial firms has been strong. Moreover, credit availability in business loan markets has shown further improvement. According to the April SLOOS, banks again eased standards on commercial and industrial (C&I) loans to firms of all sizes in the first quarter, and many banks have eased price-related and other terms on such loans. In addition, according to the Federal Reserve Board’s May 2014 Survey of Terms of Business Lending, loan rate spreads over market interest rates for newly originated C&I loans have continued to decline. In this environment, C&I loans on banks’ books and commercial paper outstanding both have registered solid increases. Issuance of leveraged loans continued to be rapid in the first half of 2014, and issuance of collateralized loan obligations reached very high levels in the period from February to April.6 Small business lending activity has picked up as well in recent months, likely reflecting some increase in credit availability as well as a strengthening in businesses’ demand for credit. In the commercial real estate (CRE) sector, loans continued to expand at a moderate pace, and increases in banks’ CRE loans remained widespread across all major CRE segments (that is, loans secured by nonfarm nonresidential properties, multifamily residential properties, and construction and land development loans). According to the April SLOOS, standards on CRE loans extended by banks also eased in the first quarter. Special survey questions asked about changes in terms on CRE loans over the past year, and many banks reported having eased interest rate spreads and increased maximum loan 6 New collateralized loan obligation (CLO) deals over this period were reportedly structured to address certain restrictions in the Volcker rule. In addition, the Federal Reserve Board announced that bank holding companies have until July 21, 2017, to disinvest from non-Volcker-compliant CLOs originated prior to the end of 2013. The extension for complying with the requirement reportedly alleviated the risk of forced liquidations of such instruments in the near term. 27 sizes and terms to maturity. Nevertheless, standards for construction and land development loans appear to have remained relatively tight. The drag from federal fiscal restraint is waning . . . Fiscal policy has been a contractionary force through most of the past three years and was especially so in 2013, when the temporary payroll tax cut expired, taxes increased for high-income households, and federal purchases were pushed down by the sequestration and caps on discretionary spending. Moreover, in the fourth quarter of last year, disruptions related to the government shutdown led to a sharp but temporary reduction in federal purchases. For 2013 as a whole, real federal purchases (as measured in the national income and product accounts) fell 6¼ percent, twice as large as the average decline in the previous two years. This year, however, fiscal policy has become somewhat less restrictive for GDP growth, as the effects of the 2013 tax and spending changes are fading. While the expiration of emergency unemployment compensation at the beginning of the year has exerted a drag on consumer spending, medical benefits provided for under the Affordable Care Act will likely support increased consumption of medical services. With few major changes in tax policy in 2014, federal receipts have edged up to around 17 percent of GDP, their highest level since before the recession. Meanwhile, nominal federal outlays as a share of GDP have continued to trend downward but have remained above the levels observed before the start of the recession. Thus, the federal unified budget deficit has narrowed again this year; the Congressional Budget Office projects that the budget deficit for fiscal year 2014 as a whole will be 3 percent of GDP, compared with the fiscal 2013 deficit of 4 percent of GDP. Overall federal debt held by the public has continued to rise, and the ratio of nominal federal debt to GDP moved up to near 75 percent in early 2014. . . . and state and local government expenditures are turning up At the state and local level, the ongoing strengthening in economic activity, as well as previous spending cuts, has helped foster a gradual improvement in the budget situations of most jurisdictions. Consistent with improving sector finances, states and localities have been expanding their workforces; employment accelerated in the first half of the year after rising 28 101st Annual Report | 2014 modestly in the second half of 2013. Construction expenditures by those governments, however, have yet to show a sustained recovery. The recovery in the housing market has lost traction After proceeding briskly in 2012 and the first half of 2013, the recovery in residential construction seems to have faltered. Real residential investment declined for two successive quarters around the turn of the year, and the available data point to only a modest gain in the second quarter. The renewed softness of late has proven more extensive and persistent than would have been expected given the rise in mortgage interest rates around the middle of last year (see the box “The Slow Recovery of Housing Activity” on pages 16–17 of the July 2014 Monetary Policy Report). That said, household formation remains depressed relative to demographic norms, and the ongoing improvement in labor market conditions could help spur a more decisive return to those norms. Productivity growth has been modest In general, gains in labor productivity have been modest in recent years. Output per hour in the nonfarm business sector has risen at an annual rate of less than 1½ percent since 2007, well below the pace of gains observed over the late 1990s and early 2000s. The relatively slow pace of productivity growth likely reflects, in part, the sustained weakness in capital investment over the recession and recovery period, and productivity gains may be better supported in the future as outlays for productivity-enhancing capital equipment strengthen. Financial Developments The expected path for the federal funds rate edged down Market-based measures of the expected path of the federal funds rate through late 2017 edged down, on balance, over the first half of the year. After accounting for transitory factors such as weather, market participants appeared to judge the incoming economic data as somewhat better than they had expected but as still continuing to point to subdued inflationary pressures and an accommodative policy stance by the FOMC. The relatively small movements of the market-based measures are consistent with the results of the most recent Survey of Primary Dealers and the pilot survey of market participants, each conducted just prior to the June FOMC meeting by the Open Market Desk at the Federal Reserve Bank of New York. Those surveys suggest that dealers and buy-side respondents both anticipate that the initial increase in the target federal funds rate from its current range will occur in the third quarter of 2015, slightly earlier than dealers had anticipated at the beginning of this year and about the same as what buy-side respondents had anticipated.7 Finally, while some forward measures of policy rate uncertainty have risen, overall policy rate uncertainty has generally remained relatively low. However, Treasury yields declined significantly, especially at longer maturities, as have sovereign bond yields in other advanced economies After rising notably over the spring and summer months of 2013, yields on longer-term Treasury securities drifted down over the first half of 2014 and now stand at fairly low levels by historical standards. In particular, while the yield on 5-year nominal Treasury securities edged down only about 5 basis points from its level at the end of December 2013, the yields on the 10- and 30-year securities decreased about 50 basis points and 60 basis points, respectively. The decline in longer-term yields reflects a notable reduction in longer-horizon forward rates, with the 5-year-forward rate 5 years ahead dropping about 105 basis points since year-end. Five-yearforward inflation compensation over this period declined 20 basis points, implying that much of this reduction in nominal forward rates was concentrated in forward real rates. Yields on 30-year agency mortgage-backed securities (MBS) decreased about 35 basis points, on balance, over the same period. Long-term benchmark sovereign yields in advanced foreign economies (AFEs) have also moved down since late last year, with particularly marked reductions in the euro area. Market participants have pointed to several potential explanations for the declines in U.S. and foreign yields. One possible explanation is that market participants have lowered their expectations for future short-term interest rates around the globe. This downward adjustment in expectations may be due to a combination of a lower assessment of the global economy’s long-run potential growth rate and a decrease in long-run inflation expectations. Indeed, the lower yields in the euro area are consistent with indications of declining inflation 7 The results of the Survey of Primary Dealers and of the pilot survey of market participants are available on the Federal Reserve Bank of New York’s website at www.newyorkfed.org/ markets/primarydealer_survey_questions.html and www.newyorkfed.org/markets/pilot_survey_market_participants .html, respectively. Monetary Policy and Economic Developments and weak growth in the euro area in recent months, bolstering expectations that the European Central Bank (ECB) would loosen its monetary policy, as it eventually did at its meeting in early June. In addition, term premiums—the extra return investors expect to obtain from holding longer-term securities as opposed to holding and rolling over a sequence of short-term securities for the same period—may have come down, reflecting several potential factors. One potential factor is a reduction in the amount of compensation for interest rate risk that investors require to hold fixed-income securities, likely due in part to perceptions that uncertainty about the outlook for monetary policy and economic growth has decreased; indeed, swaption-implied volatility on longer-term rates has fallen noticeably since the beginning of the year. Another potential factor is increased demand for Treasury securities from priceinsensitive investors, such as pension funds and commercial banks. Lastly, in light of the notable co-movements between forward interest rates at longer horizons in the United States and other advanced economies, it appears likely that there is a global component of term premiums that is affected not only by U.S. developments, but also by foreign developments, such as investors becoming increasingly confident that policy rates at the major foreign central banks will remain low for an extended period. Broad equity price indexes increased further, and risk spreads on corporate debt declined Although equity investors appeared to pull back from the market for a time early in the year in reaction to concerns about the strength of some EMEs and the possible implications for global growth, broad measures of U.S. equity prices have posted solid gains of 6 percent since the beginning of 2014, on balance, after having risen 30 percent in 2013. Overall, equity investors appeared to become more confident in the near-term economic outlook amid somewhat better-than-expected economic data releases, declining longer-term interest rates, and upward revisions to expected year-ahead earnings per share for firms in the S&P 500 index. Some broad equity price indexes have increased to all-time highs in nominal terms since the end of 2013. However, valuation measures for the overall market in early July were generally at levels not far above their historical averages, suggesting that, in aggregate, investors are not excessively optimistic regarding equities. Nevertheless, valuation metrics in some sectors do appear substantially stretched—particularly 29 those for smaller firms in the social media and biotechnology industries, despite a notable downturn in equity prices for such firms early in the year. Moreover, implied volatility for the overall S&P 500 index, as calculated from option prices, has declined in recent months to low levels last recorded in the mid1990s and mid-2000s, reflecting improved market sentiment and, perhaps, the influence of “reach for yield” behavior by some investors. Credit spreads in the corporate sector have also declined, on balance, in recent months. After having temporarily increased early in the year, the spreads of yields on corporate bonds to yields on Treasury securities of comparable maturities ended the first half of the year about unchanged or a bit narrower. Credit spreads on high-yield corporate bonds are near the bottom of their range over the past decade. While spreads on syndicated loans have changed little this year, they are also relatively low. For further discussion of asset prices and other financial stability issues, see the box “Developments Related to Financial Stability” on pages 22–23 of the July 2014 Monetary Policy Report. Treasury market functioning and liquidity conditions in the MBS market were generally stable . . . Indicators of Treasury market functioning remained stable amid ongoing reductions in the pace of the Federal Reserve’s asset purchases over the first half of 2014. In particular, liquidity conditions in Treasury markets remained stable, with with bid–asked spreads in the Treasury market staying in line with recent averages. In addition, the Treasury’s first-ever auction of a Floating Rate Note in January was well received, as were subsequent auctions of those notes. Liquidity conditions in the MBS markets were also generally stable, though there have been some signs of scarcity of certain securities, as evidenced by somewhat low levels of implied financing rates in the production-coupon “dollar roll” markets during the first half of this year. However, the implied financing rates rose in recent days, suggesting easing of settlement pressures in these markets of late.8 Gross issu8 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 Federal Reserve engages in these transactions as necessary to facilitate settlement of its agency MBS purchases. During April and May, the Open Market Desk transitioned purchases of agency MBS to FedTrade, the Desk’s proprietary trading system that uses multiple-price competitive auctions. 30 101st Annual Report | 2014 ance of these securities remained somewhat lower than in the past two years, reflecting relatively low mortgage originations. . . . and short-term funding markets also continued to function well Conditions in short-term dollar funding markets also remained stable during the first half of 2014. Early in the year, yields on Treasury bills maturing between late February and mid-March of 2014—those that could have been affected by delayed payments if a debt ceiling agreement had not been reached—were elevated for a time, but those yields declined in midFebruary in response to news of pending legislation to suspend the debt ceiling until March 2015. The federal funds rate remained at very low levels, and broader measures of unsecured dollar bank funding costs, such as the LIBOR, or London interbank offered rate, remain at very low levels, reflecting the absence of major funding pressures. Money market participants continued to focus on the Federal Reserve’s testing of its monetary policy tools. Daily awards at the overnight reverse repurchase agreement (ON RRP) exercise have ranged between about $50 billion and about $340 billion since early 2014. The number of counterparties participating and the dollar volume of take-up have been sensitive to the spread between market rates for repurchase agreements and the fixed ON RRP rate offered in the exercise.9 Indeed, take-up has been large at quarterends, when balance sheet adjustments by financial institutions tend to limit other investment options. Experience to date suggests that ON RRP operations have helped establish a floor on money market interest rates. Testing of the Term Deposit Facility, as well as take-up of and participation in its test offerings, has expanded during the first half of 2014. (For further discussion of the testing of monetary policy tools, see the box “Planning for Monetary Policy Implementation during Normalization” on pages 38–39 of the July 2014 Monetary Policy Report.) The condition of financial institutions improved further, although profitability remained below its historical average Regulatory capital ratios at bank holding companies (BHCs) increased further during the first half of 9 Fixed-rate ON RRP operations were first authorized by the FOMC at the September 2013 meeting, and were reauthorized in January 2014, for the purpose of assessing operational readiness. The Committee authorized the Open Market Desk to conduct such operations involving 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. 2014, and measures of bank liquidity remained robust. In addition, credit quality at BHCs continued to improve across major loan categories, and the ratios of loss reserves to delinquencies and to chargeoffs each edged up. At the same time, standard measures of the profitability of BHCs have been little changed for the past six months. Profitability of these companies remained below its historical average, in part because of subdued income from mortgage and trading businesses and compressed net interest margins at large banks. A few large banks have also incurred sizable costs from legal settlements associated with the origination of mortgages prior to the recent financial crisis. Aggregate credit provided by commercial banks grew at a solid pace in the first half of 2014. The increase was driven by a pickup in loan growth and a rise in holdings of U.S. Treasury securities that was reportedly influenced by banks’ efforts to meet new liquidity regulations. Equity prices of large domestic banks increased a bit from the beginning of the year, on net, but underperformed the overall market. Credit default swap (CDS) spreads for large BHCs remain low. Among nonbank financial institutions, equity prices of insurance companies have also increased slightly, on net, since the beginning of the year. Nonbank financial institutions continued to grow at a very strong pace, as assets under management at hedge funds and private equity groups each reached record highs, reflecting modest increases in asset values as well as net inflows. Nevertheless, in response to the Federal Reserve Board’s Senior Credit Officer Opinion Survey on Dealer Financing Terms for March and June, most dealers indicated that hedge funds had not changed their use of leverage since the beginning of the year.10 In the same survey, some dealers noted that the use of financial leverage by trading REITs, or real estate investment trusts, had decreased, continuing a trend that began in the summer of 2013. Assets under management at bond mutual funds also reached a record high. Municipal bond markets functioned smoothly, but some issuers remained strained Credit conditions in municipal bond markets generally appeared to remain stable over the first half of the year. Yields on 20-year general obligation municipal bonds have declined slightly since the beginning of the year, and the MCDX, an index of CDS for a 10 The Senior Credit Officer Opinion Survey on Dealer Financing Terms is available on the Board’s website at www .federalreserve.gov/econresdata/releases/scoos.htm. Monetary Policy and Economic Developments broad portfolio of municipal bonds, has also moved down. However, the ratio of an index of municipal bond yields to Treasury yields has increased a bit. Nevertheless, significant financial strains have been evident for some issuers. Standard & Poor’s, Moody’s Investors Service, and Fitch Ratings downgraded Puerto Rico’s general obligation bonds from investment grade to speculative grade in February. In addition, the City of Detroit continues to negotiate the terms of its bankruptcy plan. Liquid deposits in the banking sector continued to advance briskly, boosting M2 M2 has increased at an annual rate of about 7 percent since December, about the same pace registered in the second half of 2013 and somewhat faster than the pace of nominal GDP. The growth in M2 has been driven by an increase in liquid deposits as well as an uptick in demand for currency. International Developments As in the United States, foreign bond yields declined and asset prices increased, on net . . . As noted earlier, foreign long-term benchmark sovereign yields have moved significantly lower since the beginning of the year. Factors contributing to the decline include expectations for lower policy interest rates, a decline in the required compensation for risk, and increased demand by price-insensitive investors for these assets. Similarly, foreign corporate and sovereign yield spreads have also declined since the start of the year. In particular, peripheral euro-area sovereign yield spreads narrowed substantially, on balance, as financial stresses in the euro area have eased and central banks in the advanced economies have emphasized that they will keep monetary policy accommodative for some time, though spreads in a few economies have moved up more recently. Sovereign yield spreads in EMEs have also declined, on net, consistent with measures adopted by EME central banks to reduce vulnerabilities and with the general increase in the prices for risky assets. Foreign equity indexes rose, on net, during the first half of the year. Stock prices increased, on balance, in most of the AFEs. Japanese equities underperformed early in the year, but they have moved up recently on stronger-than-expected incoming economic data. And European bank stock prices declined lately in part on concerns over troubles at several banks. Equities in most EMEs have also 31 moved higher, as market sentiment toward these economies has continued to improve. However, the Chinese stock market fell on concerns over the economic outlook. Realized volatility across most financial markets and countries has declined since January, in part as sentiment toward risky assets generally improved. . . . and the dollar is about unchanged The broad nominal value of the dollar is little changed, on net, since the beginning of the year. The U.S. dollar appreciated notably against the Chinese renminbi in the first months of the year. However, the People’s Bank of China has since kept the value of the renminbi steady. In contrast, the dollar depreciated against most other emerging market currencies, as financial stresses earlier in the year unwound. In addition, the dollar depreciated against the British pound, as macroeconomic conditions improved in the United Kingdom and markets moved forward their expectations for the first rate hike by the Bank of England, and also depreciated against the Japanese yen, as investors reduced their expectations for stronger policy accommodation in Japan. Activity in the emerging market economies slowed in the first quarter but showed signs of picking up in the second quarter . . . Aggregate real GDP growth in the EMEs slowed in the first quarter of this year, led by a step-down in China’s economy that also weighed on activity in many of its trading partners, especially in emerging Asia. The slowing in China reflected a sharp fall in exports, as well as a restraint on domestic demand from tighter financial conditions, as the government attempted to rein in credit. In Mexico, growth remained weak in the first quarter, likely restrained by hikes in tax rates and administered fuel prices and softer U.S. demand for Mexican exports. Brazilian real GDP rose at a tepid pace in the first quarter, extending the lackluster performance of the past two years. Recent indicators, notably exports, suggest that EME growth picked up in the second quarter. In particular, Chinese exports grew robustly in the second quarter, reversing most of the sharp decline in February, and the authorities announced a series of small targeted stimulus measures to support growth. The improvement in Chinese growth, along with firmer growth in the advanced economies, will help boost global economic activity in the rest of emerging Asia. Growth in Mexico is also expected to step up in the second 32 101st Annual Report | 2014 quarter, in line with U.S. manufacturing output, and recent data in Brazil point to some, albeit modest, improvement. Advanced Economies” on pages 30–31 of the July 2014 Monetary Policy Report.) Part 2: Monetary Policy Inflation remained subdued in most EMEs, and central banks in some countries, such as Chile, Mexico, and Thailand, cut rates to support growth. In contrast, the central banks of a few EMEs, such as Brazil and India, where inflation remained elevated, raised policy rates. . . . while economic growth in most advanced foreign economies remained moderate Indicators suggest that average economic growth in the AFEs remained moderate in the first half of 2014. The severe winter weather that hampered growth in the United States also weighed on real GDP in Canada, where growth slowed to an annualized 1¼ percent pace in the first quarter. However, data including the purchasing managers index are consistent with Canadian growth bouncing back in the second quarter. In Japan, GDP growth surged in the first quarter at a nearly 7 percent pace, led by household spending ahead of the April hike in the Japanese consumption tax, but recent retail sales data suggest that activity fell back sharply in April. In the United Kingdom, GDP growth remained robust in the first quarter at 3¼ percent, and the unemployment rate fell about 1 percentage point between mid2013 and the first quarter of 2014. The euro area’s recovery continued at a subdued pace—with GDP rising at an annual rate of around ¾ percent in the first quarter—and recent indicators point to a firming in growth in the second quarter as financial and credit conditions continue to normalize. Inflation during the first half of the year has been around 2 percent in Canada and somewhat below that level in the United Kingdom. In Japan, the April tax hike as well as rising import prices in response to recent yen depreciation pushed up the 12-month rate of consumer price inflation in April. However, inflation excluding taxes remained much lower, and the Bank of Japan continued its aggressive program of asset purchases aimed at achieving its inflation target of 2 percent in a stable manner. In the euro area, inflation slowed to just ½ percent in May, and the ECB responded in June by cutting its key policy rates—taking the deposit rate into negative territory—and by announcing measures to ease credit conditions. (For further discussion of monetary policy at foreign central banks, see the box “Prospects for Monetary Policy Normalization in the To support further progress toward maximum employment and price stability, monetary policy has remained highly accommodative. The Federal Reserve kept the target federal funds rate at its effective lower bound, updated its forward guidance regarding the path of the federal funds rate, and added to its sizable holdings of longer-term securities, albeit at a reduced pace. The Federal Reserve has also continued to plan for the eventual normalization of monetary policy. The Federal Open Market Committee continued to use large-scale asset purchases and forward rate guidance to support further progress toward maximum employment and price stability The Committee has continued to judge that a highly accommodative stance of monetary policy remains warranted to support progress toward its dual mandate of maximum employment and price stability. With the target range for the federal funds rate remaining at its effective lower bound, the Federal Open Market Committee (FOMC) has made further use of nontraditional policy tools to provide appropriate monetary stimulus. In particular, the FOMC has used large-scale asset purchases to put downward pressure on longer-term interest rates and to ease financial conditions more broadly so as to promote the more rapid achievement of its dual objectives. In addition, the FOMC has provided guidance about the likely future path of the federal funds rate in an effort to give greater clarity to the public about its policy outlook and intentions. In light of the cumulative progress toward its monetary policy objectives and the outlook for further progress over coming years, the Committee made adjustments during the first half of 2014 to both its asset purchase program and its forward guidance about the path of the federal funds rate. The FOMC made further measured reductions in the pace of its asset purchases . . . During the first half of 2014, the Committee made further measured reductions in the pace of its asset purchases, following the initial modest reduction announced at the December 2013 meeting.11 These actions reflected the cumulative progress toward 11 See Board of Governors of the Federal Reserve System (2013), “Federal Reserve Issues FOMC Statement,” press release, Monetary Policy and Economic Developments maximum employment and the improvement in the outlook for labor market conditions since the inception of the current asset purchase program in the fall of 2012 as well as the Committee’s judgment that there was sufficient underlying strength in the broader economy to support ongoing improvement in labor market conditions and inflation moving back toward its longer-run objective. Specifically, at its four meetings in the first half of 2014, the Committee reduced the monthly pace of its purchases of agency mortgage-backed securities (MBS) and of longer-term Treasury securities by $5 billion each. Accordingly, beginning in July, the Committee is adding to its holdings of agency MBS at a pace of $15 billion per month (compared with $35 billion per month at the beginning of the year) and is adding to its holdings of longer-term Treasury securities at a pace of $20 billion per month (compared with $40 billion per month at the beginning of the year). The FOMC also maintained its existing policy of reinvesting principal payments from its holdings of agency debt and agency MBS in agency MBS and of rolling over maturing Treasury securities at auction. While making measured reductions in the pace of its purchases, the Committee noted that its sizable and still-increasing holdings of longer-term securities should maintain downward pressure on longer-term interest rates, support mortgage markets, and help make broader financial conditions more accommodative. More accommodative financial conditions, in turn, should promote a stronger economic recovery, a further improvement in labor market conditions, and a return of inflation, over time, toward the Committee’s 2 percent objective. At each of its meetings so far this year, the FOMC reiterated that it would closely monitor incoming information on economic and financial developments, and that it would continue asset purchases and employ its other policy tools as appropriate until the outlook for the labor market had improved substantially in a context of price stability. The Committee also noted that if incoming information broadly supports its expectation of ongoing improvement in labor market conditions and inflation moving back toward its longer-run objective, it would likely reduce the pace of asset purchases in further measured steps at future meetings. However, the Committee also December 18, www.federalreserve.gov/newsevents/press/ monetary/20131218a.htm. 33 emphasized that asset purchases are not on a preset course, and that decisions about their pace would remain contingent on the Committee’s outlook for the labor market and inflation as well as its assessment of the likely efficacy and costs of such purchases. . . . updated its forward guidance with a qualitative description of the factors that will influence its decision to begin raising the federal funds rate . . . As 2014 began, the Committee’s forward guidance included quantitative thresholds, stating that the exceptionally low target range for the federal funds rate of 0 to ¼ percent would be appropriate at least as long as the unemployment rate remained above 6½ percent, inflation between one and two years ahead was projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continued to be well anchored.12 The Committee also indicated that in determining how long to maintain a highly accommodative stance of monetary policy, it would consider not only the unemployment rate but also other indicators, including additional measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. Based on its assessment of these factors, the Committee noted that it likely would be appropriate to maintain the current target range for the federal funds rate well past the time the unemployment rate declines below 6½ percent, especially if projected inflation continues to run below the Committee’s 2 percent longer-run goal. At the time of the March meeting, with the unemployment rate quickly approaching the threshold of 6½ percent, the FOMC decided to update its forward guidance by providing a qualitative description of the factors that would influence its decision regarding the appropriate time of the first increase in the target federal funds rate from its current 0 to ¼ percent target range.13 The Committee agreed that while reliance on a single indicator—the unemployment rate— had been useful for communications purposes when employment conditions were much further from 12 13 See Board of Governors of the Federal Reserve System (2014), “Federal Reserve Issues FOMC Statement,” press release, January 29, www.federalreserve.gov/newsevents/press/monetary/ 20140129a.htm. See Board of Governors of the Federal Reserve System (2014), “Federal Reserve Issues FOMC Statement,” press release, March 19, www.federalreserve.gov/newsevents/press/monetary/ 20140319a.htm. 34 101st Annual Report | 2014 mandate-consistent levels, with labor market conditions improving, the Committee would base its judgment concerning progress in the labor market on a much broader set of indicators from that point forward. Specifically, the Committee indicated that in determining how long to maintain the current target range, it would assess progress—both realized and expected—toward its objectives of maximum employment and 2 percent inflation. This assessment would take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. Based on its assessment of these factors, the Committee indicated that it likely would be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continued to run below the Committee’s 2 percent longer-run goal and provided that longer-term inflation expectations remained well anchored. To help forestall misinterpretation of the new forward guidance, the Committee noted that the change in its guidance did not indicate any change in its policy intentions as set forth in its recent statements. . . . and added information regarding the likely behavior of the target federal funds rate after the rate is raised above its effective lower bound The Committee also stated that, when it decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent. In addition, the Committee indicated its anticipation that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run. Committee participants have noted that a prolonged period of low interest rates could lead investors to take on excessive risk, potentially posing risks to longer-term financial stability. The Federal Reserve will continue to monitor the financial system for any signs of the buildup of such risks and will take appropriate steps to address such risks as needed (see the box “Developments Related to Financial Stability” on pages 22–23 of the July 2014 Monetary Policy Report). The Committee’s large-scale asset purchases led to a further increase in the size of the Federal Reserve’s balance sheet As a result of the FOMC’s ongoing large-scale asset purchase program, Federal Reserve assets have increased further since the end of last year. Holdings of U.S. Treasury securities in the System Open Market Account (SOMA) increased $200 billion to $2.4 trillion, and holdings of agency debt and MBS increased $160 billion, on net, to $1.7 trillion.14 On the liability side of the balance sheet, the increase in the Federal Reserve’s assets was largely matched by increases in reserve balances, currency in circulation, deposits with Federal Reserve banks, and reverse repurchase agreements. Given the Federal Reserve’s large and growing balance sheet, interest income on the SOMA portfolio continued to support substantial remittances to the U.S. Treasury. Last year, remittances totaled $80 billion, and remittances over the first quarter of this year remained very high. Cumulative remittances to the Treasury from 2008 through the first quarter of 2014 exceeded $420 billion.15 The Federal Reserve continued to plan for the eventual normalization of monetary policy At its April meeting, the FOMC discussed issues associated with the eventual normalization of the stance and conduct of monetary policy during a period when the Federal Reserve’s balance sheet will be very large.16 The Committee’s discussion of this topic was undertaken as part of prudent planning and did not imply that normalization will begin soon. The Committee discussed various tools that could be used to raise short-term interest rates—and to con14 15 16 The changes in the par value of SOMA holdings, noted earlier, can differ from the amount of securities purchased over the same period, largely because of lags in the settlement of the purchases. Among other assets, the outstanding amount of dollars provided through the temporary U.S. dollar liquidity swap arrangements with foreign central banks edged lower since the end of last year and remains close to zero, reflecting the continued stability in offshore U.S. dollar funding markets. See Board of Governors of the Federal Reserve System (2014), Quarterly Report on Federal Reserve Balance Sheet Developments (Washington: Board of Governors, May), www.federalreserve .gov/monetarypolicy/files/quarterly_balance_sheet_ developments_report_201405.pdf. See Board of Governors of the Federal Reserve System (2014), “Minutes of the Federal Open Market Committee, April 29–30, 2014,” press release, May 21, www.federalreserve.gov/ newsevents/press/monetary/20140521a.htm. Monetary Policy and Economic Developments trol the level of short-term interest rates once they are above the effective lower bound—even while the balance sheet of the Federal Reserve remains very large. Those tools included the rate of interest paid on excess reserve balances, fixed-rate overnight reverse repurchase agreement (ON RRP) operations, term reverse repurchase agreements, and the Term Deposit Facility (TDF). Participants considered how various combinations of tools could have different implications for the degree of control over short-term interest rates, the Federal Reserve’s balance sheet and remittances to the Treasury, the functioning of the federal funds market, and financial stability in both normal times and periods of stress. At the June FOMC meeting, participants continued their discussion of normalization issues and considered some possible strategies for implementing and communicating monetary policy during that process.17 Most participants agreed that adjustments in the rate of interest on excess reserves (IOER) should play a central role during the normalization process. It was generally agreed that an ON RRP facility with an interest rate set below the IOER rate could play a useful supporting role by helping to firm the floor under money market interest rates. A few participants commented that the Committee should also be prepared to use its other policy tools, including term deposits and term reverse repurchase agreements, if necessary. Most participants thought that the federal funds rate should continue to play a role in the Committee’s operating framework and communications during normalization, with many of them indicating a preference for continuing to announce a target range. While generally agreeing that an ON RRP 17 See Board of Governors of the Federal Reserve System (2014), “Minutes of the Federal Open Market Committee, June 17–18, 2014,” press release, July 9, www.federalreserve.gov/newsevents/ press/monetary/20140709a.htm. 35 facility could play an important role in the policy normalization process, participants discussed several possible concerns about using such a facility, including the potential for substantial shifts in investments toward the facility and away from financial and nonfinancial firms in times of financial stress, the potential expansion of the Federal Reserve’s role in financial intermediation, and the extent to which monetary policy operations might be conducted with nontraditional counterparties. Participants discussed design features that could help address these concerns. Several participants emphasized that, although the ON RRP rate would be useful in controlling short-term interest rates during normalization, they did not anticipate that such a facility would be a permanent part of the Committee’s longer-run operating framework. Overall, participants generally expressed a preference for a simple and clear approach to normalization, and it was observed that it would be useful for the Committee to develop its plans and communicate them to the public later this year, well before the first steps in normalizing policy become appropriate, and to maintain flexibility about the evolution of the normalization process as well as the Committee’s longer-run operating framework. The Federal Reserve has continued to test the operational readiness of its policy tools, conducting daily ON RRP operations and several tests of the TDF during the first half of 2014. To date, testing has progressed smoothly, and, in recent months, short-term market rates have generally traded above the ON RRP rate. (For more discussion of the Federal Reserve’s preparations for the eventual normalization of monetary policy, see the box “Planning for Monetary Policy Implementation during Normalization” on pages 38–39 of the July 2014 Monetary Policy Report.) 37 3 Financial Stability A primary objective of the Federal Reserve since its inception has been the promotion of financial stability (box 1). As the U.S. and global financial systems have evolved, the Federal Reserve’s role in helping maintain financial system stability has necessarily adapted. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act), for example, explicitly assigned the Federal Reserve new responsibilities for promoting financial stability. A central element in the Dodd-Frank Act is the requirement that the Federal Reserve and other financial regulatory agencies adopt a macroprudential approach to supervision and regulation. Whereas a traditional—or microprudential—approach to supervision and regulation focuses on the safety and soundness of individual institutions, the macroprudential approach centers on the stability of the financial system as a whole. In particular, the macroprudential approach informs the supervision of systemically important financial institutions—including large bank holding companies (BHCs), the U.S. operations of certain foreign banking organizations (FBOs), and financial market utilities (FMUs). In addition, the Federal Reserve serves as a “consolidated supervisor” of nonbank financial companies that have been designated by the Financial Stability Oversight Council (FSOC) as institutions whose distress or failure could pose a threat to the stability of the U.S. financial system as a whole (see “Financial Stability Oversight Council Activities” later in this section). Furthermore, the changing nature of risks and fluctuations in financial markets and the broader economy require timely monitoring of conditions in domestic and foreign financial markets, among financial institutions, and in the nonfinancial sector in order to identify the buildup of vulnerabilities that might require further study or policy action. Promotion of financial stability strongly complements the primary goals of monetary policy—price stability and full employment. A smoothly operating financial system promotes the efficient allocation of Box 1. Financial Stability and the Founding of the Federal Reserve In 2014, the Federal Reserve marked the centennial anniversary of its activities since the passage of the Federal Reserve Act in 1913. Financial stability considerations were a key element in the founding of the System. Indeed, the Federal Reserve was created in response to the Panic of 1907, the latest in a series of severe financial panics that befell the nation in the late 19th and early 20th centuries. This panic led to the creation of the National Monetary Commission, whose 1911 report was a major impetus to the Federal Reserve Act, signed into law by President Woodrow Wilson on December 23, 1913. Upon enactment, the process of organizing and opening the Board and the Reserve Banks across the country began. On November 16, 1914, the Federal Reserve System began full-fledged operations. In the words of one author of the Federal Reserve Act, U.S. Senator Robert Latham Owen of Oklahoma, “It should always be kept in mind that . . . it is the prevention of panic, the protection of our commerce, the stability of business conditions, and the maintenance in active operation of the productive energies of the nation which is the question of vital importance.”1 The Federal Reserve has continued to serve this function and adapt to U.S. and global economic and financial system evolution, innovation, conditions, and dynamics. 1 See Robert L. Owen (1919), The Federal Reserve Act: Its Origin and Principles (New York: Century Company), pp. 43–44. 38 101st Annual Report | 2014 saving and investment, facilitating economic growth and employment. And price stability contributes not only to the efficient allocation of resources in the real economy, but also to reduced uncertainty and efficient pricing in financial markets, thereby supporting financial stability. This section discusses key financial stability activities undertaken by the Federal Reserve in 2014, which include monitoring risks to financial stability; macroprudential supervision and regulation of large, complex financial institutions; and domestic and international cooperation and coordination. Some of these activities are also discussed elsewhere in this annual report. A broader set of economic and financial developments are discussed in section 2, “Monetary Policy and Economic Developments,” with the discussion that follows concerning surveillance of economic and financial developments focused on financial stability. The full range of activities associated with supervision of systemically important financial institutions, designated nonbank companies, and designated FMUs is discussed in section 4, “Supervision and Regulation.” Monitoring Risks to Financial Stability Financial institutions are linked together through a complex set of relationships. Moreover, the condition of financial institutions and financial stability depends on the economic condition of the nonfinancial sector, whose borrowing from the financial sector implies that the strength of financial institutions’ balance sheets depends on the condition of the nonfinancial sector. As a result, research on financial stability has been an important part of Federal Reserve efforts in pursuit of overall economic stability (see box 2 for information on recent research). In order to understand the interaction among these factors and consider appropriate policy responses, the Federal Reserve maintains a flexible, forwardlooking financial stability monitoring program to help inform policymakers of the financial system’s vulnerabilities to a range of potential adverse events or shocks. Such a monitoring program is a critical part of a broader program in the Federal Reserve System to assess and address vulnerabilities in the U.S. financial system. Each quarter, Federal Reserve Board staff systematically assess a standard set of vulnerabilities relevant for financial stability: asset valuations and risk appetite, leverage in the financial system, liquidity risks and maturity transformation by the financial system, and borrowing by the nonfinancial sector (households and nonfinancial businesses). These monitoring efforts inform internal discussions concerning both macroprudential supervision and regulatory policies and monetary policy. They also inform Federal Reserve interactions with broader monitoring efforts, such as those by the FSOC and the Financial Stability Board (FSB). The more specific discussion that follows focuses on a subset of the most important developments over the course of 2014 concerning specific indicators, including asset valuations and risk appetite, leverage, maturity and risk transformation, and nonfinancialsector borrowing. Asset Valuations and Risk Appetite Overvalued assets constitute a fundamental vulnerability because the unwinding of high prices can be destabilizing, especially if the assets are widely held and the values are supported by excessive leverage, maturity transformation, or risk opacity. Moreover, stretched asset valuations may be an indicator of a broader buildup in risk-taking. Nonetheless, it is very difficult to judge whether an asset price is overvalued relative to fundamentals. As a result, analysis typically considers a range of possible valuation metrics, developments in areas in which asset prices are rising especially rapidly or into which investor flows have been considerable, or the implications of unusually low or high levels of volatility in certain markets. Looking across markets, valuation pressures were notable or building in several areas. Over the course of 2014, yields fell in investment-grade and in the upper end of the speculative-grade corporate debt markets, and yields on corporate debt are historically low. A key contributing factor to the decline in corporate bond yields over 2014 was the sizable decline in U.S. Treasury yields over the year (figure 1). Spreads relative to Treasury yields, a gauge of the compensation investors demand as compensation for exposure to the credit risk associated with riskier corporate borrowers, rose somewhat in late 2014 from low levels and suggested moderate valuation pressure in corporate bonds overall. The spread on high-yield Financial Stability Figure 1. Bond yields, 2010–15 39 Figure 2. Leveraged loan and high-yield bond issuance, 2004–14 Percent Billions of dollars (annual rate) Daily 10 High-yield Triple-B 10-year Treasury 6 Mar. 26 2012 2013 2014 30 1200 25 Q1 Q2 Q3 1000 800 0 2011 Total outstanding (right scale) 20 Q4 15 4 2 2010 35 High-yield bonds (left scale) Leveraged loans (left scale) 1400 8 Four-quarter percent change 1600 2015 Source: Staff estimates of smoothed corporate yield curves based on data from BofA Merrill Lynch Global Research, used with permission, and smoothed Treasury yield curve. bonds widened more notably than that on investment-grade corporate bonds. Some of this widening in spreads reflected increased concerns about the ability of firms in the energy sector to repay their borrowing in light of the sharp decline in the price of oil over the second half of the year. Despite the widening in spreads over Treasury securities, valuation pressures appeared notable in riskier corporate debt markets. Issuance of high-yield bonds remained high in 2014, as did issuance of leveraged loans (figure 2)—although the pace of issuance slowed late in the year. As a result, the level of such risky debt grew more than 10 percent in 2014, the third year of growth in excess of 10 percent. In addition, the underwriting quality of leveraged loans arranged or held by banking institutions remained relatively weak in 2014, although there may have been some improvement late in the year in response to supervisory enforcement of the 2013 guidance for leveraged lending. For example, debt multiples over earnings on new deals remain high relative to historical averages but decreased somewhat, on balance, in the fourth quarter of 2014. Even so, the increase in borrowing and loose standards for lending over recent years could imply that investors in high-yield bonds and leveraged loans are exposed to larger risks of low returns or losses in coming years, and the growth in debt among lower-rated corporations may place strains on these firms, especially if macroeconomic conditions turn out to be weaker than expected. Indeed, as described in more detail later, the 2015 round of Fed- 600 10 400 5 200 0 0 2004 2006 2008 2010 2012 2014 -5 Note: Total outstanding is quarterly data. Data include bonds and loans to both financial and nonfinancial companies, as well as unrated bonds and loans. Source: Standard & Poor’s Leveraged Commentary & Data (LCD); Mergent Corporate Fixed Income (FISD). S&P and its third-party information providers expressly disclaim the accuracy and completeness of the information provided to the Board, as well as any errors or omissions arising from the use of such information. Further, the information provided herein does not constitute, and should not be used as, advice regarding the suitability of securities for investment purposes or any other type of investment advice. eral Reserve stress testing explored the potential strains on participating institutions that could stem from a large deterioration in the credit quality of risky corporate borrowers in its severely adverse scenario. The commercial real estate market exhibited growing valuation pressures over the course of 2014. Prices have risen relative to rents, and lending standards have eased. There have also been indications of weakening in underwriting standards in securitizations, such as an increased share of interest-only loans and rising loan-to-value ratios in commercial mortgage-backed securities (CMBS) pools. However, unlike corporate debt more broadly, the volume of commercial real estate debt outstanding has begun to accelerate appreciably only over the past year. In other markets, valuation pressures appear moderate. Broad measures of equity prices rose about 10 percent over the course of 2014, but the equity premium, measured as the gap between the expected return on equity and the real long-term Treasury yield, is estimated to have remained relatively wide. However, equity prices were high relative to aggregate sales, reflecting high profit margins. In addition, residential real estate valuations appear within historical norms. For example, house prices relative to rents— one measure of valuations—have remained well 40 101st Annual Report | 2014 Figure 3. Ratio of prices to rents, 1990–2015 Jan. 2010 = 100 180 Monthly 160 United States Median Interquartile range 140 120 Jan. 100 80 60 1991 1995 1999 2003 2007 2011 2015 Note: Percentiles are based on 25 metropolitan statistical areas. Source: For house prices, CoreLogic; for rent data, Bureau of Labor Statistics. within a typical range and remain far below the levels seen in the past decade across much of the country (figure 3). Leverage in the Financial System The financial strength of the banking sector has continued to improve. Both the ratio of Tier 1 common equity to risk-weighted assets and the leverage ratio have risen to levels far above those seen in the mid2000s (figure 4). The increase in capital reflects the tougher standards implemented globally as part of the Basel III process and additional efforts implemented following the passage of the Dodd-Frank Act, including more stringent standards and the Figure 4. Regulatory capital ratios, CCAR bank holding companies, 2001–14 Gross ratio Quarterly, S.A. 12 Tier 1 common Leverage ratio Q4 8 4 2002 2004 2006 2008 2010 2012 2014 Note: The shaded bars indicate periods of business recession as defined by the National Bureau of Economic Research. CCAR is Comprehensive Capital Analysis and Review. Source: Federal Reserve Board, FR Y-9C, Consolidated Financial Statements for Bank Holding Companies. annual stress tests for larger banking organizations. As a result of steady improvements in capital positions since the financial crisis, U.S. banks, in aggregate, appear to be better positioned to absorb potential shocks, such as those related to litigation, falling oil prices, and financial contagion stemming from abroad. Securitization, which continues to be an important means of financing for several asset classes, remains relatively subdued, though issuance of non-agency CMBS and collateralized loan obligations (CLOs) continued to be robust amid continued reports of relatively accommodative underwriting standards for the underlying assets. Recent results from the Federal Reserve’s Senior Credit Officer Opinion Survey on Dealer Financing Terms indicate that the use of financial leverage by institutional investor clients to fund the purchases of securities was little changed over recent quarters, although demand for funding non-agency residential mortgage-backed securities and high-yield bonds has been rising recently.1 Liquidity Risks and Maturity Transformation by the Financial System Bank balance sheets show continued improvement in liquidity positioning as the largest BHCs transition to Basel III liquidity requirements. The Basel III liquidity coverage ratio (LCR) requirement began phasing in for U.S. BHCs with greater than $250 billion in consolidated assets on January 1, 2015, and will take full effect in January 2017. In January 2016, a “modified” LCR requirement for BHCs with between $50 billion and $250 billion in assets will begin to be phased in. Against this backdrop, balance sheet data through 2014:Q4 show the ratio of high-quality liquid assets to total assets at large- and medium-sized BHCs continued to grow (figure 5). Short-term wholesale funding remained subdued throughout 2014. Net overnight borrowing at brokerdealers against fixed-income securities continued to trend down (figure 6). The total outstanding dollar values of commercial paper and money market mutual funds (MMFs) were relatively unchanged in 2014. Structural vulnerabilities at MMFs persist: In particular, prime MMFs are 1 The Senior Credit Officer Opinion Survey on Dealer Financing Terms is available on the Board’s website at www.federalreserve .gov/econresdata/releases/scoos.htm. Financial Stability will monitor the effects of the new rules after they are implemented. Figure 5. Ratio of high-quality liquid assets to total assets, 2010–14 Percent 30 Quarterly Large (>$250B total assets or >$10B foreign assets)* Medium ($50B–$250B)** 25 Q4 20 15 10 5 2010 2011 2012 2013 2014 * Bank holding companies (BHCs) subject to the full liquidity coverage ratio (LCR) rule. ** BHCs subject to modified LCR rule. Source: High-quality liquid assets estimated using quarter-end balances reported in filings of Federal Reserve Board reporting forms FR Y-9C (Consolidated Financial Statements for Bank Holding Companies) and FR 2900 (Report of Transaction Accounts, Other Deposits, and Vault Cash). vulnerable to investor runs if a drop in the credit quality of their assets or a decline in the willingness of market participants to bear credit risk induces a fall in the market value of their assets. The U.S. Securities and Exchange Commission (SEC) rules that will require institutional prime MMFs to move from a fixed to a floating net asset value starting in 2016 may mitigate their susceptibility to runs. The SEC Figure 6. Primary dealer net borrowing, by maturity, 2001–14 Billions of dollars Weekly Net borrowing 2500 Revised survey 2000 Net overnight borrowing Net term borrowing 1500 1000 Net lending Dec. 31 41 500 0 -500 -1000 -1500 2002 2004 2006 2008 2010 2012 2014 Note: Term financing refers to agreements with an original fixed maturity of more than one business day. Overnight financing refers to agreements with an original fixed maturity of one business day and agreements with no specific maturity that can be terminated on demand by either the borrower or lender. Net borrowing is the difference between funds received (borrowing) and funds paid (lending). Source: Federal Reserve Board, FR 2004C, Weekly Report of Dealer Financing and Fails. There are signs that the structure of some asset markets is changing due to changes in broker-dealer activities and increased trading speeds that are contributing to a buildup of liquidity risks in some markets. In addition, the growth of bond mutual funds and exchange-traded funds (ETFs) in recent years means that these funds now hold a much higher fraction of the available stock of relatively less liquid assets—such as high-yield corporate debt, bank loans, and international debt—than they did before the financial crisis. It is possible that, because mutual funds and ETFs may appear to offer greater liquidity than the markets in which they transact, their growth heightens the potential for a forced sale in the underlying markets if some event were to trigger large volumes of redemptions. This possibility—among other potential vulnerabilities—was the subject of a recent request for comments from the public issued by the FSOC (see “Financial Stability Oversight Council Activities” later in this section). Borrowing by the Nonfinancial Sector Excessive borrowing by the private nonfinancial sector has been an important contributor to financial crises. Highly indebted households and nonfinancial businesses may have a difficult time withstanding negative shocks to incomes or asset values and may be forced to curtail spending in ways that amplify the effects of financial shocks. In turn, losses among households and businesses can lead to mounting losses at financial institutions, creating an “adverse feedback loop” in which weakness among households, nonfinancial businesses, and financial institutions causes further declines in income and financial losses, potentially leading to financial instability and a sharp contraction in economic activity. Borrowing by households remained relatively subdued through the fourth quarter of 2014. At the same time, borrowing by the nonfinancial business sector has grown only moderately. As a result, the ratio of household and nonfinancial business credit to nominal GDP has remained significantly below the peak seen in the 2000s (figure 7). Nonetheless, this ratio remains above levels seen prior to the mid-2000s. Within the household sector, the level of borrowing has edged up among households with strong credit histories, while borrowing by households with dam- 42 101st Annual Report | 2014 Box 2. 2014 Research on Financial Stability The macroprudential approach to ensuring financial stability builds on a substantial and growing body of research on the factors that lead to vulnerabilities in the financial system and how policies can mitigate such risks. It remains the case, however, that understanding of the array of factors important for financial stability is incomplete and evolving. As a result, the Federal Reserve engages actively in financial stability research. This research seeks to improve understanding of related issues, engages the broader research community in policy issues, and often involves collaboration with academia and researchers at other domestic and international institutions. Finally, research efforts by Federal Reserve staff reflect their attempts to identify and grapple with topics of concern to the Federal Reserve, and the views expressed are those of the individual authors and not those of the Federal Reserve. Examples of research on financial stability in 2014 include the following: • Tracking time-varying sources of systemic risk. A research note presenting a forward-looking monitoring program to identify and track timevarying sources of systemic risk. The program distinguishes between shocks, which are difficult to prevent, and the vulnerabilities that amplify shocks, which can be addressed. Drawing on a substantial body of research, the authors identify leverage, maturity transformation, interconnectedness, complexity, and the pricing of risk as the primary vulnerabilities in the financial system. The monitoring program tracks these vulnerabilities in four sectors of the economy: asset markets, the banking sector, shadow banking, and the nonfinancial sector. The framework also highlights the policy tradeoff between reducing systemic risk and raising the cost of financial intermediation by taking preemptive actions to reduce vulnerabilities.1 • Spillovers between distress among sovereigns and banks. A working paper examining the transmission channels between sovereigns and banks, 1 See Tobias Adrian, Daniel Covitz, and Nellie Liang (2014), “Financial Stability Monitoring,” FEDS Notes (Washington: Board of Governors of the Federal Reserve System, August), www .federalreserve.gov/econresdata/notes/feds-notes/2014/financialstability-monitoring-20140804.html. with a focus on the effect of sovereign distress on bank solvency and financing. It also highlights the notable cost to the real economy of the close connection between sovereigns and banks.2 • Systemic risk and policy actions. A working paper studying the impact of capital injections on the systemic risk in the banking sector in the United States and the euro area.3 • Capital and liquidity regulation. A working paper studying the interaction of capital and liquidity regulation in a macroeconomic model.4 • Lender of last resort in the 2007–09 crisis. A working paper studying lender-of-last-resort actions during the recent financial crisis.5 • Capital and liquidity reforms and Basel III. Two published journal articles studying the effects of capital reforms, liquidity reforms, or both that are similar to those associated with the Basel III process on economic activity in the medium and long run.6 2 3 4 5 6 See Ricardo Correa and Horacio Sapriza (2014), “Sovereign Debt Crises,” International Finance Discussion Papers 20141104 (Washington: Board of Governors of the Federal Reserve System, May), www.federalreserve.gov/pubs/ifdp/2014/1104/ ifdp1104.pdf. See Juan M. Londono and Mary Tian (2014), “Bank Interventions and Options-Based Systemic Risk: Evidence from the Global and Euro-Area Crisis,” International Finance Discussion Papers 2014-1117 (Washington: Board of Governors of the Fed-eral Reserve System, September), www.federalreserve.gov/ econresdata/ifdp/2014/files/ifdp1117.pdf. See Francisco Covas and John C. Driscoll (2014), “Bank Liquidity and Capital Regulation in General Equilibrium,” Finance and Economics Discussion Series 2014-85 (Washington: Board of Governors of the Federal Reserve System, September), www .federalreserve.gov/econresdata/feds/2014/files/201485pap.pdf. See Dietrich Domanski, Richhild Moessner, and William Nelson (2014), “Central Banks as Lender of Last Resort: Experiences during the 2007-2010 Crisis and Lessons for the Future,” Finance and Economics Discussion Series 2014-110 (Washington: Board of Governors of the Federal Reserve System, May), www.federalreserve.gov/econresdata/feds/2014/files/2014110pap .pdf. See Michael T. Kiley and Jae W. Sim (2014), “Bank Capital and the Macroeconomy: Policy Considerations,” Journal of Economic Dynamics and Control, vol. 43 (June), pp. 175–98, doi: 10.1016/ j.jedc.2014.01.024; and Paolo Angelini, Laurent Clerc, Vasco Cúrdia, Leonardo Gambacorta, Andrea Gerali, Alberto Locarno, Roberto Motto, Wermer Roeger, Skander Van den Heuvel, and Jan Vlek (2015), “Basel III: Long-Term Impact on Economic Performance and Fluctuations,” Manchester School, vol. 83 (March), pp. 217–51, doi: 10.1111/manc.12056. Financial Stability Figure 7. Ratio of nonfinancial sector credit to GDP, 1980–2014 43 Figure 8. Speculative-grade and unrated firm net leverage, 1995–2014 Ratio Percent 2.0 Quarterly 35 Quarterly 1.6 Q4 Q3 30 1.2 25 Household 0.8 20 Business 0.4 15 1984 1989 1994 1999 2004 2009 2014 Note: The shaded bars indicate periods of business recession as defined by the National Bureau of Economic Research. Source: Federal Reserve Board, Statistical Release Z.1, “Financial Accounts of the United States.” aged credit histories—so-called subprime borrowing—contracted further, in the aggregate, in 2014. The combination of anemic growth in borrowing in the aggregate and the tendency for such growth to represent borrowing by households with strong credit histories suggests that vulnerabilities from household borrowing did not rise in 2014. Nonetheless, pockets of household credit markets witnessed a shift toward borrowing in riskier credit segments—for example, in subprime auto lending—a trend that should be monitored. In the business sector, the rapid growth in borrowing in riskier segments of corporate debt markets, highlighted in the discussion of asset valuations earlier, has led to a notable increase in leverage—that is, debt relative to book equity—among speculative-grade corporations (figure 8). Macroprudential Supervision of Large, Complex Financial Institutions Large, complex financial institutions interact with financial markets and the broader economy in a manner that may—during times of stress and in the absence of an appropriate regulatory framework and effective supervision—lead to financial instability.2 2 For more on the Federal Reserve’s supervision and regulation of large institutions, and especially related to the integration of the microprudential objective of safety and soundness of individual 1996 1999 2002 2005 2008 2011 2014 Note: Data are annual until 1999 and quarterly thereafter. Net leverage is the ratio of the book value of total debt minus cash and cash equivalents to the book value of total assets. Source: S&P Capital IQ Compustat© 2015 Standard & Poor’s Financial Services LLC (“S&P”). All rights reserved. For intended recipient only. No further distribution and/or reproduction permitted. Key Supervisory Activities One important element of enhanced supervision of large banking organizations is the stress-testing process, which includes the Dodd-Frank Act stress tests and the Comprehensive Capital Analysis and Review. In addition to fostering the safety and soundness of the participating institutions, stress tests embed macroprudential elements by • examining the loss-absorbing capacity of institutions under a common macroeconomic scenario that has features similar to the strains experienced in a severe recession and which includes, as appropriate, identified salient risks; • conducting horizontal testing across large institutions to understand the potential correlated exposures; and • considering the effects of counterparty distress on the largest, most interconnected firms. The macroeconomic and financial scenarios that are used in the stress tests have proved to be an important macroprudential tool. As described in the 2013 policy statement on developing scenarios for stress tests, the Federal Reserve adjusts the severity of the macroeconomic scenario in a way that counteracts the natural tendency for risks to build within the institutions with the macroprudential efforts outlined later in this section, see section 4, “Supervision and Regulation.” 44 101st Annual Report | 2014 financial system during periods of strong economic activity.3 The scenarios can also be used to assess the financial system’s vulnerability to particularly significant risks and to highlight certain risks to institutions participating in the testing.4 In a severely adverse scenario for 2015 (released in October 2014), the U.S. corporate sector experiences increases in financial distress that are even larger than would be expected in a severe recession.5 This deterioration in credit quality is particularly concentrated in riskier firms. Investors pull back from a variety of assets linked to risky corporate borrowers and, in particular, highly leveraged corporations. Spreads on assets linked to these corporations, particularly high-yield bonds, leveraged loans, and CLOs backed by leveraged loans, widen to the same levels as the peaks reached in the 2007–09 recession. These developments were motivated, in part, by the rapid growth in debt owed by risky firms and valuation pressures observed in related markets that were highlighted earlier in this section. The Federal Reserve incorporates a macroprudential approach, too, in its supervision of FMUs. In 2014, the Federal Reserve Board updated its riskmanagement expectations for FMUs. For designated FMUs for which the Board or another federal banking agency serves as the supervisory agency under title VIII of the Dodd-Frank Act, the Board amended its risk-management standards to take into account new international standards for such entities (effective December 2014). As with other elements of supervision, a more thorough review of activities in 2014 is discussed in section 4, “Supervision and Regulation.” Key Regulatory Activities Over the course of 2014, the Federal Reserve has taken a number of steps to continue improving the 3 4 5 See Board of Governors of the Federal Reserve System (2013), “Federal Reserve Board Issues Final Policy Statement for Developing Scenarios for Future Capital Planning and Stress Testing Exercises,” press release, November 7, www.federalreserve.gov/ newsevents/press/bcreg/20131107a.htm. In 2014, 30 institutions participated in these stress tests. For more information, see “Stress Tests and Capital Planning” on the Federal Reserve Board’s website at www.federalreserve.gov/ bankinforeg/stress-tests-capital-planning.htm. See Board of Governors of the Federal Reserve System (2014), 2015 Supervisory Scenarios for Annual Stress Tests Required under the Dodd-Frank Act Stress Testing Rules and the Capital Plan Rule (Washington: Board of Governors, October), www .federalreserve.gov/newsevents/press/bcreg/bcreg20141023a1 .pdf. resiliency of the financial system, including approval of a final rule establishing enhanced prudential standards with respect to capital, liquidity, and risk management for large U.S. BHCs and FBOs (pursuant to section 165 of the Dodd-Frank Act). The enhanced prudential standards, together with stress testing and other regulatory safeguards, help ensure that large U.S. BHCs and FBOs operating in the United States have robust levels of capital and liquidity and strong risk management. Together, these efforts not only help ensure that these firms are financially robust individually, but also limit the risk that financial distress at these firms could cause negative spillovers to the financial sector and the broader economy. They are complemented by new rules and proposals concerning liquidity coverage ratios and strengthened capital requirements for global systemically important financial institutions, including proposed higher capital requirements for institutions more reliant on wholesale short-term funding. For more information on enhanced prudential standards activity, see section 4, “Supervision and Regulation.” During the 2007–09 financial crisis, the lack of effective resolution strategies contributed to the pernicious spillovers of distress at or between individual institutions and from those institutions to the broader economy. The Federal Reserve, in collaboration with other U.S. agencies, has continued to work with large financial institutions to develop a range of recovery and resolution strategies in the event of their distress or failure. Improvements in resolution planning will mitigate adverse effects from perceptions of “too big to fail” and contribute to more orderly conditions in the financial system if institutions face strains. For more information on recovery and resolution planning activity, see section 4, “Supervision and Regulation.” Domestic and International Cooperation and Coordination The Federal Reserve cooperated or coordinated with both domestic and international institutions in 2014 to promote financial stability. Financial Stability Oversight Council Activities As mandated by the Dodd-Frank Act, the FSOC was created in 2010 and is chaired by the Treasury Secretary (box 3). It establishes an institutional framework Financial Stability Box 3. Regular Reporting on Financial Stability Oversight Council Activities The Financial Stability Oversight Council (FSOC), created under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 and chaired by the Secretary of the Treasury Department, meets regularly to coordinate on financial stability topics that potentially affect the U.S. economy and discloses its activities. • Monthly meeting minutes. In 2014, the FSOC met monthly, and the minutes for each meeting are available on the U.S Treasury website (www .treasury.gov/initiatives/fsoc/council-meetings/ Pages/meeting-minutes.aspx). • FSOC annual report. On May 7, 2014, the FSOC released its fourth annual report (www .treasury.gov/initiatives/fsoc/studies-reports/ Pages/2014-Annual-Report.aspx), which includes a review of key developments through the beginning of 2014 and a set of recommended actions that could be taken to ensure financial stability and to mitigate systemic risks that affect the economy. For more on the FSOC, see www.treasury.gov/ initiatives/fsoc/pages/home.aspx. for identifying and responding to sources of systemic risk. The Federal Reserve Chairman, along with other financial regulators, is a member of the FSOC. Through collaborative participation in the FSOC, U.S. financial regulators monitor not only institutions, but the financial system as a whole. The Federal Reserve plays an important role in this macroprudential framework: It assists in monitoring financial risks, analyzes the implications of those risks for financial stability, and identifies steps that can be taken to mitigate those risks. In addition, when an institution is designated by the FSOC as systemically important, the Federal Reserve assumes responsibility for supervising that institution. In 2014, the Federal Reserve worked, in conjunction with other FSOC participants, on several major initiatives: • Conference examining asset management industry. On May 19, 2014, the FSOC held a conference examining the asset management industry and its relationship to financial stability. Participants included staff from U.S. government agencies, the private sector (including individuals from the asset 45 management industry), and academic participants, among others. • Roundtable on designation process. On November 12, 2014, the FSOC hosted a roundtable to discuss possible improvements to the process for designating systemically important financial institutions. • Request for public comments on asset management industry risks. On December 18, 2014, as part of its ongoing analysis of potential risks to the financial system posed by the asset management industry, the FSOC released a notice seeking public comment about potential risks to the system associated with certain products and activities in the asset management industry relating to liquidity and redemptions, leverage, operational functions, and resolution. • Determination of an additional systemically important entity. On December 19, 2014, the FSOC announced its final determination to designate MetLife as a systemically important nonbank financial company. The determination was based on the FSOC’s assessment that material financial distress at MetLife could pose a threat to the financial stability of the United States.6 Financial Stability Board Activities The Federal Reserve participates in international bodies, such as the FSB, given the interconnected global financial system and the global activities of large U.S. financial institutions. The FSB is an international body that monitors the global financial system and promotes the adoption of sound policies across countries, with much activity in recent years focused on financial stability. The Federal Reserve participates in the FSB, along with the SEC and the U.S. Treasury.7 In 2014, the Federal Reserve continued its active participation in the FSB. The FSB is engaged in several issues, including shadow banking, supervision of global systemically important financial institutions, and the development of effective resolution regimes for large financial institutions. 6 7 For more information, see U.S. Department of the Treasury (2014), “Financial Stability Oversight Council Announces Nonbank Financial Company Designation,” press release, December 19, www.treasury.gov/press-center/press-releases/Pages/ jl9726.aspx. See the Financial Stability Board website at www .financialstabilityboard.org. 47 4 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; • taking a macroprudential approach to the supervision of the largest, most systemically important financial institutions (SIFIs);1 • 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. 2014 Developments During 2014, the U.S. banking system and financial markets continued to improve following their recovery from the financial crisis that started in mid-2007. Performance of bank holding companies. An improvement in bank holding companies’ (BHCs) performance was evident during 2014. U.S. BHCs, in aggregate, reported earnings approaching an all-time high— $139 billion for 2014, up from $138 billion for the year 1 For a detailed discussion of macroprudential supervision and regulation, refer to section 3, “Financial Stability.” ending December 31, 2013. The proportion of unprofitable BHCs continues to decline, reaching 4 percent, down from 6 percent in 2013, but remains elevated compared to historical rates; unprofitable BHCs now encompass less than 1 percent of banking industry assets, in line with historical norms. Net interest margin continues to decline, reaching 2.2 percent, the lowest level in over 20 years. Provisions were flat at 0.19 percent of average assets, in line with historical lows. Nonperforming assets continue to be a challenge to industry recovery, with the nonperforming asset ratio remaining elevated at 1.9 percent of loans and foreclosed assets, an improvement from 2.5 percent at year-end 2013. (Also see “Bank Holding Companies” later in this section.) Performance of state member banks. The performance at state member banks in 2014 improved from 2013. As a group, state member banks reported a profit of $18.9 billion for 2014, up from $18.2 billion for 2013 and near pre-crisis levels. However, profitability from a return on average assets (ROA) and return on equity (ROE) perspective still lags pre-crisis levels by nearly a quarter and one-third, respectively. Provisions (as a percent of revenue) have continued to decrease and are now 2.2 percent, down from a crisis high of 32.4 percent at year-end 2009. Further, 3.6 percent of all state member banks continued to report losses, down from 4.1 percent for year-end 2013. The nonperforming assets ratio remained elevated at 1.0 percent of loans and foreclosed assets, reflecting ongoing weaknesses in asset quality since the crisis. Problem loans continued to decline during 2014; however, nonaccruals in Commercial & Industrial and Credit Cards increased from the prior year. 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 2014, one state member bank, with $155 million in assets, failed. (Also see “State Member Banks” later in this section.) 48 101st Annual Report | 2014 Box 1. Recovery and Resolution Planning The Federal Reserve, in collaboration with other U.S. agencies, has continued to work with large financial institutions to develop a range of recovery and resolution strategies in the event of their distress or failure. entities, interconnections and interdependencies, corporate governance structure and processes related to resolution, impediments to resolution, and the actions the financial institution will take to facilitate its orderly resolution. Recovery Planning Under the resolution plan rule, resolution plans are required to be submitted on an annual basis after the initial filing. The Federal Reserve has required that the largest and most globally active U.S. financial institutions develop recovery plans that describe a number of options and actions that may be taken by management to maintain the financial institution as a going concern during instances of extreme stress. On September 25, 2014, the Federal Reserve issued SR letter 14-8 (“Consolidated Recovery Planning for Certain Large Domestic Bank Holding Companies”) that applies to eight domestic bank holding companies that may pose elevated risk to U.S. financial stability (www.federalreserve.gov/bankinforeg/srletters/ sr1408.pdf). A key objective of SR letter 14-8 is to enhance the resiliency of a firm to adverse developments which, in turn, will lower the probability of its failure or inability to serve as a financial intermediary. Resolution Planning In 2011, the Federal Reserve and the FDIC jointly issued rules implementing the resolution plan requirement for financial institutions that are subject to heightened prudential standards. The Federal Reserve’s final resolution plan rule, Regulation QQ, is available at www.gpo.gov/fdsys/pkg/FR-2011-11-01/ html/2011-27377.htm. In a phased approach based on nonbank asset size, initial resolution plans were submitted by the first group of 11 financial institutions in July 2012, the second group of four institutions in July 2013, and all other covered companies in December 2013. Since the passage of the rule, seven financial institutions, three of which are nonbank financial institutions, have qualified as new covered companies and filed their initial resolution plans in 2014. The initial plan submissions identified and described the firms’ critical operations, core business lines, material legal Enhanced prudential standards. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act) directs the Board, in part, to establish prudential standards in order to prevent or mitigate risks to U.S. financial stability that could arise from the material financial distress or failure, or ongoing activities of, large, interconnected financial institutions. In 2014, the Board established or proposed to establish a variety of enhanced prudential standards. (See “Enhanced Prudential Standards” later in this section for details.) Where appropriate, the second iteration plans submitted by firms addressed supplemental guidance from the Federal Reserve and the FDIC (www .federalreserve.gov/newsevents/press/bcreg/ bcreg20130415c2.pdf). • Feedback on second round resolution plans. In 2014, the Federal Reserve and the FDIC provided feedback on the second iteration of submissions from 12 large firms that are important to U.S. financial stability (www.federalreserve.gov/ newsevents/press/bcreg/20140805a.htm and www.federalreserve.gov/newsevents/press/bcreg/ 20141125a.htm). The agencies require that the next round of submissions on July 1, 2015, demonstrate that the firms are making significant progress to address the shortcomings identified in the agency letters and are taking significant actions to improve their resolvability under the U.S. Bankruptcy Code. Resolution plan submissions must include both a confidential and public portion. The public portion of each resolution plan is available on the Federal Reserve’s website (www.federalreserve.gov/ bankinforeg/resolution-plans.htm). The Federal Reserve and the FDIC may determine that a resolution plan is not credible or would not facilitate an orderly resolution of the institution under the U.S. Bankruptcy Code. In accordance with principles promulgated by the Financial Stability Board, the Federal Reserve participates with other U.S. and international supervisors in crisis-management group meetings to enhance preparedness for the cross-border management and resolution of a failed global systemically important financial institution. Recovery and resolution planning. The Federal Reserve, in collaboration with other U.S. agencies, has continued to work with large financial institutions to develop a range of recovery and resolution strategies in the event of their distress or failure. (See box 1 for details.) Community bank focus. In 2014, the Board renewed its focus on supervision and regulation of community banks (defined as a state member bank and/or holding company with $10 billion or less in total consoli- Supervision and Regulation dated assets), with an emphasis on weighing the costs of regulatory proposals, supervisory guidance, and examination practices on these institutions against safety-and-soundness benefits. (See box 2 for details.) 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) designated by the Financial Stability Oversight Council (FSOC) as systemically important. In addition, the Dodd-Frank Act transferred authority for consolidated supervision of more than 400 savings and loan holding companies (SLHCs) and their nondepository subsidiaries from the former Office of Thrift Supervision (OTS) to the Federal Reserve. In overseeing the institutions under its authority, the Federal Reserve seeks primarily to promote safety 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 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 exami- 49 nation 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 risk-management 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.2 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. 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. 2 “Banking offices” are defined as U.S. depository institution subsidiaries, as well as the U.S. branches and agencies of foreign banking organizations. 50 101st Annual Report | 2014 Box 2. Efforts to Tailor Supervision for Community Banking Organizations In 2011, the Board established a community and regional bank subcommittee in order to better understand and respond to concerns raised by these institutions. The Board is committed to ensuring that regulatory requirements both suit community bank characteristics and foster healthy lending conditions. During 2014, the subcommittee sought additional perspectives on community bank concerns and explored additional opportunities to tailor community bank supervision. Key aspects of these efforts include the following: 1. Considering the impact of new and existing regulations on community banking organizations and streamlining regulatory rules. A subcommittee of the Board convened regularly to evaluate the effects of regulatory proposals, supervisory guidance, and examination practices on community banks. These reviews help ensure that regulatory directives are commensurate with the size and complexity of community banking organizations. In addition, throughout 2014, through an internal review of all Federal Reserve guidance and through participation in interagency efforts to comply with the Economic Growth and Regulatory Paperwork Reduction Act of 1996, the Federal Reserve began a review of outstanding supervisory guidance to identify and address any outdated, unduly burdensome, or unnecessary requirements. 2. Risk-focusing examination activities. The Federal Reserve enhanced its offsite financial screening process, which allows deployment of resources based on the risk profile of individual institutions. Accordingly, examinations of banks engaged in higher-risk activities will be more involved than examinations of banks engaged in less-risky activities. 3. Enhancing communication with the community bank industry. The Federal Reserve remains committed to fostering enhanced communication between banking supervisors and community bankers. Primary efforts to support this objective include the following: • Meeting with the Community Depository Institutions Advisory Council. Established in 2010, a council composed of community bank, thrift, and credit union representatives from each of the 12 Federal Reserve Districts provided the Board of Governors with industry input on the economy, lending conditions, and other topics of interest to community banking organizations. During 2014, this council participated in biannual meetings with Board officials to communicate their views on both the banking industry and on pertinent regulatory matters. • Communicating expectations related to the supervision of community banking organizations. In support of this objective, applicability statements were added to new supervisory proposals to help community bankers more readily identify aspects of supervisory directives pertinent to their organizations. In addition, staff from the Board of Governors had regular discussions with community bank examiners to clarify expectations related to the applicability of supervisory rules to community banks. With a similar objective, the Federal Reserve began to enhance the community bank examiner-training curriculum to ensure that supervisory expectations for larger banks do not make their way into the curriculum or the examination process. • Disseminating supervisory publications with a focus on community banking organizations. The Federal Reserve uses the following System publications to communicate with community banking organizations on emerging risks and important supervisory matters: —Community Banking Connections®— Throughout 2014, the publication offered a number of articles focused on timely regulatory topics, including loan policy development, cybersecurity, and third-party relationship management (www .communitybankingconnections.org/). —FedLinks®—Articles published throughout 2014 covered topics outlining supervisory expectations for a number of banking functions, including implementation of the new capital rules, development of contingency funding plans, and introduction of new products and services (www .communitybankingconnections.org/fedlinks). 4. Focusing on community bank research. In 2014, for the second consecutive year, the subcommittee worked with an informal working group of economists from the research and supervision functions in the Federal Reserve System to consider and support supervisory decisions relative to community banking organizations. Findings of research conducted by this group helped guide community bank policy development and implementation. Further, in 2014, for the second consecutive year, the Federal Reserve Bank of St. Louis, in collaboration with the Conference of State Bank Supervisors, hosted a Community Banking Research and Policy Conference focused on the role of community banks in the financial system. As with the first conference, this conference helped to highlight the issues most important to community bank vitality. Supervision and Regulation 51 Table 1. State member banks and bank holding companies, 2010–14 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 2014 2013 2012 2011 2010 858 2,233 723 438 285 850 2,060 745 459 286 843 2,005 769 487 282 828 1,891 809 507 302 829 1,697 912 722 190 522 16,642 738 706 501 205 32 505 16,269 716 695 509 186 21 508 16,112 712 691 514 177 21 491 16,443 672 642 461 181 30 482 15,986 677 654 491 163 23 3,902 953 2,824 2,737 142 2,595 87 4,036 953 3,131 2,962 148 2,814 169 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 3,032 141 426 40 420 39 408 38 417 40 430 43 For large bank holding companies subject to continuous, risk-focused supervision, includes multiple targeted reviews. The framework for the consolidated supervision of LISCC firms and other large financial institutions was issued in December 2012.3 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 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 3 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. 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. The framework is designed to support a tailored supervisory approach that accounts for the unique risk characteristics of each firm, including the nature and degree of potential systemic risk inherent in a firm’s activities and operations, and is being implemented in a multi-stage approach. The Federal Reserve uses a range of supervisory activities to maintain a comprehensive understanding and assessment of each large financial institution: 52 101st Annual Report | 2014 • Coordinated horizontal reviews. These reviews involve examining several institutions simultaneously and encompass firm-specific supervision and the development of cross-firm perspectives. In addition, the Federal Reserve uses a multidisciplinary approach to draw on a wide range of perspectives, including those from supervisors, examiners, economists, financial experts, payments systems analysts, and other specialists. 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 processes, 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 inspec- tion 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. Capital Planning and Stress Tests 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 CCAR and the Dodd-Frank Act stress tests (DFAST). CCAR is a horizontal exercise to evaluate capital adequacy, internal capital adequacy assessment processes, and planned capital distributions at large BHCs. In CCAR, the Federal Reserve assesses whether these BHCs have sufficient capital to withstand highly stressful operating environments and be able to continue operations, maintain ready access to funding, meet obligations to creditors and counterparties, and serve as credit intermediaries. Capital is central to a BHC’s ability to absorb losses and continue to lend to creditworthy businesses and consumers. Through CCAR, a BHC’s capital adequacy is evaluated on a forward-looking, post-stress basis as the BHCs are required to demonstrate in their capital plans how they will maintain, throughout a very stressful period, capital above a tier 1 common ratio of 5 percent and above minimum regulatory capital requirements. From a microprudential perspective, the CCAR provides a structured means for supervisors to assess not only whether these BHCs hold enough capital, but also whether they are able to rapidly and accurately determine their risk exposures, an essential element of effective risk management. From a macroprudential perspective, the use of a common scenario allows us to learn how a particular risk or combination of risks might affect the banking system as a whole—not just individual institutions. In 2014, CCAR incorporated the transition arrangements and minimum capital requirements from the revised regulatory capital framework implementing the Basel III regulatory capital reforms the Board finalized in July 2013. The 2014 CCAR results are available at www.federalreserve.gov/newsevents/press/ bcreg/ccar_20140326.pdf. DFAST is a supervisory stress test conducted by the Federal Reserve to evaluate whether large BHCs and Supervision and Regulation all nonbank financial companies designated by the FSOC have sufficient capital to absorb losses resulting from stressful economic and financial market conditions. The Dodd-Frank Act also requires BHCs and other financial companies supervised by the Federal Reserve to conduct their own stress tests. Together, the Dodd-Frank Act supervisory stress tests and the company-run stress tests are intended to provide company management and boards of directors, the public, and supervisors with forwardlooking information to help gauge the potential effect of stressful conditions on the capital adequacy of these large banking organizations. The 2014 DFAST results are available at www.federalreserve.gov/ newsevents/press/bcreg/bcreg20140320a1.pdf. State Member Banks At the end of 2014, 1,923 banks (excluding nondepository trust companies and private banks) were members of the Federal Reserve System, of which 858 were state chartered. Federal Reserve System member banks operated 57,265 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 15 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 438 exams of state member banks in 2014. Bank Holding Companies At year-end 2014, a total of 4,922 U.S. BHCs were in operation, of which 4,424 were top-tier BHCs. These organizations controlled 4,755 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 early January of 2005. The system reflects the shift in supervisory practices away from a historical analysis of financial condition toward a more dynamic, forward-looking assessment of riskmanagement 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 2014, the Federal Reserve conducted 695 inspections of large BHCs and 2,737 inspections of small, noncomplex BHCs. Financial Holding Companies Under the Gramm-Leach-Bliley Act, BHCs that meet certain capital, managerial, and other requirements 6 4 5 The Office of the Comptroller of the Currency examines nationally chartered banks, and the Federal Deposit Insurance Corporation 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. 53 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, most recently modified in 2013. See SR letter 13-21 for a discussion of the factors considered in determining whether a BHC is complex or noncomplex (www.federalreserve.gov/bankinforeg/ srletters/sr1321.htm). 54 101st Annual Report | 2014 Table 2. Savings and loan holding companies, 2011–14 2014 2013 2012 20111 76 $1,492,964,310 81 $1,500,412,835 94 $1,715,259,113 n/a n/a 45 37 1 58 13 1 53 27 2 n/a n/a n/a 272 81,558,809 n/a n/a 46 183 n/a n/a Entity/item Top-tier savings and loan holding companies Large2 Total number Total assets Number of examinations By Federal Reserve System On site Off site By states’ Department of Insurance Small Total number Total assets (billions of dollars) Number of examinations By Federal Reserve System On site Off site 1 2 $ 221 64,813,982 10 202 $ 251 75,952,384 $ 21 237 Responsibility for SLHCs was transferred to the Board in 2011. Asset data are not available for year-end 2011 due to transition. Excludes SIFI SLHCs (AIG and GE). 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 2014, 426 domestic BHCs and 40 foreign banking organizations had financial holding company status. Of the domestic financial holding companies, 23 had consolidated assets of $50 billion or more; 32, between $10 billion and $50 billion; 122, between $1 billion and $10 billion; and 249, less than $1 billion. Savings and Loan Holding Companies The Dodd-Frank Act transferred responsibility for supervision and regulation of SLHCs from the OTS to the Federal Reserve in July 2011. At year-end 2014, a total of 542 SLHCs were in operation, of which 297 were top tier SLHCs. These SLHCs control 305 thrift institutions and include 27 companies engaged primarily in nonbanking activities, such as insurance underwriting (15 SLHCs), securities brokerage (6 SLHCs), and commercial activities (6 SLHCs). Excluding nonbank SIFI SLHCs, the 25 largest SLHCs accounted for more than $1.3 trillion of total combined assets. Approximately 90 percent of SLHCs engage primarily in depository activities. These firms hold approximately 20.8 percent ($321 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. Table 2 provides information on examinations of SLHCs for the past three years. Board staff continues to work on operational, policy, and supervisory issues while engaging the industry, Reserve Banks, and other regulatory agencies. Nearly all of the SLHCs are now filing all required Federal Reserve regulatory reports. Significant milestones achieved include the formal incorporation of Federal Reserve policies into the SLHC supervision program. Several complex policy issues continue to be addressed by the Board, including those related to consolidated capital requirements for insurance SLHCs, intermediate holding companies, and the adoption of formal rating systems. 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 considered bank service providers under the Bank Service Company Act. In July 2012, the FSOC voted to designate eight FMUs as systemically important under title VIII of the Dodd-Frank Act. As a result of these designa- Supervision and Regulation tions, the Federal Reserve assumed an expanded set of responsibilities related to these designated FMUs that include promoting uniform risk-management standards, playing an enhanced role in the supervision of designated FMUs, reducing systemic risk, and supporting the stability of the broader financial system. For designated FMUs subject to the Federal Reserve’s supervision, the Board established riskmanagement standards and expectations that are articulated in Board Regulation HH (effective September 2012). The Board subsequently revised these standards to take into account new international standards (effective December 2014). In addition to setting minimum risk-management 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. Section 234.6 of Regulation HH (effective February 2014) establishes terms and conditions under which the Board may authorize a designated FMU access to Reserve Bank accounts and services. 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 works closely with the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission, both of which also have supervisory authority for certain FMUs. The Federal Reserve’s work with these agencies under title VIII, including the sharing of appropriate information and participation in designated 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. 55 Designated Nonfinancial Companies In 2013, the FSOC designated three nonbank financial companies for supervision by the Board: American International Group, Inc.; General Electric Capital Corporation, Inc. (GECC); and Prudential Financial, Inc. In late 2014, the FSOC designated a fourth nonbank financial company, Metlife, Inc. The Federal Reserve’s supervisory approach for these firms as designated companies is consistent with the approach used for the largest financial holding companies, tailored to account for different material characteristics of each firm. The Dodd-Frank Act requires the Board to apply enhanced prudential standards and early remediation requirements to BHCs with at least $50 billion in consolidated assets and to the nonbank financial companies designated by the FSOC for supervision by the Board. The act authorizes the Board to tailor the application of these standards and requirements to different companies on an individual basis or by category. As discussed in “Enhanced Prudential Standards” later in this section, in November the Board invited public comment on enhanced prudential standards for the regulation and supervision of GECC. International Activities 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 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; 56 101st Annual Report | 2014 for national banks, the examinations are coordinated with the OCC. At the end of 2014, 39 member banks were operating 444 branches in foreign countries and overseas areas of the United States; 22 national banks were operating 391 of these branches, and 17 state member banks were operating the remaining 53. In addition, 11 nonmember banks were operating 18 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 2014, out of 44 banking organizations chartered as Edge Act or agreement corporations, 3 operated 7 Edge Act and agreement branches. 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 year-end 2014, 163 foreign banks from 49 countries operated 187 state-licensed branches and agencies, of which 6 were insured by the Federal Deposit Insurance Corporation (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 47 U.S. commercial banks. Altogether, the U.S. offices of these foreign banks controlled approximately 21 percent of U.S. commercial banking assets. These 163 foreign banks also operated 89 representative offices; an additional 34 foreign banks operated in the United States through a representative office. The Federal Reserve—in coordination with appropriate state regulatory authorities—examines state-licensed, nonFDIC-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 512 examinations in 2014. 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. Anti-Money-Laundering Examinations 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 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 regulations and conducts such examinations in accordance with the Federal Financial Institutions Examination Council’s (FFIEC) Bank Secrecy Act/AntiMoney Laundering Examination Manual.9 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. 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 2014, the Federal Reserve continued as the lead supervisory agency for 8 of the 16 large, multiregional data processing servicers recognized on an interagency basis. Fiduciary Activities The Federal Reserve has supervisory responsibility for state member banks and state member nondepository trust companies, which hold assets in various fiduciary and custodial capacities. On-site examinations of fiduciary and custodial activities are riskfocused 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 2014, Federal Reserve examiners conducted 97 fiduciary examinations, excluding transfer agent examinations, of state member banks. 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, and the chair of the State Liaison Committee. 57 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 2014, the Federal Reserve conducted transfer agent examinations at 7 of the 36 state member banks and BHCs that were registered as transfer agents. 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 2014, 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 Securities Rulemaking Board’s rule G-16, at least once every two calendar years. Eight of the 10 entities supervised by the Federal Reserve that dealt in municipal securities were examined during 2014. Securities Credit Lenders 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). The Federal Reserve may conduct specialized examinations of these lenders if they are not already subject to supervision by the 58 101st Annual Report | 2014 Farm Credit Administration or the National Credit Union Administration (NCUA). Cybersecurity and Critical Infrastructure The Federal Reserve is actively engaged with interagency groups such as the Financial and Banking Information Infrastructure Committee (FBIIC) and the FFIEC’s Cybersecurity and Critical Infrastructure Working Group (CCIWG) to share information and collaborate on cyber- and critical infrastructurerelated issues impacting the financial services sector. In 2014, the Federal Reserve conducted a targeted cybersecurity assessment on a select group of large financial institutions and FMUs. The Federal Reserve and other CCIWG members also conducted cybersecurity assessments at over 500 community financial institutions to evaluate their cybersecurity risk exposure and preparedness. The cybersecurity assessment reviewed financial institutions’ current practices and overall preparedness relative to risk management and oversight, threat intelligence and collaboration, cybersecurity controls, external dependency management, and cyber incident management and resilience. The Federal Reserve is also actively engaged in raising financial institution awareness of supervisory expectations relative to cybersecurity risk assessment and risk mitigation. In 2014, the Federal Reserve contributed to the launch of the new FFIEC cybersecurity awareness web page, which is a central repository for current and future FFIEC-related materials on cybersecurity (www.ffiec.gov/cybersecurity.htm). 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 2014, the Federal Reserve completed 37 formal enforcement actions. Civil money penalties totaling $817,653,925 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/). In 2014, the Reserve Banks completed 117 informal enforcement actions. Informal enforcement actions include memoranda of understanding (MOU), commitment letters, and board of directors’ resolutions. 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. 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 2014, two major and two minor upgrades to the web-based Supervision and Regulation PRISM application were completed to enhance the user’s experience and provide the latest technology. 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 depository institutions. International Training and Technical Assistance In 2014, 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. In addition, the Middle East and North Africa (MENA) Financial Regulator’s Training Initiative (FRTI) successfully concluded. This 10-year initiative was established to provide technical assistance and bank supervision training to central banks and supervisory authorities in the region. MENA FRTI’s many accomplishments over the past decade include the sponsorship of over 50 programs and conferences as well as many shortterm, on-the-job training opportunities provided for MENA regulators with U.S. banking agencies. Now that the MENA FRTI has concluded, the Federal Reserve will forge training partnerships with the central banks of Bahrain, United Arab Emirates, and Qatar to continue technical capacity building throughout the region. In 2014, 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 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; 59 • coordinates training programs throughout the region with the help of national banking supervisors and international agencies; and, • aims to help members develop banking laws, regulations, and supervisory practices that conform to international best practices. The Federal Reserve contributes significantly to ASBA’s organizational management and to its training and technical assistance activities. Moreover, the Federal Reserve also contributes to the regional training provision under the Asia Pacific Economic Cooperation FRTI. Efforts to Support Minority-Owned 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 technical assistance tailored to MOIs by providing targeted supervisory guidance, identifying additional resources, and fostering mutually beneficial partnerships between MOIs and community organizations. As of year-end 2014, the Federal Reserve’s MOI portfolio included 18 state member banks. Throughout 2014, the Federal Reserve System continued to support MOIs through the following activities: • facilitating a meeting between the National Bankers Association (NBA), Chair Yellen, Vice Chairman Fischer, and Governor Powell during which the NBA shared with the governors their perspective on community banking issues of importance to MOIs; • publishing an article in the Federal Reserve’s Community Banking Connections® publication to highlight MOIs and their contribution to the economy (www.communitybankingconnections.org/articles/ 60 101st Annual Report | 2014 2014/q3-q4/promoting-an-inclusive-financialsystem); • participating in the 87th annual NBA convention; • hosting an internal Rapid Response® session on the topic of MOIs to educate the Federal Reserve’s community bank examination staff on the unique characteristics of these organizations; • providing technical assistance to MOIs on a wide variety of topics, including topics focused on improving regulatory ratings, navigating the regulatory applications process, and refining capitalplanning practices; • creating formal procedures related to monitoring MOI-related proposals and continuing to offer prereview of MOI applications to support early identification and resolution of issues that could create delays in the review process; • partnering with the NBA, 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, conducting several joint outreach efforts to educate MOIs on supervisory topics; and • participating in an interagency task force to consider and address supervisory challenges facing MOIs. Throughout 2014, PFP representatives hosted and participated in numerous banking workshops and seminars aimed at promoting and preserving MOIs, including the NBA’s Legislative and Regulatory Conference and the National Urban League Convention. Further, program representatives continued to collaborate with community leaders, trade groups, the Small Business Administration, and other organizations to seek support for MOIs. 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 OCC and the FDIC (together, the federal banking agencies), issues rulemakings, public SR letters, and other policy statements and guidance in order to carry out its supervisory policies. Federal Reserve staff also take part in supervisory and regu- latory forums, provide support for the work of the FFIEC, and participate in international policymaking forums, including the Basel Committee on Banking Supervision (BCBS), the Financial Stability Board, and the Joint Forum. Enhanced Prudential Standards The Board is responsible for issuing a number of rules and guidance statements under the DoddFrank Act, sometimes in conjunction with other agencies. Listed below are the initiatives undertaken by the Board in 2014. • In January, the Board issued a supervisory guidance statement, SR 14-1, to clarify the heightened supervisory expectations for recovery and resolution preparedness for the eight largest domestic BHCs that pose elevated risk to U.S. financial stability. The Board issued this SR letter as a supplement to SR letter 12-17/CA letter 12-14, “Consolidated Supervision Framework for Large Financial Institutions.” The Board plans to incorporate reviews of key capabilities for recovery and resolution preparedness in its ongoing supervisory work for each BHC subject to this guidance, which is available at www.federalreserve.gov/bankinforeg/ srletters/SR1401.htm. • In March, the Board published a final rule to implement certain enhanced prudential standards required under section 165 of the Dodd-Frank Act for BHCs, including foreign banking organizations, with total global consolidated assets of $50 billion or more. These standards include risk-based and leverage capital requirements, liquidity standards, and requirements for overall risk management. In addition, the final rule requires a foreign banking organization with $50 billion or more in U.S. nonbranch assets to form an intermediate holding company over its U.S. subsidiaries. The intermediate holding company of the foreign banking organization will be required to meet substantially the same capital, liquidity, and risk-management standards as a similar U.S. BHC. The final rule also establishes risk committee requirements and capital stress-testing requirements for certain BHCs and foreign banking organizations with total consolidated assets of $10 billion or more. The final rule is available at www.gpo.gov/fdsys/pkg/FR-2014-0327/pdf/2014-05699.pdf. • In March, the federal banking agencies issued supervisory guidance that discusses supervisory expectations for implementing the Dodd-Frank Act company-run stress tests for banking organiza- Supervision and Regulation tions with total consolidated assets of more than $10 billion but less than $50 billion. This guidance builds upon the interagency stress testing guidance issued in May 2012 for companies with more than $10 billion in total consolidated assets. It is important to note that the guidance states that such banking organizations are not subject to other requirements and expectations applicable to BHCs with assets of at least $50 billion, including the Federal Reserve’s capital plan rule, annual Comprehensive Capital Analysis and Review, supervisory stress tests for capital adequacy, or the related data collections supporting the supervisory stress test. The guidance is available at www.gpo.gov/fdsys/ pkg/FR-2014-03-13/pdf/2014-05518.pdf. • In May, the federal banking agencies issued a final rule to strengthen the leverage ratio standards for the eight largest, most systemically significant U.S. banking organizations. Under the final rule, U.S. top-tier BHCs with more than $700 billion in consolidated total assets or $10 trillion in assets under custody are required to maintain a leverage buffer greater than 2 percentage points above the 3 percent minimum supplementary leverage ratio, for a total of more than 5 percent, to avoid restrictions on capital distributions and certain discretionary bonus payments. The insured depository institution (IDI) subsidiaries of these BHCs must maintain at least a 6 percent supplementary leverage ratio to be considered “well capitalized” under the agencies’ prompt corrective action framework. The final rule, which has an effective date of January 1, 2018, is available at www.gpo.gov/fdsys/pkg/FR-2014-0501/pdf/2014-09367.pdf. • In October, the federal banking agencies finalized a rule implementing a liquidity coverage ratio (LCR) requirement based on the BCBS’s LCR standard. The LCR will be the first broadly applicable quantitative liquidity requirement for U.S. banking firms. Under the LCR, large banking organizations are required to hold an amount of high-quality liquid assets sufficient to meet expected net cash outflows over a 30-day time horizon in a standardized supervisory stress scenario. The final rule, effective January 1, 2015, applies the most stringent LCR requirements to banking organizations with consolidated total assets of $250 billion or more or consolidated total on-balance sheet foreign exposure of $10 billion or more, and their subsidiary insured depository institutions with $10 billion or more of consolidated total assets. The final rule applies a simpler, less stringent LCR requirement to depository holding companies with $50 billion 61 or more that are not otherwise covered by the rule, effective January 1, 2016. The final rule is available at www.gpo.gov/fdsys/pkg/FR-2014-10-10/pdf/ 2014-22520.pdf. • In December, the Board invited public comment on enhanced prudential standards for the regulation and supervision of General Electric Capital Corporation (GECC), a nonbank financial company that the FSOC designated for supervision by the Board. In light of the substantial similarity of GECC’s activities and risk profile to that of a similarly sized BHC, the proposal would apply enhanced prudential standards to GECC that are generally similar to those that apply to large BHCs, including standards for risk-based and leverage capital, capital planning, stress testing, liquidity, and risk management. The proposal is available at www.gpo.gov/ fdsys/pkg/FR-2014-12-03/pdf/2014-28414.pdf. • In December, the Board issued a proposed rule that would establish a methodology to identify whether a U.S. BHC is a global systemically important banking organization (GSIB). As such, a GSIB would be subject to a risk-based capital surcharge that is calibrated based on its systemic risk profile. The proposal builds on a GSIB capital surcharge framework agreed to by the BCBS and is augmented to address the risk arising from the overreliance on short-term wholesale funding. The GSIB surcharge under the proposal would generally be higher than under the BCBS approach. Failure to maintain the capital surcharge would subject the GSIB to restrictions on capital distributions and certain discretionary bonus payments. The proposal would be phased in beginning on January 1, 2016, becoming fully effective on January 1, 2019. The proposed rule is available at www.gpo .gov/fdsys/pkg/FR-2014-12-18/pdf/2014-29330.pdf. Other Capital Adequacy Standards In 2014, the Board issued several rulemakings and guidance documents related to capital adequacy, including joint rulemakings with the other federal banking agencies that would implement certain revisions to the Basel capital framework. • In March, the Board and the OCC permitted certain banking organizations to exit from the parallel run stage of the agencies’ advanced approaches risk-based capital framework, and henceforth, to use the advanced approaches rule to determine their risk-based capital requirements. Concurrently, the Board issued a final rule clarifying that BHCs 62 101st Annual Report | 2014 using the advanced approaches framework incorporate such framework into their capital planning and stress testing cycles that begin October 1, 2015. The final rule is available at www.gpo.gov/fdsys/ pkg/FR-2014-03-11/pdf/2014-05053.pdf. • In April, the federal banking agencies proposed a rule to correct the definition of eligible guarantee in the risk-based capital rules by clarifying the types of guarantees that can be recognized for purposes of calculating a banking organization’s regulatory capital under the advanced approaches framework. The federal banking agencies finalized the rule in July. The final rule is available at www.gpo.gov/fdsys/pkg/ FR-2014-07-30/pdf/2014-17858.pdf. • In September, the federal banking agencies adopted a final rule modifying the definition of the denominator of the supplementary leverage ratio, which applies to advanced approaches banking organizations, in a manner consistent with changes agreed to by the BCBS. The final rule strengthens the supplementary leverage ratio by modifying the methodology for including off-balance sheet items, including credit derivatives, repo-style transactions, and lines of credit, in the denominator of the supplementary leverage ratio. The final rule is available at www.gpo.gov/fdsys/pkg/FR-2014-0926/pdf/2014-22083.pdf. • In October, the Board issued a final rule that modifies the regulations for capital planning and stress testing and adjusts the due date for BHCs with total consolidated assets of $50 billion or more to submit their capital plans and stress test results. Beginning in 2016, the due date will shift from January to April. The final rule is available at www.gpo.gov/fdsys/pkg/ FR-2014-10-27/pdf/2014-25170.pdf. • In December, the federal banking agencies issued a proposed rule clarifying the regulatory capital rules adopted by the agencies in July 2013. The proposal applies only to large internationally active banking organizations that are subject to the advanced approaches rule. The proposed rule would make technical corrections and clarify certain aspects of the advanced approaches rule, including the qualification criteria for application of the advanced approaches and calculation requirements for riskweighted assets. The proposed rule is available at www.gpo.gov/fdsys/pkg/FR-2014-12-18/pdf/201428690.pdf. • In December, the Board issued a proposed rule to provide additional information regarding the appli- cation of the Board’s regulatory capital framework to depository institution holding companies that have non-traditional capital structures. The proposal describes examples of capital instruments potentially issued by non-stock entities that may not qualify as common equity tier 1 capital, and provides suggestions on changes that would allow qualification. The proposal also notes that the Board expects to propose regulatory capital rules in the future for SLHCs that are personal or family trusts and are not business trusts, and would provide a temporary exemption for those entities from the regulatory capital rules. Similarly, the proposal states that the Board expects to clarify the application of the regulatory capital rules to depository institution holding companies that are employee stock ownership plans. The proposed rule is available at www.gpo.gov/fdsys/pkg/FR-2014-12-19/pdf/ 2014-29561.pdf. • In December, the Board and the OCC issued an interim final rule to ensure that the treatment of over-the-counter derivatives, eligible margin loans, and repo-style transactions under the two agencies’ regulatory capital and liquidity coverage ratio rules would be unaffected by the implementation of certain foreign special resolution regimes for financial companies or by a banking organization’s adherence to the International Swaps and Derivatives Association’s Resolution Stay Protocol. The interim final rule is effective as of January 1, 2015, and is available at www.federalreserve.gov/ newsevents/press/bcreg/20141216a.htm. International Coordination on Supervisory Policies As a member of the BCBS, the Federal Reserve actively participates in efforts to advance sound supervisory policies for internationally active banking organizations and to enhance the strength and stability of the international banking system. Basel Committee on Banking Supervision During 2014, the Federal Reserve participated in ongoing international initiatives to track the progress of implementation of the BCBS framework in member countries. The Federal Reserve contributed to supervisory policy recommendations, reports, and papers issued for consultative purposes or finalized by the BCBS that are designed to improve the supervision of banking organizations’ practices and to address spe- Supervision and Regulation cific issues that emerged during the financial crisis. The list below includes key final and consultative papers issued in 2014. Final papers: • Basel III leverage ratio framework and disclosure requirements (issued in January and available at www.bis.org/publ/bcbs270.htm). • Liquidity coverage ratio disclosure standards – final document (issued in January and available at www.bis.org/publ/bcbs272.htm). 63 ber and available at www.bis.org/bcbs/publ/ d305.htm). • Capital floors: the design of a framework based on standardised approaches – consultative document (issued in December and available at www.bis.org/ bcbs/publ/d306.htm). • Revisions to the standardised approach for credit risk – consultative document (issued in December and available at www.bis.org/bcbs/publ/d307.htm). Financial Stability Board • The standardised approach for measuring counterparty credit risk exposures (issued in March and available at www.bis.org/publ/bcbs279.htm). In 2014, the Federal Reserve continued its active participation in the activities of the Financial Stability Board, 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. • Capital requirements for bank exposures to central counterparties – final standard (issued in April and available at www.bis.org/publ/bcbs282.htm). For more information on the work of the Financial Stability Board, refer to section 3, “Financial Stability.” • Supervisory framework for measuring and controlling large exposures – final standard (issued in April and available at www.bis.org/publ/bcbs283.htm). Joint Forum • The Liquidity Coverage Ratio and restricted-use committed liquidity facilities (issued in January and available at www.bis.org/publ/bcbs274.htm). Consultative papers: In 2014, 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 BCBS, the International Organization of Securities Commissions, and the International Association of Insurance Supervisors. Final papers issued by the Joint Forum in 2014 include: • Basel III: the Net Stable Funding Ratio – consultative document (issued in January and available at www.bis.org/publ/bcbs271.htm). • Point of Sale disclosure in the insurance, banking and securities sectors – final report (issued in April and available at www.bis.org/publ/joint35.pdf). • Review of Pillar 3 disclosure requirements (issued in June and available at www.bis.org/publ/ bcbs286.htm). • Report on supervisory colleges for financial conglomerates (issued in September and available at www.bis.org/publ/joint36.pdf). • Operational risk – Revisions to the simpler approaches – consultative document (issued in October and available at www.bis.org/publ/ bcbs291.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 accounting policy function is responsible for providing expertise in policy development and implementation efforts, both within and outside the Federal Reserve System, on issues affecting the banking and insurance industries in the areas of accounting, auditing, internal controls • Basel III: the net stable funding ratio (issued in October and available at www.bis.org/bcbs/publ/ d295.htm). • Revisions to the securitisation framework (issued in December and available at www.bis.org/bcbs/publ/ d303.htm). • Net Stable Funding Ratio disclosure standards – consultative document (issued in December and available at www.bis.org/bcbs/publ/d302.htm). • Fundamental review of the trading book: outstanding issues – consultative document (issued in Decem- 64 101st Annual Report | 2014 over financial reporting, financial disclosure, and supervisory financial reporting. accounting matters, as appropriate, and participated in a number of supervisory-related activities. For example, Federal Reserve staff Federal Reserve staff regularly consult with key constituents in the accounting and auditing professions, including domestic and international standardsetters, accounting firms, accounting and financial sector trade groups, and other financial sector regulators to facilitate the Board’s understanding of domestic and international practices; proposed accounting, auditing, and regulatory standards; and the interactions between accounting standards and regulatory reform efforts. The Federal Reserve also participates in various accounting, auditing, and regulatory forums in order to both formulate and communicate its views. • issued guidance on income tax allocation in a holding company structure; During 2014, Federal Reserve staff addressed numerous issues including loan accounting, troubled debt restructurings, accounting alternatives for private companies, financial instrument accounting and reporting, consolidation of structured entities, securitizations, securities financing transactions, and external and internal audit processes. The Federal Reserve shared its views with accounting and auditing standard-setters through informal discussions and public comment letters. Comment letters on the Financial Accounting Standards Board’s proposal related to business combinations and on the Public Company Accounting Oversight Board’s proposal related to the changes in the auditor’s reporting model were issued during the past year. The Federal Reserve staff also participated in meetings of the Basel Committee’s Accounting Experts Group and the International Association of Insurance Supervisors’ (IAIS) Accounting and Auditing Working Group. These groups represent their respective organizations at international meetings on accounting, auditing, and disclosure issues affecting global banking organizations. Working with international bank supervisors, Federal Reserve staff contributed to the development of numerous comment letters and publications that were issued by the Basel Committee and the IAIS. The publications issued during 2014 included guidance on the external audits of banks and the consultative document on the review of pillar 3 disclosure requirements. In 2014, the Federal Reserve issued supervisory guidance to financial institutions and supervisory staff on • developed and participated in a number of domestic and international supervisory training programs and 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 through participation in examinations and provision of expert guidance on specific queries related to financial accounting, auditing, reporting, and disclosures. The Federal Reserve System staff also provided their accounting and business expertise through participation in other supervisory activities during the past year. These activities included supporting DoddFrank Act initiatives related to stress testing of banks and credit risk retention requirements for securitization, as well as various Basel III issues. 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 management practices; and to ensure that institutions properly identify, measure, and manage credit risk. Shared National Credit Program In November, the Federal Reserve and the other banking agencies released summary results of the 2014 annual review of the Shared National Credit (SNC) Program, a long-standing program to promote an efficient and consistent review and classification of shared national credits. A SNC 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. Supervision and Regulation 65 The 2014 SNC review was prepared in the second quarter of 2014 using data as of December 31, 2013, and March 31, 2014. The 2014 SNC portfolio totaled $3.39 trillion, with roughly 9,800 credit facilities to approximately 6,200 borrowers. From the previous period, the dollar volume of the portfolio commitment amount rose by $379 billion or 12.6 percent, and the number of credits increased by 502 or 5.4 percent. 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. The SNC examination found that the volume of criticized assets increased 12.8 percent to $340.8 billion. As a percentage of total commitments, the overall criticized asset rate remained elevated at 10.1 percent, up from 10.0 percent in 2013. The elevated criticized rate is historically high when compared to SNC portfolios at this stage of the economic cycle. In 2014, the Federal Reserve continued to actively promote the development and maintenance of effective BSA/AML compliance risk-management programs, including developing supervisory strategies and providing guidance to the industry on trends in BSA/AML compliance. For example, the Federal Reserve supervisory staff participated in a number of industry conferences to continue to communicate regulatory expectations and policy interpretations for financial institutions. For the 2014 SNC review, supervisors placed significant emphasis on reviewing leveraged loans to evaluate safety and soundness of bank underwriting and risk-management practices relative to expectations articulated in the 2013 Interagency Guidance on Leveraged Lending. The review found that risk in the overall SNC portfolio was centered in the leveraged portfolio, noting a criticized rate of 33.2 percent for leveraged loans compared with 3.3 percent for the non-leveraged portfolio. The 2014 SNC review also identified several areas where institutions need to strengthen risk-management practices, including inadequate support for enterprise valuations and/or reliance on dated valuations, weaknesses in credit analysis, and overreliance on sponsor’s projections. Underwriting standards were also noted as weak in 31 percent of the SNC loan transactions sampled. Leveraged lending transactions were the primary driver of this underwriting deterioration. Refinancing risk increased moderately in the SNC portfolio as 25.0 percent of SNC commitments will mature in 2015 and 2016, compared with 15.0 percent for the same period in the 2013 SNC Review. During 2013 and into 2014, syndicated lenders continued to refinance and modify loan agreements to extend maturities. These transactions had the effect of relieving near-term refinancing risk, but, in many instances, did not improve borrowers’ ability to repay their debts in the longer term as obligors frequently added to their existing debt burden. For more information on the 2014 SNC review, visit the Board’s website at www.federalreserve.gov/newsevents/press/ bcreg/20141107a.htm. Bank Secrecy Act and Anti-Money-Laundering Compliance 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. The Federal Reserve also participated in several Treasury-led private/public sector dialogues with Latin American and Mexican financial institutions, regulators, and supervisors. These dialogues are designed to promote information sharing and understanding of issues surrounding correspondent banking relations between U.S. and country-specific financial sectors. In addition, the Federal Reserve participated in meetings during the year to discuss BSA/AML issues with delegations from Latvia, China, and Mexico regarding managing and reporting on AML risk, customer due diligence, and emerging payments. 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 SEC, the Commodity Futures Trading Commission, the Internal Revenue Service, and the Office of Foreign Assets Control (OFAC). The FFIEC BSA/AML working group is responsible for updating the FFIEC Bank Secrecy Act/Anti-Money Laundering Examination Manual. The FFIEC developed this manual as part of its ongoing commitment to provide current and consistent interagency guidance 66 101st Annual Report | 2014 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. In 2014, the FFIEC BSA/AML working group updated the manual to further clarify supervisory expectations and incorporate regulatory changes since its 2010 revision. The 2014 revisions also incorporate feedback from the banking industry and examination staff. Throughout 2014, the Federal Reserve and other federal banking agencies continued to regularly share examination findings and enforcement proceedings with FinCEN as well as with OFAC under the interagency MOUs finalized in 2004 and 2006. In 2014, the Federal Reserve continued to participate in the U.S. Treasury’s Interagency Task Force on Strengthening and Clarifying the BSA/AML Framework (task force), created in 2012, which includes representatives from the Department of Justice, OFAC, FinCEN, the federal banking agencies, the SEC, 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. The Federal Reserve participated in developing the FATF guidance for the banking sector on identifying, assessing, and monitoring money laundering and the financing of terrorism on a risk-assessed basis, which was published in October 2014. The Federal Reserve also participated in efforts by FATF to more fully understand effective AML supervision and enforcement. Finally, the Federal Reserve continues to participate in a subcommittee of the Basel Committee that focuses on AML/counter-terrorism financing issues. With respect to that subcommittee, the Federal Reserve actively contributed to updating and revising a consultative paper on the general guide to account opening, originally issued in 2003. Incentive Compensation To foster improved incentive compensation practices in the financial industry, the Federal Reserve along with the other federal banking agencies adopted interagency guidance oriented to the risk-taking incentives created by incentive compensation arrangements.10 The guidance is principles-based, recognizing that the methods used to achieve appropriately risk-sensitive compensation arrangements likely will differ significantly across and within firms. Three principles are at the core of the guidance: • Incentive compensation arrangements should balance risk and financial results in a manner that does not encourage employees to expose their organizations to imprudent risks. • A banking organization’s risk-management processes and internal controls should reinforce and support the development and maintenance of balanced incentive compensation arrangements, and incentive compensation should not hinder risk management and controls. • Banking organizations should have strong and effective corporate governance of incentive compensation. Through two Board-led horizontal reviews and with ongoing engagement with the largest firms and our supervisory teams, we have improved practice and design of incentive compensation arrangements at firms with greater than $50 billion in U.S. assets. This supervisory work has been focused on assessing the potential for incentive compensation arrangements to encourage imprudent risk-taking; reviewing actions large banking organizations have taken to correct deficiencies in incentive compensation design; and evaluating the adequacy of firms’ compensationrelated risk management, controls, and corporate governance. The Dodd-Frank Act requires the reporting to regulators of incentive compensation arrangements and prohibits incentive compensation arrangements that provide excessive compensation or that could expose the firm to inappropriate risks. Banking organizations, broker–dealers, investment advisers, and certain other firms are covered under the act if they have $1 billion or more in total consolidated assets. 10 See “Guidance on Sound Incentive Compensation Policies,” 75 Federal Register 36395–36414 (June 25, 2010). Supervision and Regulation In 2011, the seven designated financial regulatory agencies (Federal Reserve, OCC, FDIC, OTS, NCUA, SEC, and the Federal Housing Finance Agency) issued a joint proposed incentive compensation rule. The agencies continue to work toward a rule to implement the act. Other Policymaking Initiatives • In March, the Board issued an advance notice of proposed rulemaking seeking comment to inform its consideration of physical commodity activities conducted by financial holding companies, including current authorizations of these activities and the appropriateness of further restrictions. The proposed rule is available at www.gpo.gov/fdsys/ pkg/FR-2014-03-05/pdf/2014-04742.pdf. • In July, the federal banking agencies with the Conference of State Bank Supervisors, issued a supervisory guidance statement, SR 14-5, to reiterate principles of sound risk management for home equity lines of credit (HELOCs) that have reached or will be reaching their end-of-draw periods. The guidance describes risk-management practices to promote a clear understanding of potential exposures and to help guide consistent, effective responses to HELOC borrowers who may be unable to meet contractual obligations at their endof-draw periods and highlights concepts related to financial reporting for HELOCs. The guidance is available at www.federalreserve.gov/bankinforeg/ srletters/sr1405.htm. • In September, the federal banking agencies, along with the Farm Credit Administration and the Federal Housing Finance Agency, issued a proposed rule that would establish margin requirements for swap dealers, major swap participants, securitybased swap dealers, and major security-based swap participants as required by the Dodd-Frank Act. The proposed rule would establish minimum requirements for the exchange of initial and variation margin between covered swap entities and their counterparties to non-cleared swaps and noncleared security-based swaps. The proposed rule is available at www.gpo.gov/fdsys/pkg/FR-2014-0924/pdf/2014-22001.pdf. • In December, the federal banking agencies, along with the Department of Housing and Urban Development, the Federal Housing Finance Agency, and the SEC, issued a final rule requiring sponsors of securitization transactions to retain 67 risk in those transactions, implementing the risk retention requirements in the Dodd-Frank Act. The final rule requires sponsors of securitizations, such as asset-backed securities (ABS), to retain not less than 5 percent of the credit risk of the assets collateralizing the ABS issuance unless certain underwriting criteria on the securitized assets are met. The rule also sets forth prohibitions on transferring or hedging the credit risk that the sponsor is required to retain. The final rule is available at www.gpo.gov/fdsys/pkg/FR-2014-12-24/pdf/201429256.pdf. • In November, the Board announced that it would apply to SLHCs certain Federal Reserve supervisory guidance documents issued prior to July 21, 2011, the date of transfer of supervision and regulation of SLHCs from the former OTS to the Board. The Board’s determination to apply these SR letters to SLHCs follows an extensive review of its existing guidance documents. The list of SR letters applicable to SLHCs is available at www.federalreserve.gov/bankinforeg/srletters/ sr1409.pdf. • In November, the Board issued a final rule to implement section 622 of the Dodd-Frank Act, which establishes a financial sector concentration limit that prevents a financial company from merging and consolidating with another financial company if the resulting company’s consolidated liabilities would exceed 10 percent of the aggregate consolidated liabilities of all financial companies. Financial companies subject to the limit include insured depository institutions, BHCs, SLHCs, foreign banking organizations, companies that control insured depository institutions, and nonbank financial companies designated by the FSOC for Board supervision. The final rule is available at www.gpo.gov/fdsys/pkg/FR-2014-11-14/pdf/201426747.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 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 68 101st Annual Report | 2014 and timely revisions to the reporting forms and the attendant instructions. Holding Company Regulatory Reports The Federal Reserve requires that U.S. holding companies (HCs) periodically submit reports that provide information about their financial condition and structure.11 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 HCs and their nonbank subsidiaries. Foreign banking organizations (FBOs) also are required to periodically submit reports to the Federal Reserve. For more information on the various reporting forms, see www .federalreserve.gov/apps/reportforms/default.aspx. During 2014, the following reporting forms were revised: • FR Y-9C, FR Y-9SP, and the FFIEC 101—to reflect changes to the calculation of regulatory capital consistent with the Federal Reserve’s revised regulatory capital rules. The Federal Reserve modified the FR Y-9C to split Schedule HC-R, Regulatory Capital, into two parts: Part I, which collects information on revised regulatory capital components and ratios; and Part II, which collects information on existing risk-weighted assets. The Federal Reserve (with the other FFIEC member banking agencies) modified the FFIEC 101 Schedule A, Advanced Risk-Based Capital, and nine other schedules to implement the revised advanced approaches capital rules. • Part II of Schedule HC-R of the FR Y-9C, and line items related to securities lent and borrowed on the FR Y-9C—to ensure that all banking organizations are reporting risk-weighted assets consistent with the standardized approach outlined in the revised regulatory capital rules. • FR Y-7Q—to require all FBOs with total consolidated assets of $50 billion or more to begin filing quarterly regardless of financial holding company status. In addition, a data item was added to Part 1 to collect the top-tier FBO’s total combined assets of U.S. operations, net of intercompany balances and transactions between U.S. domiciled affiliates, branches, and agencies (effective March 2014). In December 2014, the FR Y-7Q report was revised to collect a new data item to implement the enhanced prudential standards for FBOs adopted pursuant 11 HCs are defined as bank holding companies, savings and loan holding companies, and securities holding companies. to section 165 of the Dodd-Frank Act. The new item, Total U.S. Non-Branch Assets, is used to determine which FBOs would be required to form an intermediate holding company. • FR 2052a and 2052b—finalized in 2014. Subsequently, in December 2014, the Federal Reserve Board proposed changes to the FR 2052a report, including increasing granularity of data items, updating reporting platform structure, and expanding the scope of those institutions reporting. These changes allow the Federal Reserve to monitor compliance with the liquidity coverage ratio, but more generally improve supervisory staff’s ability to monitor liquidity risk. • FR XX-1—created to implement a reporting requirement established by Regulation XX (Concentration Limit) for financial companies that do not otherwise report consolidated total liabilities to the Federal Reserve or other appropriate federal banking agency. • FR Y-14—to better align FR Y-14A Schedule A (Summary) with the changes to Part II of Schedule HC-R of the FR Y-9C mentioned above. Also, numerous items were added to the counterparty collection that provides netting set and asset type information for securities financing transactions and derivative exposures to support ongoing supervision and supervisory modelling. Finally, several items were added to the collection of wholesale loan information. • FR Y-16—to incorporate the new capital framework requirements of collecting common equity tier 1 capital and the common equity tier 1 riskbased capital ratio, and to modify the reporting instructions to clarify a number of items. The majority of SLHCs became compliant with Federal Reserve regulatory reporting by the end of 2013. At this time, approximately 20 commercial and insurance SLHCs remain exempt from filing consolidated regulatory reports. 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 the Consolidated Reports of Condition and Income (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 Supervision and Regulation 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 2014, the FFIEC revised the Call Report to reflect changes to the calculation of regulatory capital consistent with the banking agencies’ revised regulatory capital rules. The FFIEC modified the Call Report to split Schedule RC-R, Regulatory Capital, into two parts: Part I, which collects information on revised regulatory capital components and ratios, and Part II, which collects information on existing riskweighted assets. The FFIEC also revised the following types of information on the Call Report: effective March 2014 (1) information about international remittance transfers; (2) information on trade names (other than an institution’s legal title) used to identify physical offices and the addresses of any publicfacing Internet websites (other than the institution’s primary Internet website address) at which the institution accepts or solicits deposits from the public; (3) responses to a yes-no question asking whether the reporting institution offers any deposit account products (other than time deposits) primarily intended for consumers; (4) for institutions with $1 billion or more in total assets that offer one or more deposit account products (other than time deposits) primarily intended for consumers, information on the total balances of these consumer deposit account products; and, effective March 2015, (5) for institutions with $1 billion or more in total assets that offer one or more deposit account products (other than time deposits) primarily intended for consumers, information on the amount of income earned from each of three categories of service charges on their consumer deposit account products. Also during 2014, the FFIEC proposed revisions to Part II of Schedule RC-R, and to line items related to securities lent and borrowed on Schedule RC-L, Derivatives and Off-Balance-Sheet Items, to ensure that all banking organizations are reporting riskweighted assets consistent with the standardized approach outlined in the revised regulatory capital rules. 69 Supervisory Information Technology The Federal Reserve’s supervisory information technology function, 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. Initiatives include the development and maintenance of applications and tools to assist with the examination of banking institutions, data collection and storage, development and deployment of collaboration tools, and data security. In 2014, the information technology supervisory function focused on • Large bank and foreign bank supervision. Continued improving the supervision of large financial institutions and foreign banks by integrating document repositories for continuous monitoring and point-in-time examinations. One such application used to improve monitoring and tracking capabilities is C-SCAPE (Consolidated Supervision Comparative Analysis Planning and Execution). • Community and regional bank supervision. For banking institutions with less than $50 billion in assets, worked with community and regional bank examiners, as well as the FDIC and state bank supervisors, to enhance supervisory tools used jointly by the federal and state banking agencies. • Supervisory support tools. Continued to develop and implement administrative technical solutions to help support examiners and other supervisory staff become more efficient through the management of documentation, travel, and time. One such application implemented in 2014 is ROAM – S—a new supervisory scheduling tool that supports all supervisory programs. • Content, collaboration, and mobility. (1) Provided technology development and support on a broader scale, with applications and programs designed to be used across the supervisory function to enhance efficiency and increase collaboration, mobility, and data collection and storage; (2) implemented a new document management platform to replace retired platforms used by the Reserve Banks; (3) unveiled new and enhanced collaboration tools, including business social sites for internal and external collaboration; and (4) leveraged an Interagency Steering Group to improve methods for sharing work among state and federal regulators. 70 101st Annual Report | 2014 Table 3. Training for banking supervision and regulation, 2014 Number of enrollments Course sponsor or type Federal Reserve personnel State and federal banking agency personnel 1,948 7,445 17,146 489 336 4,022 Federal Reserve System FFIEC Rapid Response2 1 2 Instructional time (approximate training days)1 Number of course offerings 838 428 11 1,892 107 90 Training days are approximate. System courses were calculated using five days as an average, with FFIEC courses calculated using four days as an average. Rapid Response® is a virtual program created by the Federal Reserve System as a means of providing information on emerging topics to Federal Reserve and state bank examiners. • Streamlined data access and improved security. Continued to streamline data access for the supervisory function, while enhancing overall data security. National Information Center The National Information Center (NIC) is the Federal Reserve’s comprehensive repository for supervisory, financial, banking structure data, as well as supervisory documents. The NIC includes (1) data on banking structure throughout the United States as well as foreign banking concerns; (2) the National Examination Data, an application that enables supervisory personnel and 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, an application that contains documents supporting the supervisory processes. • Database enhancements. In 2014, the supervisory information technology function strengthened capabilities in the areas of data collection and data stewardship, implemented new tools for the analysis of large volumes of data, and enhanced data acquisition and analysis through the deployment of new or improved applications. The NIC team has also continued to partner with the Board’s Office of the Chief Data Officer to collaborate on enterprise data inventory, application architecture, and integration activities. • Public website and external collaboration. Several reports were added to the NIC public website, including the Banking Organization Systemic Risk Report, snapshots of data used in the calculation of global systemically important banks, and RiskBased Capital Reporting for Institutions Subject to the Advanced Capital Adequacy Framework (FFIEC 101). Structure data were made available in bulk format for attributes, relationships, and transformation information for holding companies with total assets greater than $10 billion. In addition, steps were taken to improve collaboration with other agencies in terms of sharing institutionspecific financial data. Staff Development The Federal Reserve’s staff development program supports the ongoing development of about 3,000 professional supervisory staff, ensuring 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 2014 are summarized in table 3. Examiner Commissioning Program The Federal Reserve System’s commissioning program for assistant examiners is set forth in the Examiner Commissioning Program (SR letter 98-02).12 Examiners choose one of two specialty tracks— (1) safety and soundness or (2) consumer compliance. On average, individuals move through a combination of classroom offerings, self-paced learning, and on-the-job training over a period of three years. Achievement is measured by completing the required course content, demonstrating adequate on-the-job knowledge, and passing a professionally validated proficiency examination. In 2014, 156 examiners passed the first proficiency exam (113 in safety and soundness and 43 in consumer compliance). 12 SR letter 98-02 is available at www.federalreserve.gov/ boarddocs/srletters/1998/sr9802.htm. Supervision and Regulation Currently, the Federal Reserve is undertaking a major initiative to modernize its Community Bank Examiner Commissioning Program. Additionally, efforts are underway to build an Examiner Commissioning Program for Large Financial Institutions. Continuing Professional Development As part of an ongoing strategic effort related to learning and development, the Federal Reserve is enhancing continuing professional development through the addition and modernization of several courses, tools, and programs. Technical, professional, and leadership skill development opportunities are available to examiners in a blended learning approach. This includes self-study materials, online virtual learning options, and traditional classroom instruction. Schools, conferences, and programs covering a variety of regulatory topics are offered within the System, Board, and FFIEC. System programs are also available to state and federal banking agency personnel. Regulation The Federal Reserve exercises important regulatory influence over entry into the U.S. banking 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), and the International Banking Act. In administering these statutes, the Federal Reserve acts on a variety of applications and notices that directly or indirectly 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 71 foreign banks. The applications and notices concern BHC and SLHC formations and acquisitions, bank mergers, and other transactions involving banks and savings associations or nonbank firms. In 2014, the Federal Reserve acted on 1,133 applications filed under the six statutes. In 2014, the Federal Reserve released its first Semiannual Report on Banking Applications Activity, which provides aggregate information on proposals filed by banking organizations and reviewed by the Federal Reserve. The report includes statistics on the number of proposals that have been approved, denied, and withdrawn, as well as general information about the length of time taken to process proposals. Additionally, the report discusses common reasons that proposals have been withdrawn from consideration. The first report is available at www.federalreserve.gov/ newsevents/press/other/20141124a.htm. 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.13 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 approval, the Federal Reserve considers 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 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 must consider the views of the U.S. Department of Justice regarding 13 Since 1996, the BHC 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 BHC 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 101st Annual Report | 2014 the competitive aspects of any proposed BHC acquisition involving unaffiliated insured depository institutions. 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 home-country supervisor. In 2014, the Federal Reserve acted on 253 applications and notices filed by BHCs to acquire a bank or a nonbank firm, or to otherwise expand their activities. A BHC may repurchase its own shares from its shareholders. Certain stock redemptions require prior Federal Reserve approval. 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 2014, 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 2014, 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. In 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, financial stability factors, 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 2014, the Federal Reserve approved 70 merger applications under the Bank Merger 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 also may contact other regulatory or law enforcement agencies for information about relevant individuals. In 2014, the Federal Reserve approved 131 change in control notices. 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 2014, the Federal Reserve acted on 47 membership applications, 525 new and mergerrelated domestic branch applications, and one foreign branch application. State member banks also must 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 2014, one financial subsidiary application was approved. 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 that 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 2014, the Federal Reserve acted on 29 applications 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 2014, the Federal Reserve acted on no applications for MHC reorganizations. In 2014, the Federal Reserve acted on nine applications filed by MHCs to convert to stock form, and seven applications to waive dividends. When reviewing an SLHC application or notice that requires approval, the Federal Reserve considers 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 must consider the views of the U.S. Department of Justice regarding the competitive aspects of any SLHC proposal involving the acquisition or merger of unaffiliated insured depository institutions. The Federal Reserve also reviews elections submitted by SLHCs seeking status as financial holding companies under the authority granted by the Dodd-Frank 73 Act. SLHCs seeking financial holding company status must file a written declaration with the Federal Reserve. In 2014, three SLHC financial holding company declarations were approved. 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 2014, the Federal Reserve approved 15 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 2014, the Federal Reserve approved four applications by foreign banks to establish branches, agencies, or representative offices in the United States. 74 101st Annual Report | 2014 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 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 and 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/2014orders.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 Under the Securities Exchange Act of 1934 and Federal Reserve’s Regulation H, certain state member banks are required to make financial disclosures to the Federal Reserve using the same reporting forms (such as Form 10K—annual report and Schedule 14A—proxy statement) that are normally used by publicly held entities to submit information to the Securities Exchange Commission.14 As most of the 14 Under Section 12(g) of the Securities Exchange Act, certain companies that have issued securities are subject to SEC registration and filing requirements that are similar to those imposed on public companies. Per Section 12(i) of the Securities publicly held banking organizations are BHCs and the reporting threshold was recently raised, only two state member banks were required to submit data to the Federal Reserve in 2014. The information submitted by these two small state member banks is available to the public upon request and is primarily used for disclosure to the bank’s shareholders and public investors. 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. Exchange Act, the powers of the SEC over banking entities that fall under Section 12(g) are vested with the appropriate banking regulator. Specifically, state member banks with 2,000 or more shareholders and more than $10 million in total assets are required to register with, and submit data to, the Federal Reserve. These thresholds reflect the recent amendments by the Jumpstart Our Business Startups Act (JOBS Act). 75 5 Consumer and Community Affairs The Division of Consumer and Community Affairs (DCCA) has primary responsibility for carrying out the Board of Governor’s role in consumer financial protection and community development. DCCA conducts consumer-focused supervision, research, and policy analysis, as well as implements relevant statutory requirements and facilitates community development. Through these efforts, the division works to ensure that consumer and community perspectives inform Federal Reserve policy, actions, and research in advancing DCCA’s mission to promote a fair and transparent consumer financial services marketplace and effective community development. Throughout 2014, the division engaged in numerous consumer and community-related functions and policy activities in the following areas: • Formulating consumer-focused supervision and examination policy to ensure that financial institutions for which the Federal Reserve has authority comply with consumer protection and meet requirements of community reinvestment laws and regulations. The division provided oversight for the Reserve Bank consumer compliance supervision and examination programs in state member banks and bank holding companies (BHCs) through its policy development, examiner training, and supervision oversight programs, which include enforcement of fair lending, unfair or deceptive acts or practices (UDAP), and flood insurance rules; analysis of bank and BHC applications in regard to consumer protection; and processing of consumer complaints. • Conducting rigorous research, analysis, and data collection to inform Federal Reserve and other policymakers about consumer protection and community economic development issues and opportunities. The division analyzed emerging issues in consumer financial services research, 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 related to financial services, implications of the financial crisis on young workers, and access to credit for small businesses. • Engaging, convening, and informing key stakeholders to identify emerging issues and advance what works in community reinvestment and consumer protection. The division continued to promote fair and informed access to financial markets for all consumers, particularly the 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. • Writing and reviewing regulations that effectively implement consumer protection and community reinvestment laws. The division manages the Board’s regulatory responsibilities with respect to certain entities and specific statutory provisions of the consumer financial services and fair lending laws. DCCA drafted regulations and issued interpretations and compliance guidance for the industry and the Reserve Banks. Supervision and Examinations DCCA 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 the Board has authority, including holding companies, state member banks, and foreign banking organizations. The division also administers the Federal Reserve System’s riskfocused 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 consumer protection laws and regulations are rigorously and con- 76 101st Annual Report | 2014 sistently enforced for the 850 state member banks that the Federal Reserve supervises for compliance with consumer protection and community reinvestment laws and regulations. Division staff provide guidance and expertise to the Reserve Banks on consumer protection laws and regulations, bank and BHC application analysis and processing, examination and enforcement techniques and policy matters, examiner training, and emerging issues. Finally, staff members participate in interagency activities that promote consistency in examination principles, standards, and processes. Examinations are one of the Federal Reserve’s methods of ensuring compliance with consumer protection laws and assessing the adequacy of consumer compliance risk-management systems within regulated entities. During 2014, the Reserve Banks completed 225 consumer compliance examinations of state member banks and 31 examinations of foreign banking organizations, 1 examination of an Edge Act corporation, and 1 examination of an agreement corporation.1 Bank Holding Company Consolidated Supervision During 2014, staff reviewed more than 115 bank and financial holding companies to ensure consumer compliance risk was appropriately incorporated into the consolidated risk-management program for the organization. Division staff participated with staff from the Board’s Division of Banking Supervision and Regulation on numerous projects related to ongoing implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act), including standards for assessing corporate governance and continued integration of savings and loan holding companies (SLHCs) under Federal Reserve supervision. 1 In 2013, DCCA began reporting the number of examinations completed based on the calendar year (from January 1 to December 31); in prior years, numbers had been reported for the period from July 1 through June 30. Agency and branch offices of foreign banking organizations, Edge Act corporations, and agreement corporations fall under the Federal Reserve’s purview for consumer compliance activities. An agreement corporation is a type of bank chartered by a state to engage in international banking. The bank “agrees” with the Federal Reserve Board to limit its activities to those allowed an Edge Act corporation. An Edge Act corporation is a banking institution with a special charter from the Federal Reserve to conduct international banking operations and certain other forms of business without complying with state-by-state banking laws. By setting up or investing in Edge Act corporations, U.S. banks are able to gain portfolio exposure to financial investing operations not available under standard banking laws. In November 2014, the Federal Reserve issued a detailed listing of Federal Reserve supervisory guidance documents that are applicable to SLHCs.2 The listing is supplemental to previously issued guidance that informed SLHCs to comply with Federal Reserve guidance and not Office of Thrift Supervision (OTS) guidance issued prior to July 21, 2011— the date that supervision and regulation of SLHCs transferred from the OTS to the Federal Reserve. Mortgage Servicing and Foreclosure Payment Agreement Status Throughout 2014, Board staff continued to work to oversee and implement the enforcement actions against 16 mortgage loan servicers that were issued by the Federal Reserve and the Office of the Comptroller of the Currency (OCC) between April 2011 and April 2012. At that time, along with other requirements, the two regulators directed servicers to retain independent consultants to conduct comprehensive reviews of foreclosure activity to determine whether eligible3 borrowers suffered financial injury because of servicer errors, misrepresentations, or other deficiencies. The file review initiated by the independent consultants, combined with a significant borrower outreach process, was referred to as the Independent Foreclosure Review (IFR). In 2013, the regulators entered into agreements with 15 of the mortgage loan servicers to replace the IFR with direct cash payments to all eligible borrowers and other assistance (the Payment Agreement).4 The participating servicers agreed to pay an estimated $3.9 billion to 4.4 million borrowers whose primary residence was in a foreclosure process in 2009 or 2010. The Payment Agreement also required the servicers to contribute an additional $5.8 billion dollars in other foreclosure prevention assistance, such as loan modifications and forgiveness of deficiency judgments. For the participating servicers, fulfillment of the agreement will satisfy the foreclosure review requirements of the enforcement actions issued by the regulators in 2011 and 2012. The Payment Agreement did not affect the servicers’ continuing obligations under the enforcement actions to address defi2 3 4 For more information, see www.federalreserve.gov/bankinforeg/ srletters/sr1409.htm. Borrowers were eligible if their primary residence was in a foreclosure action with one of the 16 mortgage loan servicers at any time in 2009 or 2010. One OCC-regulated servicer elected to complete the Independent Foreclosure Review, and did not, therefore, enter into the Payment Agreement. Consumer and Community Affairs ciencies in their mortgage servicing and foreclosure policies and procedures. A paying agent, Rust Consulting, Inc., (Rust) was retained to administer payments to borrowers on behalf of the participating servicers. Beginning in April 2013, a letter with an enclosed check was sent to borrowers who had a foreclosure action initiated, pending, or completed in 2009 or 2010 with any of the participating servicers. Letters with checks were mailed to eligible borrowers throughout 2013 and 2014, including checks that were reissued upon the borrower’s request due to expiration, a request for a change in payee, or a request by borrowers to split the check amongst the borrowers on the loan. For checks that have not been cashed or were returned undeliverable, the agencies directed Rust to expand its efforts to locate more-current address information for the unpaid borrowers. This resulted in additional consumers receiving payments under the agreements, with replacement checks scheduled to be sent to any updated address or the last known address on record for those borrowers who have not yet cashed their checks. As of December 31, 2014, $3.4 billion has been distributed through 3.7 million checks, representing 87 percent of the total value of the funds. Receiving a payment under the agreement will not prevent borrowers from taking any action they may wish to pursue related to their foreclosure. Servicers are not permitted to ask borrowers to sign a waiver of any legal claims they may have against their servicer in connection with receiving payment.5 Foreclosure Prevention Actions The Payment Agreement also required servicers to undertake well-structured loss-mitigation efforts focused on foreclosure prevention, with preference given to activities designed to keep borrowers in their homes through affordable, sustainable, and meaningful home preservation actions within two years from the date the agreement in principle was reached. The foreclosure prevention actions are expected to provide significant and meaningful relief or assistance to qualified borrowers and, as stated in the agreement, “should not disfavor a specific geography within or among states, nor disfavor low and/or moderate income borrowers, and not discriminate against any protected class.” 5 For more information, see www.federalreserve.gov/ consumerinfo/independent-foreclosure-review-paymentagreement.htm. 77 Servicers may fulfill their obligations through three specific consumer-relief activities set forth in the National Mortgage Settlement, including first-lien loan modifications, second-lien loan modifications, and short sales or deeds-in-lieu of foreclosure. Servicers were given the option, subject to non-objection from their regulator, to meet their foreclosure prevention assistance requirements by paying additional cash into the qualified settlement funds to be used for direct payments to consumers or by providing cash or other resource commitments to borrower counseling or education. Several of the participating servicers chose this option and have met their foreclosure prevention obligations. As of December 31, 2014, all servicers have submitted reports detailing the consumer-relief actions they have taken to satisfy these requirements. The foreclosure prevention assistance actions reported include loan modifications, short sales, deeds-in-lieu of foreclosure, debt cancellation, and lien extinguishment. In order to receive credit toward the servicer’s total foreclosure prevention obligation, the actions submitted must be validated by the regulators. A process has been established for a third party to conduct this validation and ensure that the foreclosure prevention assistance amounts meet the requirements of the amendments to the enforcement actions. Servicer Efforts to Address Deficiencies In addition to the foreclosure review requirements, the enforcement actions required mortgage servicers to submit acceptable written plans to address various mortgage loan servicing and foreclosure processing deficiencies. In the time since the enforcement actions were issued, the banking organizations have been implementing the action plans, including enhanced controls, and improving systems and processes. To date, the supervisory review of the mortgage servicers’ action plans has shown that the banking organizations under the enforcement actions have implemented significant corrective actions with regard to their mortgage servicing and foreclosure processes, but that some additional actions need to be taken. Federal Reserve supervisory teams will continue to monitor and evaluate the servicers’ progress on implementing the action plans to address unsafe and unsound mortgage servicing and foreclosure practices as required by the enforcement actions. In July 2014, the Federal Reserve Board published a report regarding the IFR and the Payment Agreement that replaced the IFR. The report, which focused primarily on servicers regulated by the Fed- 78 101st Annual Report | 2014 eral Reserve, provides information on the process for the review of the foreclosure files during the IFR and file-review results—including servicer error rates during the IFR—up to the time the IFR was replaced.6 In addition, the report contains information on direct borrower payments and other assistance from the Payment Agreement and discusses the Federal Reserve’s ongoing supervision of corrective actions the mortgage servicers are required to implement. After the Payment Agreement has been fully implemented, the Federal Reserve expects to publish data on the final status of the cash payments and the foreclosure prevention assistance as well as the status of corrective actions implemented by the mortgage servicers. Supervisory Matters Risk-Focused Supervision On January 1, 2014, the Board implemented a new Community Bank Risk-Focused Consumer Compliance Supervision Program for state member banks with consolidated assets of $10 billion or less and their subsidiaries. The new program is designed to promote strong compliance risk-management practices and consumer protection at state member community banks. Under the updated program, consumer compliance examiners base the examination intensity more explicitly on the individual financial institution’s risk profile, including its consumer compliance culture and how effectively it identifies and manages consumer compliance risk. The new program is intended to enhance the efficacy of the Board’s supervision program and reduce regulatory burden on many community banking organizations.7 To ensure effective implementation of the Community Bank Risk-Focused Consumer Compliance Supervision Program, the Board undertook several examiner training and banker outreach initiatives. Consumer compliance examiner training was delivered through two Rapid Response webinars (discussed further in this section under “Ongoing Training Opportunities”) and a daylong case study exercise conducted at each Reserve Bank. Banker outreach was provided in a public Outlook Live8 webinar in March 2014 and a Consumer Compliance 6 7 8 The report is available at www.federalreserve.gov/publications/ other-reports/files/independent-foreclosure-review-2014.pdf. For more information, see www.federalreserve.gov/boarddocs/ supmanual/supervision_cch.htm. Outlook Live is the Federal Reserve System’s audio conference series on consumer compliance issues. For more information on this webinar, see https://consumercomplianceoutlook.org/ Outlook newsletter9 article in the second-quarter 2014 edition. In addition, the Board issued an enhanced examination frequency policy to complement the new Community Bank Risk-Focused Supervision Program. The frequency policy promotes effective supervision through deployment of examiner resources commensurate with an institution’s size, compliance rating, and CRA rating while reducing burden on many community banks. This new policy expands the number of financial institutions subject to a longer consumer compliance and CRA examination frequency cycle, as follows: • 48 or 60 months for banks with assets less than $350 million and satisfactory or better compliance and CRA ratings (formerly the threshold was $250 million) • 36 months for financial institutions with assets between $350 million and $1 billion and satisfactory or better compliance and CRA ratings (formerly 24 months) The new examination policy does not affect financial institutions with assets less than $250 million and those with assets more than or equal to $1 billion. The exam frequency schedule remains the same for these financial institutions and institutions with less than satisfactory compliance and/or CRA ratings, as follows: • 48 or 60 months for institutions with assets less than $250 million and satisfactory or better compliance and CRA ratings (48 months if the CRA rating is satisfactory; 60 months if the rating is outstanding) • 24 months for institutions with assets greater than or equal to $1 billion and satisfactory or better compliance and CRA ratings • 12 months for any institution with less than satisfactory ratings for either compliance or CRA 9 outlook-live/2014/community-bank-risk-focused-consumercompliance-supervision-program/. Consumer Compliance Outlook is a Federal Reserve System publication dedicated to consumer compliance issues. For more information on this newsletter article, see https:// consumercomplianceoutlook.org/2014/second-quarter/riskfocused-consumer-compliance-supervision-program-forcommunity-banks/. Consumer and Community Affairs Enforcement Activities Fair Lending and UDAP Enforcement With respect to fair lending, pursuant to provisions of the Dodd-Frank Act that took effect July 21, 2011, the Consumer Financial Protection Bureau (CFPB) supervises state member banks with assets of more than $10 billion for compliance with the Equal Credit Opportunity Act (ECOA). The Board also has supervisory authority for compliance with the Fair Housing Act. For the 829 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. With respect to the Federal Trade Commission Act, which prohibits UDAP, the Board has supervisory authority over state member banks, regardless of asset size. Fair lending and UDAP reviews are conducted regularly within the supervisory cycle. Additionally, examiners may conduct fair lending and UDAP reviews outside of the usual supervisory cycle, if warranted by fair lending and UDAP risk. When examiners find evidence of potential discrimination or potential UDAP violations, they work closely with DCCA’s Fair Lending Enforcement Section, which provides additional legal and statistical expertise and ensures that fair lending and UDAP laws are enforced consistently and rigorously throughout the Federal Reserve System. With respect to fair lending, 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 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 ensure that the institution takes all appropriate corrective action. There were no referrals to the DOJ in 2014. If there is a UDAP or fair lending violation that does not constitute a pattern or practice under ECOA, 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 and UDAP 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 79 banks’ boards of directors and the Reserve Banks, or board resolutions) to ensure that violations are corrected. When necessary, the Board can bring public enforcement actions. Given the complexity of this area of supervision, the Federal Reserve seeks to provide clarity on its perspectives and processes to the industry and the public. DCCA staff participates in numerous meetings, conferences, and trainings sponsored by consumer advocates, industry representatives, and interagency groups. Fair Lending Enforcement staff meet 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. For example, in 2014, the Board sponsored a free interagency webinar on fair lending supervision through Compliance Outlook Live, which was attended by more than 5,000 registrants, most of which were community banks.10 In 2014, the Board issued a consent order to cease and desist and a civil money penalty assessment of $3.5 million against an institution and its non-bank agent for deceptive practices associated with an account that was in violation of the Federal Trade Commission Act. The actions addressed in this order involved several practices that, at various points in the financial aid refund selection process, misled students about various aspects of the account, including terms and fees.11 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 10 11 For more information and to obtain the webcast, see https:// consumercomplianceoutlook.org/outlook-live/2014/federalinteragency-fair-lending-hot-topics/. For more information, see www.federalreserve.gov/newsevents/ press/enforcement/20140701b.htm. 80 101st Annual Report | 2014 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. The enactment of two statutes, the Biggert-Waters Flood Insurance Reform Act of 2012 (BiggertWaters Act) and the Homeowner Flood Insurance Affordability Act of 2014 (HFIAA), requires the federal financial institution supervisory agencies to update certain provisions of the federal flood insurance regulations. To that end, the Board and four other federal agencies have issued two joint notices of proposed rulemaking, one in October 2013 and a second in October 2014, to implement portions of the Biggert-Waters Act and HFIAA with respect to private flood insurance, the escrow of flood insurance payments, and the forced placement of flood insurance. The agencies continue work to finalize regulations to implement these statutes. The Biggert-Waters Act also increased the maximum limits of building coverage available for noncondominium residential buildings designed for use for five or more families, classified as “Other Residential” buildings. FEMA announced the availability of insurance under the Standard Flood Insurance Policy, or SFIP, reflecting these increased maximum limits effective June 1, 2014. In response to the availability of SFIPs with the increased limits, the federal financial institution supervisory agencies issued the “Interagency Statement on Increased Maximum Flood Insurance Coverage for Other Residential Buildings” on May 30, 2014.12 This statement conveys the agencies’ expectations of supervised institutions with regard to any loans secured by other residential buildings located in a special flood hazard area that may be affected by the availability of increased maximum insurance for these types of properties. In 2014, the Federal Reserve issued 14 formal consent orders and assessed $143,925 in civil money penalties against state member banks to address violations of the flood regulations. These statutorily mandated penalties were forwarded to the National Flood Miti- gation Fund held by the Department of the Treasury for the benefit of FEMA. Community Reinvestment Act The CRA requires that the Federal Reserve and other federal banking and thrift regulatory 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; • considers state member banks’ and bank holding companies’ CRA performance in context with other supervisory information when analyzing applications for mergers and acquisitions; and • 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 2014 reporting period, the Reserve Banks completed 189 CRA examinations of state member banks. Of those banks examined, 18 were rated “Outstanding,” 169 were rated “Satisfactory,” two were rated “Needs to Improve,” and none were rated “Substantial Non-Compliance.” In April, the Board, the OCC, and the Federal Deposit Insurance Corporation (FDIC) published revised large-institution CRA examination procedures, which explain how community development activities that benefit a broader statewide or regional area that includes an institution’s assessment area(s) and investments in nationwide funds will be considered when evaluating an institution’s CRA performance, assigning ratings, and developing public performance evaluations. The revised examination procedures reflect, and are consistent with, revisions to the Interagency Questions and Answers Regarding Community Reinvestment that were published in November 2013.13 In September, the Board, the OCC, and the FDIC proposed additional revisions to the Interagency 12 The agencies issuing this statement are the Board of Governors, the Farm Credit Administration, the Federal Deposit Insurance Corporation (FDIC), the National Credit Union Administration (NCUA), and the Office of the Comptroller of the Currency (OCC). For more information, see www.federalreserve .gov/bankinforeg/caletters/caltr1403.htm. 13 For more information, see www.ffiec.gov/cra/whatsnew.htm and www.federalreserve.gov/bankinforeg/caletters/caltr1402.htm. The Interagency Questions and Answers document provides additional guidance to financial institutions and the public on the agencies’ CRA regulations. Consumer and Community Affairs Questions and Answers.14 The proposed guidance addresses additional questions raised by bankers, community organizations, and others regarding the agencies’ CRA regulations. In particular, the proposed revisions to the questions and answers would • address alternative systems for delivering retail banking services; • add examples of innovative or flexible lending practices; • address community development-related issues by (1) clarifying guidance on economic development, (2) providing examples of community development loans and activities that are considered to revitalize or stabilize an underserved nonmetropolitan middle-income geography, and (3) clarifying how community development services are evaluated; and • offer guidance on how examiners evaluate the responsiveness and innovativeness of an institution’s loans, qualified investments, and community development services. The agencies are currently reviewing comments received in response to the proposed revisions to the Interagency Questions and Answers. Mergers and Acquisitions The Federal Reserve analyzes expansionary applications by banks or BHCs, taking into account the likely effects of the acquisition on competition, the convenience and needs of the communities to be served, the financial and managerial resources and future prospects of the companies and banks involved, and the effectiveness of the company’s policies to combat money laundering. As part of this process, DCCA evaluates whether the institutions are currently meeting the convenience and needs of their communities and existing managerial resources, as well as the institutions’ ability to meet the convenience and needs of their communities and their managerial resources after the proposed transaction. The CRA requires the Federal Reserve to consider a depository institution’s record of helping to meet the credit needs of its local communities in evaluating applications for mergers, acquisitions, and branches. An institution’s most recent CRA performance evaluation is a particularly important, and often controlling, consideration in the applications process 14 For more information, see www.federalreserve.gov/newsevents/ press/bcreg/20140908a.htm. 81 because it represents a detailed on-site evaluation of the institution’s performance under the CRA by its federal supervisor. As part of the analysis of managerial resources, the Federal Reserve reviews the institution’s record of compliance with consumer protection laws and regulations. The institution’s most recent consumer compliance rating is central to this review because, like the CRA performance evaluation, it represents the detailed findings of the institution’s supervisory agency. Less than satisfactory CRA or consumer compliance ratings can pose an impediment to the processing and approval of the application. Federal Reserve staff gather additional information about CRA and consumer compliance performance when the financial institution(s) involved in an application have less than satisfactory CRA or compliance ratings or when the Federal Reserve receives comments from interested parties that raise CRA or consumer compliance issues. To further enhance transparency on this process, the Board issued guidance to the public in February 2014 describing the Federal Reserve’s approach to applications and notices, indicating those that may not satisfy statutory requirements for approval of a proposal or otherwise raise supervisory or regulatory concerns.15 The Board provides information on its actions associated with these merger and acquisition transactions, issuing press releases and the Board Orders for each.16 As part of the February 2014 guidance, the Federal Reserve also informed the industry and public that the Federal Reserve would start publishing a semiannual report that provides pertinent information on applications and notices filed with the Federal Reserve. The first of these reports was issued in November 2014, covering the first six months of 2014.17 The report included statistics on the number of proposals that had been approved, denied, and withdrawn, as well as general information about the length of time taken to process proposals. Additionally, the report discussed common reasons that proposals had been withdrawn from consideration. Board staff also conducted educational webinars to 15 16 17 For more information, see www.federalreserve.gov/bankinforeg/ srletters/sr1402.htm. For access to the Board’s Orders on Banking Applications, see www.federalreserve.gov/newsevents/press/orders/2014orders .htm. For the report, see www.federalreserve.gov/newsevents/press/ other/20141124a.htm. 82 101st Annual Report | 2014 discuss this guidance and report with banking institutions and members of the public.18 Because these applications are of interest to the public, they often generate comments that raise various issues for Board staff to consider in their analyses of the supervisory and lending records of the applicants. With respect to consumer compliance and community reinvestment, commenters often allege that various institutions fail to make credit available to certain minority groups and to low- and moderate-income (LMI) individuals, or when they do extend credit to those borrowers, it is at a higher cost. Commenters also often express their view that the institutions fail to meet the needs of small businesses in LMI geographies and/or to adequately fulfill their CRA obligation to meet the credit needs of all of the communities in their assessment area, particularly LMI areas. • PacWest Bancorp, Los Angeles, California, and its controlling shareholders, CapGen Capital Group II LP and CapGen Capital Group II LLC, both of New York, New York, to acquire CapitalSource Inc. and thereby indirectly acquire its subsidiary industrial bank, CapitalSource Bank, both of Los Angeles, was approved in April. In evaluating the applications and the merits of public comments, the Board considers information provided by applicants and analyzes supervisory information, including examination reports with evaluations of compliance with fair lending and other consumer protection laws and regulations, and confers with other regulators for their supervisory views. The Board conducts analyses to understand the lending activities of the applicant and target institutions. • Mercantile Bank Corporation, Grand Rapids, to merge with Firstbank Corporation, Alma, and thereby indirectly acquire its subsidiary banks, Firstbank, Mount Pleasant, and Keystone Community Bank, Kalamazoo, all of Michigan, and an election by Mercantile Bank Corporation to become a financial holding company were approved in May. During 2014, the Board considered over 100 applications—with a range of topics from change in control notices, to branching requests, to mergers and acquisitions—with outstanding issues involving compliance with consumer protection statutes and regulations, including fair lending laws and the CRA. DCCA staff analyzed the following 14 unrelated notices and applications for transactions involving bank mergers and branching that involved adverse public comments on CRA issues or consumer compliance issues, such as fair lending, which the Board considered and approved:19 • Community & Southern Holdings, Inc., Atlanta, Georgia, to acquire Verity Capital Group, Inc. and thereby indirectly acquire its subsidiary bank, Verity Bank, both of Winder, Georgia, was approved in March. 18 19 The webinars were part of the “Ask the Fed” and “Consumer Compliance Outlook Live” series. For access to “Ask the Fed,” see https://bsr.stlouisfed.org/askthefed/public-users/login.aspx? ReturnUrl=%2faskthefed%2ffaq. For access to “Consumer Compliance Outlook Live,” see https:// consumercomplianceoutlook.org/outlook-live/. Related notices and applications for which a single Board Order was issued were counted as a single notice or application in this total. • Umpqua Holdings Corporation, Portland, Oregon, to merge with Sterling Financial Corporation and thereby acquire its subsidiary bank, Sterling Savings Bank, both of Spokane, Washington, was approved in April. • Old National Bancorp, Evansville, Indiana, to merge with Tower Financial Corporation and thereby indirectly acquire its subsidiary bank, Tower Bank and Trust Company, both of Fort Wayne, Indiana, was approved in April. • Cullen/Frost Bankers, Inc., San Antonio, Texas, (1) to merge with WNB Bancshares, Inc., and thereby acquire its subsidiary bank, Western National Bank, both of Odessa, Texas; (2) to have Cullen/Frost’s subsidiary state member bank, Frost Bank, San Antonio, merge with Western National Bank, with Frost Bank as the surviving entity; and (3) to have Frost Bank establish and operate branches at the main office and the branches of Western National Bank were approved in May. • MB Financial, Inc., Chicago, to merge with Taylor Capital Group, Inc., Rosemont, and thereby indirectly acquire its subsidiary bank, Cole Taylor Bank, Chicago, all of Illinois, was approved in July. • Old National Bancorp, Evansville, Indiana, to merge with United Bancorp, Inc., and thereby indirectly acquire its subsidiary bank, United Bank & Trust, both of Ann Arbor, Michigan, was approved in July. • Regions Bank, Birmingham, Alabama, to establish a branch in Kingwood, Texas, was approved in September. • First American Bank Corporation, Elk Grove Village, Illinois, to acquire Bank of Coral Gables, Coral Gables, Florida, was approved in November. Consumer and Community Affairs • Veritex Community Bank, a state member bank subsidiary of Veritex Holdings, Inc., both of Dallas, Texas, to establish a branch at 2700 Oak Lawn Avenue, Dallas, Texas, was approved in December. • ViewPoint Financial Group, Inc. to merge with LegacyTexas Group, Inc., and thereby acquire its subsidiary state member bank, LegacyTexas Bank, all of Plano, Texas; LegacyTexas Bank to merge with ViewPoint’s subsidiary bank, ViewPoint Bank, N.A., Plano, Texas, with LegacyTexas Bank as the surviving entity; and LegacyTexas Bank to establish and operate branches at the locations of the main office and the branches of ViewPoint Bank were approved in December. • Midland States Bancorp, Effingham, Illinois, to acquire by merger Love Savings Holding Company and its wholly owned subsidiary, Heartland Bank, FSB, both of St. Louis, Missouri; Midland States Bank, Midland’s subsidiary state member bank, also of Effingham, Illinois, to merge with Heartland Bank, with Midland Bank as the surviving entity; and Midland States Bank to establish and operate branches at the locations of Heartland Bank’s main office and branches were approved in December.20 • A notice by Southside Bancshares, Inc., Tyler, Texas, to acquire OmniAmerican Bancorp, Inc., and thereby indirectly acquire its subsidiary savings association, OmniAmerican Bank, both of Fort Worth, Texas, was approved in December. Coordination with the Consumer Financial Protection Bureau During 2014, staff continued to work through the implementation of the Interagency Memorandum of Understanding on Supervision Coordination with the CFPB. The agreement is intended to establish arrangements for coordination and cooperation among the CFPB and the OCC, the FDIC, the National Credit Union Association (NCUA), and the Board of Governors. The agreement strives to minimize unnecessary regulatory burden and to avoid unnecessary duplication of effort and conflicting supervisory directives amongst the prudential regulators. The regulators work cooperatively to share exam schedules for covered institutions and covered activities to plan simultaneous exams, provide final 20 An adverse comment was also received for a related notice under the Change in Bank Control Act of 1978, as amended, with respect to this transaction. The Board approved that notice in December. For access to notices under the Change in Bank Control Act, see www.federalreserve.gov/bankinforeg/ LegalInterpretations/bhc_changeincontrol2014.htm. 83 drafts of examination reports for comment, and share supervisory information. Coordination with Other Federal Banking Agencies The member agencies of the Federal Financial Institutions Examination Council (FFIEC) develop consistent examination principles, standards, procedures, and report formats.21 In 2014, the FFIEC member organizations continued to work together on various initiatives, including developing examination procedures that incorporate amendments to Regulations X (Real Estate Settlement Procedures Act [RESPA]) and Z (Truth in Lending Act [TILA]) issued by the CFPB in 2013 that integrate certain mortgage loan disclosures currently required under TILA and RESPA. Those amendments will be effective on August 1, 2015. Interagency Guidance on Home Equity Lines of Credit Nearing Their End-of-Draw Periods In July, the Board—along with the Conference of State Bank Supervisors, the FDIC, the NCUA, and the OCC—issued guidance to reiterate principles of sound risk management for home equity lines of credit (HELOCs) that have reached or will be reaching their end-of-draw periods.22 The guidance articulates the agencies’ expectation that supervised financial institutions will have adequate risk-management practices to monitor, manage, and control the risks in their HELOC portfolios as lines near their end-ofdraw periods as well as to promote compliance with applicable laws and regulations. In particular, this HELOC guidance describes risk-management practices that promote a clear understanding of potential exposures and help guide consistent, effective responses to HELOC borrowers who may be unable to meet contractual obligations at their end-of-draw periods. The guidance also highlights concepts related to financial reporting for HELOCs. Additionally, it reminds financial institutions that applicable consumer protection laws include, but are not limited to, the Equal Credit Opportunity Act, the Fair Hous21 22 The FFIEC is a formal interagency body empowered to prescribe uniform principles, standards, and report forms for the federal examination of financial institutions by the Board of Governors, the FDIC, the NCUA, the OCC, and the CFPB and to make recommendations to promote uniformity in the supervision of financial institutions. In 2006, the State Liaison Committee (SLC) was added to the council as a voting member. The SLC includes representatives from the Conference of State Bank Supervisors, the American Council of State Savings Supervisors, and the National Association of State Credit Union Supervisors. For more information, see www.federalreserve.gov/bankinforeg/ srletters/sr1405.htm. 84 101st Annual Report | 2014 ing Act, federal and state prohibitions against UDAP (such as section 5 of the Federal Trade Commission Act), RESPA, the Servicemembers Civil Relief Act, and TILA. In 2014, these courses were offered in 10 sessions, and training was delivered to a total of 175 System consumer compliance examiners and staff members and 12 state banking agency examiners. Interagency Guidance Regarding Unfair or Deceptive Credit Practices When appropriate, courses are delivered via alternative methods, such as online or other distancelearning technologies. For instance, several courses use a combination of instructional methods, including both classroom instruction focused on case studies and 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 2014, staff began migrating introductory content from a classroom-based training model to more online delivery, dedicating classroom time for examiners to apply their learning using case studies and reviewing loan files. In August, the Board—in conjunction with the CFPB, the FDIC, the NCUA, and the OCC—issued guidance regarding certain consumer credit practices.23 The guidance notes that prior to the DoddFrank Act, several rules prohibited banks, savings associations, and federal credit unions from engaging in certain credit practices. The Dodd–Frank Act repealed the rulemaking authority for these credit practices rules and, consequently, the Board, the OCC, and the NCUA are repealing those former rules. This guidance states the agencies’ view that the unfair or deceptive acts or practices described in these former credit practices rules, including those in the Board’s former Regulation AA, could violate the prohibition against unfair or deceptive acts or practices in section 5 of the Federal Trade Commission Act and title X of the Dodd-Frank Act, even in the absence of a specific regulation governing the conduct. Examiner Training Ensuring that financial institutions comply with laws that protect consumers and encourage community reinvestment is a fundamental aspect of the bank examination and supervision process. As the complexity of both consumer financial transactions and the regulatory landscape has increased, training for consumer compliance examiners has become more important than ever before. The division’s examiner training function is responsible for the ongoing development of the professional consumer compliance supervisory staff, from an initial introduction to the Federal Reserve System through the development of proficiency in consumer compliance topics sufficient to earn an examiner’s commission. DCCA’s role is to ensure that examiners have the skills necessary to meet their supervisory responsibilities now and in the future. Consumer Compliance Examiner Training Curriculum Outreach and Training: Dodd-Frank Act During 2014, the CFPB continued to promulgate new rules pursuant to the Dodd-Frank Act. Board and CFPB staff collaborated on examiner training and outreach to bankers. For instance, four Outlook Live webinars dedicated to the CFPB’s TILA/ RESPA Integrated Disclosures Rule, were broadcast beginning in June 2014 and continuing through November 2014. Other Outlook Live webinars covered issues ranging from general compliance management to specific fair lending and community reinvestment matters, for a total of nine compliance-related broadcasts in 2014.24 Ongoing Training Opportunities In addition to providing core examiner training, the examiner staff development function emphasizes the importance of continuing lifelong 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. The consumer compliance examiner training curriculum consists of five courses focused on consumer protection laws, regulations, and examining concepts. In 2014, the System continued to offer Rapid Response sessions. Introduced in 2008, this platform offers examiners one-hour teleconferences that 23 24 For more information, see www.federalreserve.gov/bankinforeg/ caletters/caltr1405.htm. For more information, see https://consumercomplianceoutlook .org/outlook-live/2014/consumer-compliance-hot-topics/. Consumer and Community Affairs explore emerging issues; provide urgent training to address the implementation of new laws, regulations, or supervisory guidance; and highlight case studies. Seven consumer compliance Rapid Response sessions were designed, developed, and presented to System staff during 2014. The sessions covered a broad range of topics including social media, flood insurance violations, and vendor management considerations. Table 1. Complaints against state member banks and selected nonbank subsidiaries of bank holding companies about regulated practices, by regulation/act, 2014 Regulation/act Regulation AA (Unfair or Deceptive Acts or Practices) Regulation B (Equal Credit Opportunity) Regulation BB (Community Reinvestment) Regulation CC (Expedited Funds Availability) Regulation D (Reserve Requirements) Regulation DD (Truth in Savings) Regulation E (Electronic Funds Transfers) Regulation H (National Flood Insurance Act/Insurance Sales) Regulation M (Consumer Leasing Act) Regulation P (Privacy of Consumer Financial Information) Regulation V (Fair and Accurate Credit Transactions) Regulation Z (Truth in Lending) Garnishment Rule Fair Credit Reporting Act Fair Debt Collection Practices Act Fair Housing Act Homeowners Protection Act Real Estate Settlement Procedures Act Servicemembers Civil Relief Act Total Responding to Consumer Complaints and Inquiries The Federal Reserve investigates complaints against state member banks and selected nonbank subsidiaries of BHCs (Federal Reserve regulated entities), and forwards complaints against other creditors and businesses to the appropriate enforcement agency. Each Reserve Bank investigates complaints against Federal Reserve regulated entities 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 intake of consumer complaints and inquiries. In 2014, FRCH processed 32,339 cases. Of these cases, more than half (19,179) were inquiries and the remainder (13,160) were complaints, with most cases received directly from consumers. Of the 13,160 complaints, FRCH referred 76 percent to other federal and state banking agencies in 2014. Approximately 5 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, most FRCH consumer contacts occurred by telephone (59 percent). Thirtyseven percent (12,118) of complaint and inquiry submissions were made electronically (via e-mail, online submissions, and fax), and the online form page received approximately 59,174 visits during the year. Complaint Referrals In 2014, the Federal Reserve forwarded 9,992 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 85 Number 5 25 2 71 4 50 51 9 1 18 18 86 1 158 54 18 5 28 6 610 Act.25 The Federal Reserve’s investigation of these complaints revealed one instance of illegal credit discrimination. Consumer Inquiries The Federal Reserve received over 19,000 consumer inquiries in 2014, 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 Complaints Complaints against Federal Reserve regulated entities totaled 3,159 in 2014. Approximately 42 percent (1,334) of these complaints were received by telephone, with 94 percent (1,254) of those requiring additional information from consumers to be provided in writing to enable investigation. Approximately six percent of the total complaints received in 2014 were still under investigation as of December 2014. Of the remaining complaints (1,412), 67 percent (1,215) involved unregulated practices and 33 percent (610) involved regulated practices. (Table 1 shows the breakdown of complaints about regulated 25 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. 86 101st Annual Report | 2014 Table 2. Complaints against state member banks and selected nonbank subsidiaries of bank holding companies about regulated practices, by product type, 2014 All complaints Complaints involving violations Subject of complaint/product type Number Total Discrimination alleged Real estate loans Credit cards Other loans Nondiscrimination complaints Checking accounts Real estate loans Credit cards Other 610 Percent 100 Number Percent 22 4 22 2 2 3.6 0.4 0.4 0 0 0 0 0 0 128 83 216 157 20.9 13.6 35.4 25.7 7 8 0 7 1.3 1.4 0 1.3 practices by regulation or act; table 2 shows complaints by product type.) plaints alleging discrimination based on a prohibited basis received in 2014, there were no violations. Complaints about Regulated Practices The majority of regulated practices complaints concerned checking accounts (21 percent), real estate (17 percent), and credit cards (36 percent).26 The most common checking account complaints related to funds availability not as expected (34 percent), insufficient funds/overdraft charges and procedures (19 percent), and alleged forgery/fraud/ embezzlement/theft (9 percent). The most common real estate complaints related to debt collection/ foreclosure concerns (14 percent); escrow problems (12 percent); and disputed rates, terms, and fees (8 percent). The most common credit card complaints related to inaccurate credit reporting (38 percent), bank debt-collection tactics (18 percent), billing error resolutions (8 percent), and payment errors/ delays (7 percent). In 86 percent of complaints against Federal Reserve regulated entities received in 2014, staff analysis revealed that institutions correctly handled the situation. Of the remaining 14 percent of investigated complaints, 4 percent were deemed violations of law; 4 percent were 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. Twenty-six regulated practices complaints alleging discrimination on the basis of prohibited borrower traits or rights were received in 2014.27 Nineteen discrimination complaints were related to the race, color, national origin, or ethnicity of the applicant or borrower. Seven discrimination complaints were related to either the age, handicap, familial status, or religion of the applicant or borrower. Of the com- 26 27 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. Complaints about Unregulated Practices The Board continued to monitor complaints about banking practices not subject to existing regulations. In 2014, the Board received 1,215 complaints against Federal Reserve regulated entities that involved these unregulated practices.28 The majority of the complaints were related to electronic transactions/prepaid products (30 percent), credit cards (20 percent), checking account activity (13 percent), real estate products (13 percent), and commercial loans/leases (6 percent). Consumer Laws and Regulations Throughout 2014, 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. 28 Examples of unregulated practices include (but are not limited to) customer service issues; allegations of forgery, embezzlement, or theft; policy or procedure concerns; issues with account opening and closing; and contractual issues that are not covered under existing federal banking regulations. Consumer and Community Affairs This includes drafting regulations and issuing interpretations and compliance guidance for the industry and the Reserve Banks. Proposed Flood Insurance Rule In October, the Board, along with the Farm Credit Administration, the FDIC, the NCUA, and the OCC jointly issued a proposed rule to amend regulations pertaining to loans secured by residential improved real estate or mobile homes located in special flood hazard areas.29 The proposed rule would implement provisions of the Homeowner Flood Insurance Affordability Act of 2014 (HFIAA) relating to escrowing flood insurance payments and the exemption of certain detached structures from the mandatory flood insurance purchase requirement. The HFIAA amends the escrow provisions of the Biggert-Waters Act. In accordance with the HFIAA, the proposed rule would require regulated lending institutions to escrow flood insurance premiums and fees for loans made, increased, extended, or renewed on or after January 1, 2016, unless the regulated lending institution or a loan qualifies for a statutory exception. In addition, for outstanding residential loans made before that date, the proposed rule would require institutions to provide borrowers the option to escrow flood insurance premiums and fees. To facilitate compliance, the agencies’ proposal includes new and revised sample notice forms and clauses concerning the escrow requirement and the option to escrow. Consistent with the HFIAA, the proposed rule would eliminate the legal requirement to purchase flood insurance for a structure that is a part of a residential property located in a special flood hazard area if that structure is detached from the primary residential structure and does not also serve as a residence. Under the HFIAA, however, lenders may nevertheless require the purchase of flood insurance for such structures to protect the value of the collateral securing the loan. In a separate rulemaking, the agencies will address other provisions of the Biggert-Waters Act for which the agencies have jurisdiction and that were not amended by the HFIAA. Repealing Rules Pursuant to the Dodd-Frank Act Under title X of the Dodd-Frank Act, rulemaking authority for a number of consumer financial protection laws was transferred from the Board to the CFPB, except with respect to certain motor vehicle dealers. In May 2014, the Board repealed its Regulation DD (Truth in Savings) and Regulation P (Privacy of Consumer Financial Information), which were superseded by substantially identical rules issued by the CFPB.30 At the same time, the Board issued final amendments to the Identity Theft Red Flags rule in Regulation V (Fair Credit Reporting), which require financial institutions and creditors to implement identity theft prevention programs and clarify that these provisions apply only to creditors that regularly extend credit or obtain consumer reports in the ordinary course of their business.31 In August, the Board issued a proposal to repeal its Regulation AA (Unfair or Deceptive Acts or Practices), which includes the Board’s “credit practices rule” that prohibits banks from using certain remedies to enforce consumer credit obligations and from including these remedies in their consumer credit contracts.32 The Dodd-Frank Act repealed the provision in the Federal Trade Commission Act that authorized the Board to issue rules addressing unfair or deceptive acts or practices by banks. Notwithstanding the repeal of the Board’s rulemaking authority, the Board continues to have enforcement authority under the Federal Trade Commission Act and the Dodd-Frank Act to prevent and remedy unfair or deceptive acts or practices by the institutions it supervises. Concurrent with the proposed repeal of Regulation AA, the Board, the CFPB, the FDIC, the NCUA, and the OCC issued interagency guidance clarifying that the unfair or deceptive practices described in the former credit practices rules, including those in Regulation AA, could violate the statutory prohibitions against unfair or deceptive practices, even in the absence of a specific regulation governing the conduct. 30 31 29 For more information, see www.federalreserve.gov/newsevents/ press/bcreg/20141024a.htm. 87 32 For more information, see www.federalreserve.gov/newsevents/ press/bcreg/20140522a.htm. The amendments to the Fair Credit Reporting Act were intended to narrow the scope of the law so that it would not be applied to professionals, such as doctors or lawyers, who sometimes allow consumers to delay payment. For more information, see www.federalreserve.gov/newsevents/ press/bcreg/bcreg20140822a.htm. 88 101st Annual Report | 2014 Consumer Research and Emerging-Issues and Policy Analysis duce a corresponding report summarizing the survey results. Throughout 2014, DCCA analyzed emerging issues in consumer financial services policies and practices in order to understand their implications for the market risk surveillance and supervisory policies that are core to the Federal Reserve’s functions, as well as to gain insight into consumer financial decisionmaking. In addition, results from DCCA’s newest survey in the financial services area—the Survey of Household Economics and Decisionmaking—were published in the Report on the Economic Well-Being of U.S. Households in 2013, released in August 2014. (See box 1 for details.) DCCA launched the survey to better understand consumer decisionmaking in the wake of the Great Recession. Researching Issues Affecting Consumers and Communities In 2014, DCCA explored various issues related to consumers and communities through convening experts, conducting original research, and fielding new and ongoing surveys. The information gleaned from these undertakings provided insights into the factors affecting consumers and households. Consumer Behavior Research Surveys In order to better understand consumer decisionmaking in the rapidly evolving financial services sector, DCCA periodically conducts Internet panel surveys to gather data on consumers’ experiences and perspectives on various issues of interest. With respect to ongoing surveys, DCCA conducted its annual survey of consumers’ use of, and opinions about, mobile financial services. Since 2011, the survey has polled more than 2,200 individuals each year to learn whether and how they use mobile devices for banking and payments. The survey was also 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 these surveys, conducted in the winter, are released each spring in the report Consumers and Mobile Financial Services. Results from the survey conducted in November 2013 were published in March 2014.33 For the fourth survey, conducted in December 2014, results will be published in March 2015. Given the rapid pace of developments in the mobile financial services market, DCCA plans to conduct another survey of consumers’ use of mobile financial services in the coming year and pro33 See Board of Governors of the Federal Reserve System (2014), Consumers and Mobile Financial Services 2014 (Washington: Board of Governors, March), www.federalreserve.gov/ econresdata/consumers-and-mobile-financial-services-report201403.pdf. Survey of Experiences and Perspectives of Young Workers In 2013, the Community Development staff at the Federal Reserve Board began exploring the experiences and expectations of young Americans entering the labor market. Staff reviewed existing research and engaged external research and policy experts to identify the potential economic implications of these labor market trends on young workers. This initial exploration raised several questions about the experiences of young workers that were not fully explained by existing data. In response, the Federal Reserve conducted the Survey of Young Workers in December 2013 to develop a deeper understanding of the forces at play. The online survey was intended to be exploratory—ultimately confirming some insights and highlighting areas worthy of additional study. The survey was administered via an Internet panel. The 2,097 survey respondents ranged in age from 18 to 30. In the Shadow of the Great Recession: Experiences and Perspectives of Young Workers was released in November 2014, with preliminary findings highlighted at a conference co-sponsored by the Federal Reserve Banks of Atlanta and Kansas City and Rutgers University’s John J. Heldrich Center for Workforce Development.34 The report summarizes insights from the Survey of Young Workers and frames policy and research issues for future consideration by the Federal Reserve Board. One of the major findings highlighted in the report is that many young adults remain optimistic about their job future and that respondents with higher levels of education and work experience are more likely to be optimistic than respondents who lack such skills and experiences. A second finding is that young workers are responding to the labor market’s increasing demand for postsec34 For more information on the event, see www.frbatlanta.org/ news/conferences/2014/141015-workforce-development.aspx and www.kc.frb.org/events/eventdetail.cfm?event= 7379EDCCC3274761D20CF8C1F7524B47. Consumer and Community Affairs Box 1. Shedding Light on Household Finances: Survey of Household Economics and Decisionmaking DCCA has been exploring knowledge gaps about consumer financial behavior, decisionmaking, and experiences following the Great Recession. The Survey of Household Economics and Decisionmaking (SHED) focuses on issues not sufficiently understood through external data and research or not already explored through other Federal Reserve resources, such as the Survey of Consumer Finances. The SHED includes questions about housing and living arrangements, credit access and behavior, education and student debt, savings, retirement, and medical expenses. The results of the September 2013 SHED survey are outlined in the Report on the Economic WellBeing of U.S. Households in 2013, released in July 2014.1 A second round of the survey was conducted in the fall of 2014, and a report on its findings will be published in summer 2015. Overall, the survey found that, as of September 2013, many households were faring well but that sizable fractions of the population were displaying some signs of financial stress: Lingering effects of the recession: Thirtyfour percent of individuals reported that they were worse off financially than they had been five years earlier in 2008, and 34 percent said that they were doing about the same. While over 60 percent of respondents indicated that their families were either “doing okay” or “living comfortably” financially, onefourth said that they were “just getting by” and another 13 percent said they were struggling to do so. Credit availability: While 31 percent of survey respondents had applied for some type of credit in the prior 12 months, one-third of those who applied for credit were turned down or given less credit than they applied for. Moreover, 15 percent of those who did not apply reported that they put off applying because they thought they would be turned down. Overall, 23 percent of respondents were either denied credit, offered less credit than they requested, or put off applying for fear of denial. Housing and mortgages: Many renters expressed an implied interest in homeownership, as the most 1 For the press release and publication, see www.federalreserve .gov/newsevents/press/other/20140807a.htm. common reasons for renting rather than owning a home were an inability to afford the down payment (45 percent) and an inability to qualify for a mortgage (29 percent). Overall, confidence in mortgage approval was mixed, with 53 percent of all respondents—including homeowners—indicating they were confident that they would be approved for a mortgage if they were to apply at the time of the survey. In contrast, 29 percent said they were not confident and 17 percent did not know whether they could obtain approval. Education debt: Twenty-four percent of the population held education debt for themselves or a family member, with 16 percent holding debt from their own education. Some individuals struggle to service this debt, with 18 percent of those with education debt indicating that they were behind on payments in some way, including 9 percent with loans in collections. The rate of being behind or in collections was far greater among those who failed to complete the program for which they borrowed money, and also varied by type of institution attended. Emergency savings: Many respondents indicated a lack of preparedness for financial emergencies. When asked how they would pay for a theoretical emergency expense of $400, less than half of respondents said that they would completely pay it using cash or a credit card that they pay in full, while 19 percent indicated they could not pay the expense and 33 percent would pay the expense by borrowing or selling something. Over two-fifths of respondents are ill-prepared for a loss of their main source of income and could not cover expenses for three months even by borrowing money, using savings, selling assets, or borrowing from friends or family. Retirement planning: The survey results suggest that many individuals are not adequately prepared for retirement. Thirty-one percent of non-retired respondents reported having no retirement savings or pension, including 19 percent of those ages 55 to 64. Retirement plans for many individuals at or near retirement were also altered by the Great Recession. Two-fifths of those over age 45 who had not yet retired said that they pushed back the planned date of retirement because of the recession, and 15 percent of those who had retired since 2008 reported that they retired earlier than planned due to the recession. 89 90 101st Annual Report | 2014 ondary credentials and degrees. A third finding is that intangibles still play an important role and that finding a job is still heavily based on personal connections. Lastly, the survey found that young workers value job stability, and when given the choice, respondents generally preferred steady employment (67 percent) to higher pay (30 percent). 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, analyze, and anticipate trends; lead Division-wide issues working groups; and organize expert roundtables to identify emerging risks and inform policy recommendations. In 2014, the Policy Analysis team contributed analyses on a broad range of policy issues—from recent trends in auto lending, to the impact on consumers of student loan debt, to the implications of mobile banking, to existing and emerging credit products for small businesses, and to challenges facing certain segments of consumers. New mortgage rules took effect at the beginning of the year and Policy staff, together with colleagues at the Board and in the Federal Reserve Banks, continued to closely monitor the availability of mortgage credit and the impact on local housing markets, neighborhoods, and potential homebuyers. Impact of Resets on Home Equity Lines of Credit and Mortgage Interest Rates In 2014, the first wave of interest-rate resets occurred on HELOCs, interest-only (I-O) loans, and loans in the Home Affordable Modification Program (HAMP) program. These resets could result in payment shock for millions of homeowners, depending on their FICO scores and other debts. About one-quarter, or 2.5 million, of the more than 10 million HELOCs outstanding are expected to reach their end-of-draw periods and convert to amortizing loans by the end of 2017, with the average payment estimated to rise by $250 per month. In response, some large banks have implemented HELOC-assistance programs to borrowers in need of flexible payment arrangements. Also, many of the I-O mortgages, which were in wide use during the height of the lending bubble in 2007 and put borrowers into homes with artificially low mortgage payments for an initial period, are beginning to reset to payments that reflect full amortization. Payment increases, in some cases, may be significant. Meanwhile, the first loan modifications made under the government’s HAMP program are reaching their five-year mark, after which interest rates will increase up to 1 percent per year until they adjust to the market rate at the time of their modification. HAMP modifications will continue to enter this multiyear reset process with completion expected by 2021. The Policy Analysis team participated in an interagency regulatory conference on mortgage resets with researchers and examiners working on the topic. Assistance also was provided for interagency guidance on mortgage resets to ensure that, in addition to bank safety and soundness considerations, consumers will be provided with adequate notice to prepare for the increases and that concerns on the part of affected borrowers will be addressed.35 Trends in Auto Lending The Policy team continued to monitor developments in auto lending. While Federal Reserve research shows a solid recovery of the auto market post-crisis and growth in auto loan originations, concerns have been raised that increased lending to below-prime borrowers, high-cost loans, and longer loan terms could result in financial hardship for households struggling with living expenses. In August, Policy Analysis staff held a forum for Federal Reserve System staff to discuss their research to assess current auto market conditions and loan performance data, with a particular focus on the subprime sector, and explore any potential risk areas and consumer harms. Staff also engaged with industry representatives and consumer groups who also attended to share their perspectives about certain auto lending practices and the implications for consumers. The dialogue provided an opportunity for staff and external experts to exchange views about the future state of auto financing and to identify areas where additional data and analysis would be useful to better monitor market and lending conditions affecting the availability of and access to affordable auto loan products. 35 For more information, see www.federalreserve.gov/bankinforeg/ srletters/sr1405.htm. Consumer and Community Affairs The Evolving Small Business–Bank Relationship The Federal Reserve System has typically concentrated its small business–related activities around the study of credit conditions and the impact of a strong business climate on community and economic development. Less understood is the overall impact of a changing financial landscape on the small business customer and existing banking business models. In the past, small business banking has been considered largely “relationship banking.” Recent trends, however, suggest that small businesses engage in a more complex web of relationships among competing financial service providers. A vast array of nonbank service providers has cropped up to help small businesses manage various aspects of their banking and payments processes, including deposits, debit and credit card payments, Treasury services, remote deposit, payroll, automated clearinghouse (ACH), and wire services. Likewise, online alternative lenders have developed innovative technologies to underwrite and originate loans and now offer short-term loan products aimed at filling small businesses’ smalldollar needs. Among these new players are peer-topeer lenders, direct loan providers, and payment processing firms making forays into cash-advance lending. Consequently, competition and new technologies are altering the conventional concept of small business relationship banking. The Policy team convened a working session for staff from throughout the Federal Reserve System—including the community development, research, regional economics, consumer compliance, and operations functions—who are concerned with small business issues. Internal and external experts presented research on current trends in traditional and online small business banking. The session was aimed at exploring how small business–bank relationships are developed and maintained in an environment of technological change, the growth of nonbank service providers, and the resulting impact on traditional bank business models and small businesses. To supplement small business research being conducted throughout the Federal Reserve System, the Policy team commissioned two research studies from outside organizations. One, a survey of 60 community bank CEOs, found that banks recognize that their small business customers are savvier today than in the past when it comes to assessing their banking needs and options. The survey also found that banks appear to have the desire and liquidity to lend, but 91 are becoming more conservative in their underwriting for small business borrowers. The second study, an online focus group of 22 small business borrowers, examined small businesses’ awareness, perceptions, and understanding of short-term, small-dollar online loan products. The study revealed that small businesses find it difficult to compare and evaluate the costs and benefits of various online small-dollar products. Potential borrowers also expressed concerns about safeguards to protect their personal and business information were they to borrow funds from these online sources. Community Development The Federal Reserve System’s Community Development function promotes economic growth and financial stability for LMI communities and individuals through a range of activities: convening stakeholders, conducting and sharing research, and identifying emerging issues (see box 2 for more information). 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 to promote and coordinate Systemwide priorities. Exploring New Sources of Community Development Finance One of the responsibilities of the Federal Reserve’s Community Development function is to research the sources of community development finance for underserved communities and work with stakeholders to improve the supply and delivery of these funds. Historically, the Federal Reserve’s interest in these funding sources has mainly included the more traditional sources, such as government funding, foundations, Community Development Financial Institutions, and CRA-motivated bank investments. All of these remain critical sources of funding, but many of these have also been shrinking in recent years. Therefore, the Board’s Community Development team has begun to investigate how new and innovative sources of funding could be used to finance community development and small business. A key part of this expansion is technology, which is changing fundraising and investment and has the potential to streamline and scale community development transactions. In March 2014, the Board’s Community Development team hosted a small group of community devel- 92 101st Annual Report | 2014 Box 2. How Does the Fed Promote Effective Community Development? The Federal Reserve understands that stable communities promote stable regions and a more robust economy overall. Staff in the Community Development function at the Board and all 12 Reserve Banks engage in applied research, public programs, outreach, and technical assistance in order to help promote economic growth and financial stability in communities across the country, especially low- and moderate-income areas. The System’s commitment to community development is captured in the Community Development Perspectives report, which represents its various opment and technology thought leaders for a discussion on the challenges and opportunities presented by crowdfunding investment as a significant new source of capital for the community development industry. The event was also live-streamed on the Board’s website and set the groundwork for these two otherwise divergent fields to facilitate a functional, fair, and prosperous crowdfunding market for community development. In September 2014, the Board hosted a meeting entitled “Family Philanthropy and Impact Investing,” and brought together staff and trustees from family foundations, family offices, advisors, and other thought leaders to discuss the increasing demand for family foundations to engage in impact investing. In October 2014, the Board hosted a targeted meeting for online community development platforms. The meeting brought together practitioners that were either currently operating, or seriously investing in the development of, online platforms that facilitate community development transactions. The meeting was structured as a peer-to-peer interaction and focused on identifying the current landscape of community development online platforms, common barriers and challenges, best practices, and opportunities for collaboration. These three meetings, in addition to dozens of other conversations and meetings, have greatly expanded the Board’s knowledge of potential new sources of community development finance, and helped to connect the various stakeholders in this field. points of engagement in this work around the country. Released in conjunction with the FedCommunities.org site launch, this report includes brief summaries of Community Development’s work in its strategic focal points of people, place, the policy and practice of community development, and small business. Within each of these focus areas, the report includes background information that helps to provide context for this work; a sampling of key research, outreach programs, and other initiatives; and some ideas on future challenges, needs, and opportunities. Read the interactive report at www.fedcommunities.org. Expanding Access to Information on System Community Development Activities In 2012, the Federal Reserve’s Community Development function conducted an environmental scan to assess community development needs around the country. One of the key findings from this process was that Community Development staff could improve their efforts to share the wide array of resources with the public and System colleagues alike in a more systematic and user-friendly way. As a result, the FedCommunities.org web portal was created to improve the awareness of, and access to, Federal Reserve community development resources by providing users with a single, web-based entry point. Resources are organized according to the System’s strategic focus areas supporting people, place, the policy and practice of community development, and small business.36 Launched in June 2014, FedCommunities.org functions as a referral site, in that it aggregates information on relevant, timely community development resources from all 12 Reserve Banks and the Board of Governors in a centralized spot. Users are then redirected to specific Reserve Bank websites for access to the materials themselves, and for additional content. In its first quarter of operation, FedCommunities.org drew 12,840 page views for the approximately 350 resources it hosted from across the Federal Reserve System. The site offers four key features: 36 To access the site, see www.fedcommunities.org. Consumer and Community Affairs • Resources are easy to locate and are organized by two key pieces of information: topic/community development content and type of resource (e.g., national and local data, speeches, publications, etc.). • A robust search feature helps users locate resources, either by specific criteria or general interest categories. • Users can sign up to be notified of new content according to preference criteria that they select. • Content is populated regularly to keep the site fresh and current. 93 95 6 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 sections 2 through 4 of this annual report). Federal Reserve Priced Services Reserve Banks provide a range of payment and related services to depository and certain other institutions; these “priced services” include collecting checks, operating an automated clearinghouse (ACH) service, transferring funds and securities, and providing a multilateral settlement service.1 The Reserve Banks, working with the financial services 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; the Reserve Banks offer a bundle of all-electronic payment services and offer information and riskmanagement 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. In 2014, the Reserve Banks continued efforts to migrate the FedACH, Fedwire Funds, and Fedwire Securities services from a mainframe system to a distributed computing environment. A significant mile- stone was reached by successfully migrating the Fedwire Funds Settlement application and the Reserve Banks’ accounting system to a distributed environment. The Reserve Banks continued to make progress on the migration of the Fedwire Securities applications. However, after conducting an assessment of the viability and cost-effectiveness of the FedACH program, the Reserve Banks suspended the initiative and began to investigate the use of other technology solutions. In October 2014, the Federal Reserve Board announced final revisions to part I of the Federal Reserve Policy on Payment System Risk (PSR policy) that are based on and generally consistent with the international risk-management standards in the April 2012 Principles for Financial Market Infrastructures developed jointly by the Committee on Payment and Settlement Systems and the International Organization of Securities Commissions.2 The revised policy retains the expectation that the Fedwire Funds Service and the Fedwire Securities Service will meet or exceed the applicable risk-management standards in the policy. The final policy became effective on December 31, 2014. In December 2014, the Federal Reserve Board adopted changes to part II of the PSR policy and companion amendments to Regulation J (Collection of Checks and Other Items by Federal Reserve Banks and Funds Transfers through Fedwire) that were designed to enhance the efficiency of the payment system. The changes are largely related to the posting rules for ACH and commercial check transactions.3 Under the current posting rules for commercial and government ACH transactions, ACH debit transactions post at 11:00 a.m., and ACH credit transactions 2 1 The ACH enables depository institutions and their customers to process large volumes of payments effectively through electronic batch processes. 3 Effective September 1, 2014, the Committee on Payment and Settlement Systems changed its name to Committee on Payments and Market Infrastructures. 12 CFR part 210. 96 101st Annual Report | 2014 Table 1. Priced services cost recovery, 2005–14 Millions of dollars, except as noted Year 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2005–14 Revenue from services1 Operating expenses and imputed costs2 Targeted return on equity3 Total costs Cost recovery (percent)4 993.8 1,029.7 1,012.3 873.8 675.4 574.7 478.6 449.8 441.3 433.1 6,962.4 834.4 874.8 912.9 820.4 707.5 532.8 444.4 423.0 409.3 418.7 6,378.3 103.0 72.0 80.4 66.5 19.9 13.1 16.8 8.9 4.2 5.5 390.3 937.4 946.8 993.3 886.9 727.5 545.9 461.2 432.0 413.5 424.1 6,768.6 106.0 108.8 101.9 98.5 92.8 105.3 103.8 104.1 106.7 102.1 102.9 Note: Here and elsewhere in this section, components may not sum to totals or yield percentages shown because of rounding. 1 For the 10-year period, includes revenue from services of $6,491.6 million and other income and expense (net) of $470.8 million. 2 For the 10-year period, includes operating expenses of $6,079.4 million, imputed costs of $34.5 million, and imputed income taxes of $264.5 million. 3 From 2009 to 2012, the PSAF was adjusted to reflect the actual clearing balance levels maintained; previously, the PSAF had been calculated based on a projection of clearing balance levels. 4 Revenue from services divided by total costs. For the 10-year period, cost recovery is 95.1 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 3 to the “Pro Forma Financial Statements for Federal Reserve Priced Services” at the end of this section. post at 8:30 a.m.4 The Board changed the posting of ACH debit transactions to 8:30 a.m. to align with the posting time of ACH credit transactions. In addition, the Board’s current posting rules for commercial check transactions reflect a presumption that banks generally handle checks in paper form and do not reflect banks’ widespread use of electronic check-processing methods. To reflect the current electronic check-processing environment, the Board changed the posting time for receiving most credits for deposits and debits for presentments to 8:30 a.m. and established two other posting times at 1:00 p.m. and 5:30 p.m. The amendments to Regulation J permit the Reserve Banks to obtain settlement from paying banks as early as 8:30 a.m. for checks that the Reserve Banks present. The amendments also permit the Reserve Banks to require paying banks that receive presentment of checks from the Reserve Banks to make the proceeds of settlement for those checks available to the Reserve Banks as soon as 30 minutes after receipt of the checks. These changes to the PSR policy and Regulation J become effective July 23, 2015. 4 All times are eastern time unless otherwise specified. Recovery of Direct and Indirect Costs The Monetary Control Act of 1980 requires that the Federal Reserve establish fees for priced services 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.5 The imputed costs and imputed profit are collectively referred to as the private-sector adjustment factor (PSAF). From 2005 through 2014, the Reserve Banks recovered 102.9 percent of the total priced services costs, including the PSAF (see table 1).6 5 6 Pub. Law No. 96-221, March 31, 1980. Financial data reported throughout this section—including revenue, other income, costs, income before taxes, and net income—will reference the “Pro Forma Financial Statements for Federal Reserve Priced Services” at the end of this section. According to the Accounting Standards Codification (ASC) Topic 715 (ASC 715), Compensation–Retirement Benefits, the Reserve Banks recognized a $549.7 million reduction in equity related to the priced services’ benefit plans through 2014. Including this reduction in equity, which represents a decline in economic value, results in cost recovery of 95.1 percent for the 10-year period. For details on how implementing ASC 715 affected the pro forma financial statements, refer to note 3 to the pro forma financial statements at the end of this section. Federal Reserve Banks 97 Table 2. Activity in Federal Reserve priced services, 2012–14 Thousands of items Percent change Service Commercial check Commercial ACH Fedwire funds transfer National settlement Fedwire securities 2014 5,741,527 11,620,376 138,133 597 4578 2013 5,988,302 11,142,821 137,219 661 6,535 2012 6,622,265 10,664,613 134,409 663 6,441 2013 to 2014 2012 to 2013 -4.1 4.3 0.7 -9.7 -30.0 -9.6 4.5 2.1 -0.3 1.5 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. In 2014, Reserve Banks recovered 102.1 percent of the total priced services costs, including the PSAF.7 The Reserve Banks’ operating expenses and imputed costs totaled $418.7 million. Revenue from operations totaled $433.1 million, resulting in net income from priced services of $14.5 million. Although the check service, the Fedwire Funds and National Settlement Services, and the Fedwire Securities Service achieved full cost recovery, the FedACH Service recovered 86.7 percent of its costs because of a $31.6 million charge associated with the decision to suspend its investment in a multiyear technology initiative to modernize its processing platform. Greaterthan-expected check volume processed by the Reserve Banks was the single most significant factor influencing priced services cost recovery. Commercial Automated Clearinghouse Service The Reserve Banks’ long-run cost recovery average from 2005 to 2014 for FedACH was 100.0 percent. In 2014, the Reserve Banks recovered 86.7 percent of the total costs of their commercial ACH services, including the related PSAF. Revenue from ACH operations totaled $124.4 million, an increase of $5.5 million from 2013. Reserve Bank operating expenses and imputed costs totaled $141.4 million, resulting in a net loss of $17.0 million. In 2014, the Reserve Banks processed 11.6 billion commercial ACH transactions, an increase of 4.3 percent from 2013. The average daily value of FedACH transfers in 2014 was approximately $79.2 billion, an increase of 1.0 percent from the previous year. Commercial Check-Collection Service In 2014, Reserve Banks recovered 115.6 percent of the total costs of their commercial check-collection service, including the related PSAF. Revenue from operations totaled $174.7 million, resulting in net income of $25.4 million. This revenue decreased $24.1 million from 2013. The Reserve Banks’ operating expenses and imputed costs totaled $149.3 million. Reserve Banks handled 5.7 billion checks in 2014, a decrease of 4.1 percent from 2013 (see table 2). The decline in Reserve Bank check volume, attributable to the decline in the number of checks written generally, was not as great as anticipated and led to the resulting net income. The average daily value of checks collected by the Reserve Banks in 2014 was approximately $32.3 billion, an increase of 1.9 percent from the previous year. 7 Total cost is the sum of operating expenses, imputed costs (income taxes, interest on debt, interest on float, and sales taxes), and the targeted return on equity. Fedwire Funds and National Settlement Services In 2014, Reserve Banks recovered 103.2 percent of the costs of their Fedwire Funds and National Settlement Services, including the PSAF. Reserve Bank operating expenses and imputed costs for these operations totaled $105.2 million in 2014. Revenue from these services totaled $110.1 million, resulting in a net income of $4.8 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 2014, the number of Fedwire funds transfers originated by depository institutions increased 0.7 percent from 2013, to approximately 138 million. The average daily value of Fedwire funds transfers in 2014 was $3.5 trillion, an increase of 24 percent from the previous year. 98 101st Annual Report | 2014 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 2014, the service processed settlement files for 17 local and national private-sector arrangements. The Reserve Banks processed 9,896 files that contained 569,502 settlement entries for these arrangements in 2014. Activity in 2014 represents a decrease from the 661,466 settlement entries processed in 2013. Fedwire Securities Service The Fedwire Securities Service allows its participants to transfer electronically to other service participants certain securities issued by the U.S. Treasury Department, federal government agencies, governmentsponsored enterprises (GSEs), and certain international organizations.8 In 2014, the number of nonTreasury securities transfers processed via the service decreased 30.0 percent from 2013, to approximately 9.4 million. The average daily value of Fedwire Securities transfers in 2014 was $1.1 trillion, a decrease of 3 percent from the previous year. The Reserve Banks recovered 104.1 percent of the total costs of the priced-service component of their Fedwire Securities Service, including the PSAF. The Reserve Banks’ operating expenses and imputed costs for providing this service totaled $22.7 million in 2014. Revenue from the service totaled $24.0 million, resulting in a net income of $1.2 million. Float In 2014, the Reserve Banks had daily average credit float of $590.8 million, compared with daily average credit float of $630.2 million in 2013.9 Currency and Coin The Board is the issuing authority for the nation’s currency (in the form of Federal Reserve notes). In 2014, the Board paid the U.S. Treasury Department’s Bureau of Engraving and Printing (BEP) $656.8 million for costs associated with the production of 6.9 billion Federal Reserve notes. The Reserve Banks distribute and receive currency and coin through depository institutions in response to public demand. Together, the Board and Reserve Banks work to maintain the integrity of and confidence in Federal Reserve notes. In 2014, the Reserve Banks distributed 37.6 billion Federal Reserve notes into circulation, a 0.6 percent increase from 2013, and received 35.7 billion Federal Reserve notes from circulation, a 0.2 percent decrease from 2013. The value of Federal Reserve notes in circulation increased nearly 8.4 percent in 2014, to $1,298.7 billion at year-end, largely because of international demand for $100 notes. In 2014, the Reserve Banks also distributed 69.4 billion coins into circulation, a 1.7 percent increase from 2013, and received 55.4 billion coins from circulation, a 2.5 percent decrease from 2013. Redesigned $100 Note The Federal Reserve began supplying financial institutions with a redesigned $100 note on October 8, 2013. The Federal Reserve, U.S. Department of the Treasury, the BEP, and the U.S. Secret Service partner to redesign Federal Reserve notes to stay ahead of counterfeiting threats. During 2014, the Federal Reserve Banks distributed 3.6 billion redesigned $100 notes and replaced nearly 30 percent of all $100 notes in circulation with the redesigned $100 note. Improvements to Efficiency and Risk Management 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” later in this section. 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). Advances in currency-processing equipment and sensor technology 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. In 2014, Reserve Banks installed a new type of fitness sensor and began installing a new type of authentication sensor. Additionally, the Reserve Banks continue working with equipment manufacturers to explore the next generation of equipment to process the high volume of Federal Reserve Banks 99 notes received annually for authentication and fitness sorting. inspection,” should reduce spoilage rates and printing costs. During 2014, some Reserve Banks began implementing new processes designed to increase productivity and enhance risk management, which all Reserve Banks will implement in 2015. Fiscal Agency and Government Depository Services 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 more cost effectively. The new platform will also facilitate business continuity and contingency planning and enhance the support provided to Reserve Bank customers. In 2014, the Reserve Banks continued application development and testing efforts for the new automation platform, which is scheduled to be deployed to all cash offices by year-end 2017. The Board and the BEP continued implementing components of a new quality system for the BEP throughout 2014. The BEP installed and began using sorting equipment that culls good notes from rejected half sheets. This process, known as “single note As fiscal agents and depositories for the federal government, the 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 depository services to other entities; these services are primarily related to book-entry securities. Treasury and other entities fully reimburse the Reserve Banks for the expense of providing fiscal agency and depository services. In 2014, fiscal agency expenses amounted to $569.6 million, a 7.5 percent increase from 2013 (see table 3). Expenses increased as a result of requests from Treasury’s Bureau of the Fiscal Service (Fiscal Service). Support for Treasury programs accounted for 93.9 percent of expenses, and support for other entities accounted for 6.1 percent. Table 3. Expenses of the Federal Reserve Banks for fiscal agency and depository services, 2012–14 Thousands of dollars Agency and service 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 2014 2013 2012 54,966 16,568 29,499 5,792 853 107,678 55,334 14,397 26,673 5,801 2,971 105,176 60,208 14,131 30,648 4,990 3,340 113,317 161,629 54,355 75,878 79,289 11,465 382,615 151,715 44,788 66,519 75,565 9,360 347,947 141,534 41,456 58,975 70,075 9,075 321,115 44,756 535,049 42,826 495,949 37,011 471,443 34,588 569,638 34,077 530,026 34,569 506,012 Note: The decrease in “Treasury Securities Services: Other Services” is due to the reclassification of programs into “Treasury Securities Services: Treasury Retail Securities.” 100 101st Annual Report | 2014 In April 2014, as part of the federal government’s effort to increase operational efficiency and effectiveness, Treasury announced the consolidation of the fiscal agency services provided by the Reserve Banks. Although Treasury expects long-term savings by reducing the number of Reserve Banks that provide fiscal agency services, an increase in expenses is projected during the consolidation process. Select Reserve Bank business lines began transitioning in 2014 and the consolidation is expected to conclude in 2018. Total consolidation expenses for 2014 amounted to $27.3 million. Consolidation expenses are included in the line items for Payment, Collection, and Cash-management services in table 3. Of the consolidation expenses, $6.7 million is attributable to pension costs incurred by exiting Reserve Banks. Treasury Securities Services The Reserve Banks work closely with Treasury’s Fiscal Service in support of the borrowing needs of the federal government. The Reserve 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. Retail Securities Programs Reserve Bank operating expenses for the retail securities programs were $55.0 million in 2014, a 0.7 percent decrease compared with $55.3 million in 2013. Increased operational efficiencies in retail securities resulted in lower staffing levels and led to an overall decrease in expenses. Throughout the year, Reserve Banks and Treasury continued work on Treasury’s Retail E-Services initiative to create a new customer service and support environment. Reserve Banks also engaged in an ongoing effort to decommission the Legacy Treasury Direct system—established in 1986 as an application for investors to hold Treasury marketable securities (bills, notes, bonds, and Treasury Inflation-Protected Securities)—in order to eliminate aging technology platforms. Wholesale Securities Programs The Reserve Banks support wholesale securities programs through the sale, issuance, safekeeping, and transfer of marketable Treasury securities for institutional investors. The Reserve Banks conducted 270 Treasury securities auctions in 2014. Of the 270 auctions, 12 auctions were for Floating Rate Notes—a new marketable Treasury security with a floating rate interest payment. Floating Rate Notes are the first new Treasury security issued since the introduction of Treasury Inflation-Protected Securities almost two decades ago. In 2014, Reserve Bank operating expenses in support of Treasury securities auctions were $29.5 million, compared with $26.7 million in 2013. This increase was driven by upgrades to the auction system, which receives and processes bids submitted primarily by wholesale security auction participants. Operating expenses associated with Treasury securities safekeeping and transfer activities were $16.6 million in 2014, compared with $14.4 million in 2013. The increase is attributable to the Reserve Banks’ ongoing technological effort to migrate securities services from a mainframe system to a distributed computing environment. Payment Services The Reserve Banks work closely with the Treasury’s Fiscal Service and other government agencies to process payments to individuals and companies. The Reserve 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 $161.6 million in 2014, compared with $151.7 million in 2013. Total paymentsrelated operating expenses in 2014 included $17.0 million in consolidation expenses. The increase in 2014 expenses was due to a combination of consolidation costs and increased programmatic expenses associated with the Invoice Processing Platform (IPP), the Post Payment System (PPS) initiative, Do Not Pay (DNP), and International Treasury Services (ITS). These expense increases were partly offset by lower expenses for the U.S. Treasury Electronic Payment Solution Center (formerly known as the Go Direct Contact Center). The IPP is part of Treasury’s all-electronic initiative—an electronic invoicing and payment information system that allows vendors to enter invoice data electronically, either through a web-based portal or Federal Reserve Banks electronic submission. The IPP accepts, processes, and presents data from agencies and supplier systems related to all stages of a payment transaction, including the purchase order, invoice, and other payment information. In 2014, the Reserve Banks’ IPP expenses increased 42.0 percent, to $24.6 million. This increase was primarily attributable to $5.3 million in consolidation expenses. Additional program expenses were incurred to increase staffing levels in support of a Department of Defense mandate to implement IPP for intragovernmental transactions, as well as to provide support for broader agency participation and greater invoice volumes. Reserve Banks continued work on the PPS initiative, a multiyear effort to modernize several of Treasury’s legacy post-payment processing systems into a single application to provide a centralized and standardized set of payment data, enhance operations, reduce expenses, and improve data analytics capabilities. In 2014, program expenses for PPS increased 248.4 percent, from $4.9 million to $17.0 million, as the result of greater system development expenses and $3.9 million in consolidation expenses. In support of Treasury’s DNP initiative, the Reserve Banks continued to enhance the DNP Portal, which is a single point of access through which federal agencies can query multiple data sources before making federal payments. In 2014, expenses for DNP increased 10.8 percent to $15.4 million, largely because of additional staffing necessary to support application development, advanced analytics, and new data source purchases. The Reserve Banks operate the ITS application, which provides cross-border payment and collection services as well as cash-management functions on behalf of the Treasury. U.S. government agencies use ITS to issue international benefit, payroll, and vendor payments in 100 currencies to recipients in established and emerging markets. ITS expenses increased 24.3 percent, to $17.9 million, in 2014 primarily because of $3.7 million in consolidation costs. The Treasury’s 2014 payments-related expenses were offset by lower spending for the U.S. Treasury Electronic Payment Solution Center, which helps convert individuals’ federal benefit payments from paper check to electronic delivery. As of December 2014, 97.8 percent of all federal benefit payments were made electronically. In 2014, expenses for the U.S. Treasury Electronic Payment Solution Center 101 decreased 31.3 percent, to $16.4 million, primarily because of a reduction in enrollment calls that followed the end of the Go Direct Campaign. Collection Services The Reserve Banks also work closely with the Fiscal Service to collect funds owed to the federal government, including various taxes, fees for goods and services, and delinquent debts. In 2014, Reserve Bank operating expenses related to collection services increased 21.4 percent to $54.4 million, largely because of $3.7 million in consolidation expenses and increased operating expenses for Pay.gov and eCommerce. The Reserve Banks operate Pay.gov, an application 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 100 new agency programs and processed more than 123 million online payments totaling $144 billion, a 9 percent and a 20 percent increase, respectively, from 2013. Increased operational support and expanded functionality resulted in expenses increasing 18.2 percent, to $18.3 million. The Reserve Banks also continued supporting the Treasury’s electronic commerce initiative (eCommerce) to expand ways for agencies and the public to do business with the Treasury through online banking solutions, mobile technologies, and other payment methods. Program expenses for eCommerce increased from $156,000 in 2013 to $1.6 million in 2014, largely because of expenses associated with developing a new mobile payment platform that will facilitate more-efficient federal revenue collections. 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 2014, Reserve Bank operating expenses related to Treasury cashmanagement services totaled $75.9 million, compared with $66.5 million in 2013. Total cash-managementrelated operating expenses for 2014 included $6.0 million in consolidation expenses. 102 101st Annual Report | 2014 During 2014, the Reserve Banks continued to support Treasury’s efforts to improve centralized government accounting and reporting functions. In particular, the Reserve Banks, in collaboration with the Fiscal Service, completed software development efforts for the Central Accounting Reporting System (CARS). CARS will provide Treasury with a modernized system for the collection and dissemination of financial management and accounting information transmitted by and to federal program agencies. In 2014, expenses for CARS decreased to $18.6 million, from $26.6 million in 2013, primarily because of decreased application development expenses. Figure 1. Aggregate daylight overdrafts, 2007–14 Billions of dollars 200 Peak daylight overdrafts Average daylight overdrafts 160 120 80 40 0 2007 2008 2009 2010 2011 2012 2013 2014 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. Reserve Bank operating expenses for services provided to other entities were $34.6 million in 2014, compared with $34.1 million in 2013. 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 (Freddie Mac), the Federal National Mortgage Association (Fannie Mae), and the Government National Mortgage Association (Ginnie Mae). Use of Federal Reserve Intraday Credit The Board’s 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 the 2007–09 financial crisis, 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 around $60 billion. In contrast, institutions held historically high levels of overnight balances—on average more than $2.7 trillion—at the Reserve Banks in 2014, while daylight overdrafts remained historically low. Average daylight overdrafts across the Federal Reserve System declined to $1.62 billion in 2014 from $1.9 billion in 2013, a decrease of about 17 percent (see figure 1). The average level of peak daylight overdrafts fell to $8.44 billion in 2014 from $12 billion in 2013; the average level of peak daylight overdrafts in 2014 was just a fraction of its level in 2008 (about 5 percent). Daylight overdraft fees are also at historically low levels. In 2014, institutions paid about $31,000 in daylight overdraft fees; in contrast, fees totaled more than $50 million in 2008. The decrease in fees is largely attributable to the elevated level of reserve balances that began to accumulate in late 2008 and to the March 2011 policy revision that eliminated fees for collateralized daylight overdrafts. FedLine Access to Reserve Bank Services The Reserve Banks’ FedLine access solutions provide depository institutions with a variety of alternatives for electronically accessing the Banks’ payment and information services. The Reserve Banks charge fees for these electronic connections and allocate the associated costs and revenue to the various priced services. There are currently five FedLine channels through which customers can access the Reserve Banks’ priced services: FedMail, FedLine Web, FedLine Advantage, FedLine Command, and FedLine Federal Reserve Banks Direct. These FedLine channels are designed to meet the individual connectivity, security, and contingency requirements of depository institution customers. Between 2007 and 2014, the number of depository institutions in the United States declined 22.2 percent, and Reserve Bank FedLine connections decreased 11.7 percent. During this same period, the number of employees within depository institutions who have FedLine credentials increased 11.6 percent, reflecting in part the expansion of value-added services provided. Additionally, the FedLine network was broadened to nonfinancial services. Between 2012 and 2014, more than 10,000 credentials were issued to individuals accessing central bank applications via FedLine. The Reserve Banks continue to maintain their focus on security and resiliency by upgrading critical elements of the FedLine solutions. The next-generation virtual private network solution is a key component of the security model for the FedLine Advantage and FedLine Command access solutions used by approximately 5,000 financial institutions.10 The solution was certified for general availability in July 2013, and the overall migration is nearing completion. Information Technology The Federal Reserve Banks continued to improve the efficiency, effectiveness, and security of information technology (IT) services and operations in 2014. National IT continued its restructuring to streamline the organization to maintain strong operational performance; streamline layers of management to achieve a flatter, more efficient structure; and strengthen skills and proficiency in critical areas.11 Major multiyear programs to consolidate the Federal Reserve’s IT operations and networking services were completed and improved the overall efficiency and quality of business operations. Additional efforts helped System leaders articulate business needs through IT roadmaps and to identify more opportunities to employ common technology services and solutions. 10 11 Virtual private network or VPN technology supports remote, secure, and private network access over a public network connection, such as the Internet. National IT supplies national infrastructure and business line technology services to the Federal Reserve Banks and provides guidance on the System’s information technology architecture and business use of technology. 103 National IT also led an effort to institute common IT principles throughout the System to motivate strategic decisions and behaviors throughout System IT.12 These principles provide a common foundation for delivering IT services as effectively, securely, efficiently, and innovatively as possible, and support the System’s IT objective to deliver highly effective and efficient IT services and solutions that support business objectives and enhance productivity while safeguarding Federal Reserve data and assets. Finally, under the direction of the chief information security officer, management of the Federal Reserve’s information systems (IS) risk continues to mature, with priority given to cybersecurity and IS strategy. The Federal Reserve remains vigilant about its cybersecurity posture, making thoughtful investments in key risk-mitigation initiatives and programs and continuously monitoring and assessing cybersecurity risks to its operations. In 2014, the Federal Reserve completed its implementation of a new IS framework for key systems. The framework, known as System Assurance for the Federal Reserve, is based on guidance from the National Institute of Standards and Technology and adapted to the Federal Reserve’s environment. Examinations of the Federal Reserve Banks The Reserve Banks and several consolidated variable interest entities (VIEs) operated by the Federal Reserve System in response to the 2007–09 financial crisis are subject to several levels of audit and review.13 The combined financial statements of the Reserve Banks—as well as the financial statements of each of the 12 Reserve Banks and Maiden Lane LLC—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. The Reserve Banks use the 2013 framework established by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) to assess their internal controls over financial reporting, 12 13 14 System IT is technology provisioned for and by Reserve Banks, business lines, and National IT. The New York Reserve Bank is considered to be the controlling financial interest holder of each of the consolidated VIEs. See “Federal Reserve Banks Combined Financial Statements” in section 12 of this report. 104 101st Annual Report | 2014 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. The Federal Reserve Board engaged Deloitte & Touche LLP (D&T) to audit the 2014 combined and individual financial statements of the Reserve Banks and Maiden Lane LLC.15 In 2014, D&T also conducted audits of the internal controls associated with financial reporting for each of the Reserve Banks. Fees for D&T’s services totaled $6.9 million, of which $0.4 million was for the audit of Maiden Lane LLC. 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 2014, the Reserve Banks did not engage D&T for any nonaudit services.16 The Board also reviews 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 • assess SOMA-related 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 Board review. Income and Expenses Table 4 summarizes the income, expenses, and distributions of net earnings of the Reserve Banks for 2014 and 2013. Income in 2014 was $116,562 million, compared with $91,150 million in 2013. Expenses totaled $12,579 million: 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, National IT, and the System’s Office of Employee Benefits (OEB). They conduct a comprehensive on-site review of each Reserve Bank, and OEB at least once every three years and review National IT, the System Open Market Account (SOMA), and Fedwire annually. • $6,862 million in interest paid to depository institutions on reserve balances and term deposits; The comprehensive on-site reviews include an assessment of the internal audit function’s effectiveness and its conformance to the Institute of Internal Auditors’ (IIA) International Standards for the Professional Practice of Internal Auditing, applicable policies and guidance, the IIA’s code of ethics, and the definition of internal auditing. • $563 million for Consumer Financial Protection Bureau costs; and 15 16 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, the OEB, and the Consumer Financial Protection Bureau. One Bank leases office space to D&T. • $3,926 million in Reserve Bank operating expenses; • $383 million in net periodic pension expense; • $112 million in interest expense on securities sold under agreements to repurchase; • $590 million in assessments for Board of Governors expenditure; • $711 million for new currency costs; • $2 million in other costs. The expenses were reduced by $570 million in reimbursements for services provided to government agencies. Net deductions from current net income totaled $2,718 million, which includes $2,907 million in unrealized losses on foreign currency denominated investments revalued to reflect current market exchange rates, $110 million in net income associated with consolidated VIEs, and $81 million in realized gains on federal agency and GSE mortgage-backed securities (GSE MBS). Dividends paid to member banks, set at 6 percent of paid-in capital by sec- Federal Reserve Banks 105 Table 4. Income, expenses, and distribution of net earnings of the Federal Reserve Banks, 2014 and 2013 Millions of dollars Item Current income Loan interest income SOMA interest income Other current income2 Net expenses Operating expenses Reimbursements Net periodic pension expense Interest paid on depository institutions deposits and term deposits Interest expense on securities sold under agreements to repurchase Other expenses Current net income Net additions to (deductions from) current net income Federal agency and government-sponsored enterprise mortgage-backed securities Foreign currency translation losses Net income (loss) from consolidated VIEs Other deductions Assessments by the Board of Governors For Board expenditures For currency costs For Consumer Financial Protection Bureau costs3 Net income before providing for remittances to the Treasury Earnings remittances to the Treasury Net income (loss) Other comprehensive (loss) gain Comprehensive income Total distribution of net income Dividends on capital stock Transfer to surplus and change in accumulated other comprehensive income Earnings remittances to the Treasury 1 2 3 2014 20131 116,562 2 115,933 627 10,715 3,926 -570 383 6,862 112 2 105,847 -2,718 81 -2,907 110 -2 1,864 590 711 563 101,265 96,902 4,363 -1,612 2,751 91,150 6 90,503 641 9,135 3,765 -530 617 5,223 60 0 82,015 -1,029 51 -1,257 181 -4 1,845 580 702 563 79,141 79,633 -492 2,289 1,797 99,653 1,686 1,065 96,902 81,430 1,650 147 79,633 Certain amounts relating to 2013 have been reclassified to conform to the current-year presentation. Includes income from priced services, compensation received for services provided, and securities lending fees. The Board of Governors assesses the Reserve Banks to fund the operations of the Consumer Financial Protection Bureau. tion 7(1) of the Federal Reserve Act, totaled $1,686 million. Comprehensive net income before interest on Federal Reserve notes expense remitted to Treasury totaled $99,653 million in 2014 (net income of $101,265 million, decreased by other comprehensive loss of $1,612 million). Earnings remittances to Treasury totaled $96,902 million in 2014. The remittances equal comprehensive income after the deduction of dividends paid and the amount necessary to equate the Reserve Banks’ surplus to paid-in capital. Section 11 of this report, “Statistical Tables,” 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 2014; table 11 shows a condensed statement for each Reserve Bank for the years 1914 through 2014; 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 section 12, “Federal Reserve System Audits”). SOMA Holdings and Loans The Reserve Banks’ average net daily holdings of securities and loans during 2014 amounted to $4,055,301 million, an increase of $717,603 million from 2013 (see table 5). 106 101st Annual Report | 2014 Table 5. System Open Market Account (SOMA) holdings and loans of the Federal Reserve Banks, 2014 and 2013 Millions of dollars, except as noted Average daily assets (+)/liabilities (–) Current income (+)/expense (–) Average interest rate (percent) Item U.S. Treasury securities1 Government-sponsored enterprise debt (GSE) securities1 Federal agency and GSE mortgage-backed securities2 Foreign currency denominated investments3 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 Term Asset-Backed Securities Loan Facility (TALF)7 Total loans to others Total loans Total SOMA holdings and loans 2014 2013 2014 2013 2014 2013 2,520,120 46,122 1,700,521 23,296 192 28 4,290,279 -233,249 -1,899 -235,148 4,055,131 118 118 52 52 170 4,055,301 2,092,769 69,872 1,249,810 23,941 3,361 63 3,439,816 -99,680r -2,781 -102,461r 3,337,355r 79 79 264 264 343 3,337,698r 63,011 1,579 51,264 78 1 * 115,933 -112 n/a -112 115,821 * * 2 2 2 115,823 51,591 2,166 36,628 96 22 * 90,503 -60 n/a -60 90,443 * * 6 6 6 90,449 2.50 3.42 3.01 0.33 0.52 0.01 2.70 0.05 n/a 0.05 2.86 0.21 0.21 3.85 3.85 1.18 2.86 2.47 3.10 2.93 0.40 0.65 0.03 2.63 0.06 n/a 0.06 2.55r 0.25 0.25 2.27 2.27 1.75 2.55r 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 (GSE MBS) 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 Represents the remaining principal balance. During the year ended December 31, 2014, all remaining TALF loans were repaid in full, including accrued interest. r Revised. n/a Not applicable. * Less than $500 thousand. 2 SOMA Securities Holdings The average daily holdings of Treasury securities increased by $427,351 million, to an average daily amount of $2,520,120 million. The average daily holdings of GSE debt securities decreased by $23,750 million, to an average daily amount of $46,122 million. The average daily holdings of federal agency and GSE MBS increased by $450,711 million, to an average daily amount of $1,700,521 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 maturities. There were no significant holdings of securities purchased under agreements to resell in 2014 or 2013. Average daily holdings of foreign currency denominated investments in 2014 were $23,296 million, compared with $23,941 million in 2013. The average daily balance of central bank liquidity swap drawings was $192 million in 2014 and $3,361 million in 2013. The average daily balance of securities sold under agreements to repurchase was $233,249 million, an increase of $133,569 million from 2013. The average rates of interest earned on the Reserve Banks’ holdings of Treasury securities increased to 2.50 percent and the average rates on GSE debt securities increased to 3.42 percent in 2014. The average rate of interest earned on federal agency and GSE MBS increased to 3.01 percent in 2014. The average interest rates for securities sold under agreements to repurchase decreased to 0.05 percent in 2014. The Federal Reserve Banks 107 Table 6. Key financial data for consolidated variable interest entities (VIEs), 2014 and 2013 Millions of dollars TALF LLC Maiden Lane LLC Maiden Lane II LLC Maiden Lane III LLC 2014 2014 Total VIEs Item 2014 2013 2014 2013 2013 2013 Net portfolio assets of the consolidated VIEs and the net position of the New York Reserve Bank (FRBNY) and subordinated interest holders Net portfolio assets1 0 109 1,811 1,732 0 63 0 22 Liabilities of consolidated VIEs 0 0 -127 -157 0 0 0 0 Net portfolio assets available2 0 109 1,684 1,575 0 63 0 22 Loans extended to the consolidated VIEs by the FRBNY3 0 0 0 0 0 0 0 0 Other beneficial interests3 0 0 0 0 0 0 0 0 Total loans extended to the consolidated VIEs by the FRBNY and other beneficial interests 0 0 0 0 0 0 0 0 Cumulative change in net assets since the inception of the program4 Allocated to FRBNY 0 11 1,684 1,575 0 53 0 15 Allocated to other beneficial interests 0 98 0 0 0 10 0 7 Cumulative change in net assets 0 109 1,684 1,575 0 63 0 22 Summary of consolidated VIE net income, including a reconciliation of total consolidated VIE net income to the consolidated VIE net income Portfolio interest income5 * 0 77 2 * 4 * * Portfolio holdings gains (losses) * -573 37 183 0 0 * 0 Professional fees * -1 -4 -6 * -1 * * Net income (loss) of consolidated VIEs * -574 110 179 * 3 * * Less: Net income (loss) allocated to other beneficial interests * 574 0 0 * -1 * * Net income (loss) allocated to and * 0 110 179 * 2 * 0 recorded by FRBNY6 2014 2013 1,811 -127 1,684 1,926 -157 1,769 0 0 0 0 0 0 1,684 0 1,684 1,654 115 1,769 77 37 -4 110 6 -390 -8 -392 0 573 110 181 1 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. 2 Represents the net assets available for distribution to FRBNY and “other beneficiaries” of the consolidated VIEs. During the year ended December 31, 2014, all remaining assets of TALF LLC, Maiden Lane II, and Maiden Lane III, were distributed to the FRBNY and other beneficial interest holders and these entities were dissolved. 3 The remaining balances of the loans extended to the consolidated VIEs by the FRBNY and by amounts provided to the VIEs by other beneficial interest holders were repaid in full, including accrued interest, during the years ended December 31, 2012, and December 31, 2013. 4 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. 5 Interest income is recorded when earned and includes amortization of premiums, accretion of discounts, and paydown gains and losses. 6 In addition to the net income attributable to TALF LLC, FRBNY earned $3 million on TALF loans during the year ended December 31, 2013 (interest income of $6 million and a loss on the valuation of loans of $3 million). * Less than $500 thousand. average rate of interest earned on foreign currency denominated investments decreased to 0.33 percent while the average rate of interest earned on central bank liquidity swaps decreased to 0.52 percent in 2014. Lending In 2014, the average daily primary, secondary, and seasonal credit extended by the Reserve Banks to depository institutions increased by $39 million, to $118 million. The average rate of interest earned on primary, secondary, and seasonal credit decreased to 0.21 percent in 2014, from 0.25 percent in 2013. The average daily balance of Term Asset-Backed Securities Loan Facility (TALF) loans in 2014 was $52 million, a decrease of $212 million from 2013. The aver- age rate of interest earned on TALF loans in 2014 was 3.85 percent. Investments of the Consolidated VIEs Certain 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 (GAAP), 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. Net portfolio assets of the consolidated VIEs decreased from $1,926 million in 2013 to $1,811 mil- 108 101st Annual Report | 2014 lion in 2014. In 2013, the loan extended to TALF LLC by the Treasury was repaid in full, including outstanding principal and accrued interest. During 2014, final distributions of assets were made by Maiden Lane II LLC, Maiden Lane III LLC, and TALF LLC, and the entities were dissolved. Federal Reserve Bank Premises Several Reserve Banks took action in 2014 to maintain and renovate their facilities. The multiyear renovation programs at the Boston, New York, Richmond, St. Louis, and San Francisco Reserve Banks’ headquarters buildings continued. All Reserve Banks continued to implement projects to maintain building systems to ensure efficient and reliable operations. The New York Reserve Bank continued repairs and renovations to the 33 Maiden Lane building, and the Chicago Federal Reserve Bank continued construction of security enhancements to its building. In 2014, the Dallas Reserve Bank moved to leased office space for its San Antonio Branch and sold the building that previously housed the Branch’s operations. For more information on the acquisition costs and net book value of the 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, 2014 and 2013 Millions of dollars Item Short-term assets (Note 1) Imputed investments Receivables Materials and supplies Prepaid expenses Items in process of collection Total short-term assets Long-term assets (Note 2) Premises Furniture and equipment Leases, leasehold improvements, and long-term prepayments Prepaid pension costs Deferred tax asset Total long-term assets Total assets Short-term liabilities 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 $549.7 million and $466.2 million at December 31, 2014 and 2013, respectively) Total liabilities and equity (Note 3) 2014 2013 556.7 36.9 0.7 11.1 85.7 913.3 36.2 0.9 6.6 165.3 691.2 131.2 35.9 101.7 0.0 325.6 1,122.5 144.2 32.5 95.0 59.2 291.8 594.4 1,285.6 642.4 24.8 24.0 622.8 1,745.3 1,078.6 20.4 23.4 691.2 60.9 459.3 1,122.5 129.4 406.1 520.2 1,211.4 535.5 1,658.0 74.2 1,285.6 87.3 1,745.3 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. 109 110 101st Annual Report | 2014 Table 8. Pro forma income statement for Federal Reserve priced services, 2014 and 2013 Millions of dollars Item 2014 Revenue from services provided to depository institutions (Note 4) Operating expenses (Note 5) Income from operations Imputed costs (Note 6) Interest on debt Interest on float Sales taxes Income from operations after imputed costs Other income and expenses (Note 7) Investment income Income before income taxes Imputed income taxes (Note 6) Net income Memo: Targeted return on equity (Note 6) 2013 433.1 399.0 34.1 7.1 -0.5 4.5 441.2 385.5 55.7 0.1 -0.7 4.4 11.0 23.0 0.0 23.0 8.6 14.5 5.5 3.8 51.9 0.1 0.1 52.0 20.0 32.0 4.2 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, 2014 Millions of dollars Item Revenue from services (Note 4) Operating expenses (Note 5)1 Income from operations Imputed costs (Note 6) Income from operations after imputed costs Other income and expenses, net (Note 7) Income before income taxes Imputed income taxes (Note 6) Net income Memo: Targeted return on equity (Note 6) Cost recovery (percent) (Note 8) Total Commercial check collection Commercial ACH Fedwire funds Fedwire securities 433.1 399.0 34.1 11.0 23.0 0.0 23.0 8.6 14.5 5.5 102.1 174.7 130.9 43.8 3.4 40.4 0.0 40.4 15.0 25.4 1.8 115.6 124.4 147.2 -22.9 4.2 -27.0 0.0 -27.0 -10.1 -17.0 2.0 86.7 110.1 99.5 10.5 2.9 7.7 0.0 7.7 2.9 4.8 1.4 103.2 24.0 21.4 2.6 0.6 2.0 0.0 2.0 0.7 1.2 0.3 104.1 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. Operating expenses include pension costs, Board expenses, and reimbursements for certain nonpriced services. 1 Federal Reserve Banks Notes to Pro Forma Financial Statements for Priced Services (1) Short-Term Assets 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. Investments of excess financing derived from credit float are assumed to be invested in federal funds. (2) 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 a deferred tax asset related to the priced services pension and postretirement benefits obligation. The tax rate associated with the deferred tax asset was 37.2 percent and 38.5 percent for 2014 and 2013, respectively. Long-term assets also consist of an estimate of the assets of the Board of Governors used in the development of priced services. (3) Liabilities and Equity Under the matched-book capital structure for assets, short-term assets are financed with short-term payables and imputed short-term debt, if needed. Longterm assets are financed with long-term liabilities, imputed long-term debt, and imputed equity, if needed. To meet the Federal Deposit Insurance Corporation (FDIC) requirements for a well-capitalized institution, in 2014 equity is imputed at 5.8 percent of total assets and 10 percent of risk-weighted assets, and in 2013 equity is imputed at 5.0 percent of total assets and 10.2 percent of risk-weighted assets. In accordance with Accounting Standards Codification (ASC) Topic 715 (ASC 715), Compensation–Retirement Benefits, the Reserve Banks recorded the funded status of pension and other benefit plans on their balance sheets. To reflect the funded status of their 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 plan liabilities 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, which is a component of accrued benefit costs, of $42.0 million and a pension asset of $59.2 million in 2014 and 2013, 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 $83.5 million in 2014. 111 112 101st Annual Report | 2014 (4) Revenue Revenue represents fees charged to depository institutions for priced services and is realized from each institution through direct charges to an institution’s account. (5) Operating Expenses Operating expenses consist of the direct, indirect, and other general administrative expenses of the Reserve Banks for priced services and the expenses of the Board related to the development of priced services. Board expenses were $4.1 million in 2014 and $4.0 million in 2013. In accordance with ASC 715, the Reserve Bank priced services recognized qualified pension-plan operating expenses of $22.7 million in 2014 and $45.4 million in 2013. Operating expenses also include the nonqualified net pension expense of $4.7 million in 2014 and net pension credit of $0.7 million in 2013. The implementation of ASC 715 does not change the systematic approach required by GAAP 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. The income statement by service reflects revenue, operating expenses, imputed costs, other income and expenses, and cost recovery. (6) Imputed Costs Imputed costs consist of income taxes, return on equity, interest on debt, sales taxes, and interest on float. Many imputed costs are derived from the PSAF model. The 2014 cost of short-term debt imputed in the PSAF model is based on nonfinancial commercial paper rates; the cost of imputed long-term debt is based on Merrill Lynch Corporate and High Yield Index returns; and the effective tax rate is derived from U.S. publicly traded firm data, which serve as the proxy for the financial data of a representative private-sector firm. The after-tax rate of return on equity is based on the returns of the equity market as a whole.17 Interest is imputed on the debt assumed necessary to finance priced-service assets. These 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. Interest on float is derived from the value of float to be recovered for the check and ACH services, Fedwire Funds Service, and Fedwire Securities Services through per-item fees during the period. Float income or cost is based on the actual float incurred for each priced service. 17 Details regarding the PSAF methodology change can be found at www.gpo.gov/fdsys/pkg/FR-201211-08/pdf/2012-26918.pdf. Federal Reserve Banks The following shows the daily average recovery of actual float by the Reserve Banks for 2014, in millions of dollars: Total float Unrecovered float Float subject to recovery through per item fees -590.8 4.7 -595.5 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 ACH funding requirements and check products generate credit float; this float has been subtracted from the cost base subject to recovery in 2014 and 2013. (7) Other Income and Expenses Other income consists of income on imputed investments. Excess financing resulting from additional equity imputed to meet the FDIC well-capitalized requirements is assumed to be invested and earning interest at the 3-month Treasury bill rate. (8) 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 after-tax targeted return on equity. 113 115 7 Other Federal Reserve Operations Regulatory Developments: Dodd-Frank Act Implementation Throughout 2014, the Federal Reserve continued to implement the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) (Pub. L. No. 111-203), which 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. The Board also continued to implement other regulatory reforms to increase the resiliency of banking organizations and help to ensure that they are operating in a safe and sound manner. The following is a summary of the key regulatory initiatives that were completed during 2014. Enhanced Prudential Standards for U.S. and Foreign Banking Organizations Section 165 of the Dodd-Frank Act requires the Board to establish enhanced prudential standards for bank holding companies (BHCs) and foreign banking organizations with total consolidated assets of $50 billion or more and nonbank financial companies that have been designated by the Financial Stability Oversight Council (FSOC) for supervision by the Board. The standards must include enhanced risk-based and leverage capital; liquidity, riskmanagement, and risk-committee requirements; a requirement to submit a resolution plan; singlecounterparty credit limits; stress tests requirements; and, for companies that the FSOC has determined pose a grave threat to financial stability, a debt-toequity limit. Section 165 also permits the Board to establish additional prudential standards, including three enumerated standards—a contingent capital requirement, enhanced public disclosures, and short- term debt limits—and other prudential standards that the Board determines are appropriate. In February 2014, the Board adopted a final rule to implement enhanced prudential standards under the Dodd-Frank Act for BHCs and foreign banking organizations with $50 billion or more in total consolidated assets. For a BHC with total consolidated assets of $50 billion or more, the final rule adopts enhanced risk-management and liquidity requirements. The 165 final rule also incorporates the Board’s capital, capital planning, and stress testing requirements as enhanced prudential standards. For a foreign banking organization with total consolidated assets of $50 billion or more, the final rule implements enhanced risk-based and leverage capital, liquidity, risk-management, and stress testing requirements. In addition, the final rule requires foreign banking organizations with U.S. non-branch assets of $50 billion or more to form a U.S. intermediate holding company and imposes enhanced prudential standards on that intermediate holding company. Generally, as the size, complexity, and risk to U.S. financial stability of a U.S. BHC or foreign banking organization increases, the standards imposed on the organization become more stringent, mitigating risks to the financial stability of the United States posed by the material financial distress or failure of the institution. Finally, the final rule also establishes a riskcommittee requirement for publicly traded U.S. and foreign banking organizations with total consolidated assets of $10 billion or more, implements stress testing requirements for foreign banking organizations and foreign savings and loan holding companies with total consolidated assets of more than $10 billion, and requires companies that the FSOC has determined pose a grave threat to the financial stability of 116 101st Annual Report | 2014 the United States achieve and maintain a debt-toequity ratio of no more than 15 to 1. Continued Implementation of the Regulatory Capital Framework In July 2013, the Board issued a final rule to comprehensively revise the capital regulations applicable to banking organizations (revised capital framework).1 The revised capital framework strengthens the definition of regulatory capital, generally increases the minimum risk-based capital requirements, modifies the methodologies for calculating risk-weighted assets, and imposes a minimum generally applicable leverage ratio of 4 percent (measured as the ratio of tier 1 capital to on-balance-sheet assets). In addition, internationally active banking organizations must meet a minimum supplementary leverage ratio of 3 percent (measured as the ratio of tier 1 capital to on- and off-balance-sheet exposures). The rule was published jointly with the Office of the Comptroller of the Currency (OCC), and the Federal Deposit Insurance Corporation (FDIC) published a substantively identical rule. The Board continued to develop and enhance the regulatory capital framework in 2014. In April 2014, the Board, the FDIC, and the OCC adopted a final rule that enhances the supplementary leverage ratio requirement described above for the largest, most interconnected U.S. banking organizations. A BHC with at least $700 billion in total consolidated assets or at least $10 trillion in assets under custody must maintain a supplementary leverage ratio of 5 percent or more in order to avoid limitations on distributions and certain discretionary bonus payments, and their insured depository institution subsidiaries must maintain a supplementary leverage ratio of 6 percent or more to be “well capitalized.” These enhanced supplementary leverage ratio standards are designed to help reduce the probability of failure of systemically important banking organizations, thereby mitigating the risks to the financial stability of the United States posed by these organizations. In 2014, the agencies issued three other final rules to adjust aspects of the regulatory capital framework. In July 2015, the agencies adopted a final rule to correct the definition of “eligible guarantee.” In September 2014, the agencies adopted a final rule to revise the definition of total leverage exposure used in the calculation of the supplementary leverage ratio. Spe1 See 78 Federal Register 62018 (October 11, 2013). cifically, the final rule modifies the methodology for including off-balance-sheet items, such as credit derivatives, repo-style transactions, and lines of credit, in the denominator of the supplementary leverage ratio to more appropriately capture a banking organization’s on- and off-balance-sheet exposures. In December 2014, the Board and the OCC adopted an interim final rule to adjust the definition of “qualifying master netting agreement” and related definitions in the regulatory capital and the liquidity coverage ratio rules. The changes were intended to ensure that the regulatory capital and liquidity treatment of certain financial transactions is not affected by the implementation of special resolution regimes in foreign jurisdictions or by contractual provisions that incorporate stays of special resolution regimes. Capital Planning and Stress Testing Requirements On an annual basis, the Federal Reserve assesses whether BHCs with total consolidated assets of $50 billion or more have effective capital planning processes and sufficient capital to absorb losses during stressful conditions, while meeting obligations to creditors and counterparties and continuing to serve as credit intermediaries. This annual assessment includes two related programs: the Comprehensive Capital Analysis and Review (CCAR), which evaluates a BHC’s capital adequacy, capital adequacy process, and planned capital distributions in accordance with the Board’s capital plan rule, and the DoddFrank Act supervisory stress tests. Pursuant to the Dodd-Frank Act, BHCs and state member banks with more than $10 billion in total consolidated assets are required to conduct company-run stress tests. On October 16, 2014, the Board revised its capital plan and stress testing rules to adjust the time frame for annual submissions of capital plans and the company-run and supervisory stress tests. Beginning in 2016, participating BHCs must submit their capital plans and stress testing results to the Federal Reserve on or before April 5. Liquidity Requirements for Large Financial Institutions In October 2014, the Board, the OCC, and the FDIC issued a final rule implementing the liquidity coverage ratio (LCR), a quantitative liquidity requirement for large and internationally active banking organizations. The LCR is the first broadly applicable quanti- Other Federal Reserve Operations tative liquidity requirement for U.S. banking firms and establishes an enhanced prudential liquidity standard consistent with the Dodd-Frank Act. Under the final rule, covered banking firms will be required to maintain a minimum amount of highquality liquid assets sufficient to cover their net cash outflows over a 30-calendar-day period in a standardized supervisory stress scenario. The most stringent LCR requirements apply to banking organizations with consolidated total assets of $250 billion or more or consolidated total on-balance-sheet foreign exposure of $10 billion or more and their subsidiary insured depository institutions with $10 billion or more of consolidated total assets. The rule applies a simpler, less stringent LCR requirement to certain smaller depository institution holding companies with $50 billion or more that are not otherwise covered by the rule. Credit-Risk Retention In December 2014, the Board—jointly with other federal banking agencies, the Department of Housing and Urban Development, the Federal Housing Finance Agency, and the Securities and Exchange Commission (SEC)—approved a final rule to implement the credit-risk retention requirements in the Dodd-Frank Act. The final rule generally requires the sponsors of securitization transactions to retain not less than 5 percent of the credit risk of the assets they securitize and includes prohibitions on transferring or hedging the retained credit risk. The final rule provides exemptions for asset-backed securities that are collateralized exclusively by residential mortgages that qualify as qualified residential mortgages (QRMs). In addition, the final rule does not require risk retention for securitizations of commercial loans, commercial mortgages, or automobile loans, provided that the transactions meet specific standards for high-quality underwriting. The implementing agencies have agreed to review the QRM definition and its effect on the residential mortgage market no later than four years after the rule’s effective date and periodically thereafter. The Volcker Rule: Prohibitions against Proprietary Trading and Other Activities Section 619 of the Dodd-Frank Act generally prohibits insured depository institutions (IDIs) and their affiliates (collectively, banking entities) from engaging in proprietary trading or from investing in, sponsoring, or having certain relationships with a hedge fund or private equity fund. These prohibitions and 117 other provisions of section 619 are commonly known as the “Volcker rule.” In January 2014, the Board, the FDIC, the OCC, the SEC, and the Commodity Futures Trading Commission approved an interim final rule permitting banking entities to retain interests in, and act as sponsors to, certain collateralized debt obligations backed primarily by trust preferred securities that meet the definition of covered funds, as permitted under the grandfathering provisions for certain trust preferred securities in the Dodd-Frank Act. The interim final rule, a companion rule to the Volcker rule approved in December 2013, establishes specific qualifications for the type of covered funds that may be retained. Financial Sector Concentration Limits In November 2014, the Board issued a final rule to implement section 622 of the Dodd-Frank Act, which generally prohibits a financial company from merging or consolidating with, or from acquiring, another company if the resulting company’s liabilities would exceed 10 percent of the aggregate liabilities of all financial companies. Financial companies subject to the limit include insured depository institutions, BHCs, savings and loan holding companies, foreign banking organizations, companies that control insured depository institutions, and nonbank financial companies designated by the FSOC for Board supervision. In addition, the final rule establishes reporting requirements for financial companies that do not otherwise report consolidated financial information to the Board or another federal banking agency, in accordance with the Bank Holding Company Act. Risk-Management Standards for Financial Market Utilities Title VIII of the Dodd-Frank Act establishes a supervisory framework for financial market utilities (FMUs) that are designated as systemically important by the FSOC. FMUs are multilateral systems that provide the essential infrastructure for transferring, clearing, and settling payments, securities, and other financial transactions among financial institutions or between financial institutions and the system. In October 2014, the Board approved final amendments to Regulation HH regarding the riskmanagement standards for FMUs that have been designated as systemically important by the FSOC 118 101st Annual Report | 2014 and for which the Board has standard-setting authority under the Dodd-Frank Act. The Board also approved revisions to the Federal Reserve Policy on Payment System Risk, which applies to financial market infrastructures more generally, including those operated by the Federal Reserve Banks.2 The final rule adopts standards to address credit risk and liquidity risk, new requirements on recovery and orderly wind-down planning, a new standard on general business risk, a new standard on tiered participation arrangements, and heightened requirements on transparency and disclosure. Key Regulatory Initiatives Proposed in 2014 A number of important regulatory developments are in the proposal stage. The following is a summary of additional regulatory initiatives that the Board proposed in 2014. Capital Surcharge for Global Systemically Important Banking Organizations In December 2014, the Board invited comment on a proposed rule that would establish a methodology to identify whether a U.S. BHC is a global systemically important banking organization (GSIB). As such, a GSIB would be subject to a risk-based capital surcharge that is calibrated based on its systemic risk profile. The proposal builds on a GSIB capital surcharge framework designed by the Basel Committee on Banking Supervision and augments that framework to address the risk arising from reliance on 2 For more information on the Federal Reserve Policy on Payment System Risk, see www.federalreserve.gov/paymentsystems/ psr_about.htm. short-term wholesale funding. Failure to maintain the capital surcharge would subject the GSIB to restrictions on capital distributions and certain discretionary bonus payments. Enhanced Prudential Standards for the Regulation and Supervision of General Electric Capital Corporation In December 2014, the Board invited public comment on enhanced prudential standards for the regulation and supervision of General Electric Capital Corporation (GECC), a nonbank financial company that the FSOC designated for supervision by the Board. In light of the substantial similarity of GECC’s activities and risk profile to that of a similarly sized BHC, the proposal would apply enhanced prudential standards to GECC that are generally similar to those that apply to large BHCs, including standards for risk-based and leverage capital, capital planning, stress testing, liquidity, and risk management. Clarifications to Regulatory Capital Rules The Board continues to implement the regulatory capital rules. In December 2014, the federal banking agencies issued a proposed rule to make technical corrections and clarify certain aspects of the advanced approaches rule. Also in December 2014, the Board issued a proposed rule to provide additional information regarding the application of the Board’s regulatory capital framework to depository institution holding companies that have nontraditional capital structures. 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 federal agencies, in consultation with Congress and outside stakeholders, to prepare a strategic plan covering a multiyear period. GPRA also requires each agency to submit an annual performance plan and an annual performance report. The GPRA Modernization Act of 2010 further 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 other federal agencies, prepares an annual performance plan and an annual performance report. Strategic Framework, Performance Plan, and Performance Report The Board’s 2012–15 Strategic Framework (framework) articulates the Board’s mission within the con- 119 text of resources required to meet Dodd-Frank Act mandates, close cross-disciplinary knowledge gaps, develop appropriate policy, and continue addressing the recovery of a fragile global economy. The framework sets forth major goals, outlines strategies for achieving those goals, and identifies key measures of performance toward achieving the strategic objectives. The annual performance plan outlines the planned projects, initiatives, and activities that support the framework’s long-term objectives and resources necessary to achieve those objectives. The annual performance report summarizes the Board’s accomplishments that contributed toward achieving the strategic goals and objectives identified in the framework. The framework, performance plan, and performance report are available on the Board’s website at www .federalreserve.gov/publications/gpra/files/2012-2015strategic-framework.pdf, www.federalreserve.gov/ publications/gpra/files/2014-gpra-performance-plan .pdf, and www.federalreserve.gov/publications/gpra/ files/2013-gpra-performance-report.pdf. 121 8 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 2014, as implemented through (1) rules and regulations, (2) policy statements and other actions, and (3) discount rates for depository institutions. Policy actions were approved by all Board members in office, unless indicated otherwise.1 More information on the actions is available from the relevant Federal Register notices or other documents (see links in footnotes) or on request from the Board’s Freedom of Information Office. For information on the Federal Open Market Committee’s policy actions relating to open market operations, see section 9, “Minutes of Federal Open Market Committee Meetings.” tion and Office of the Comptroller of the Currency.2 The final rule applies to any U.S. top-tier bank holding company with more than $700 billion in total consolidated assets or more than $10 trillion in assets under custody (covered bank holding companies) and to its insured depository institution subsidiaries. Currently, eight large U.S. banking organizations meet the asset threshold to be considered covered bank holding companies. Under the rule, covered bank holding companies must maintain a leverage buffer greater than 2 percentage points above the minimum supplementary leverage ratio requirement of 3 percent, for a total of more than 5 percent, to avoid restrictions on capital distributions and discretionary bonus payments. Insured depository institution subsidiaries of covered bank holding companies must maintain at least a 6 percent supplementary leverage ratio to be considered “well capitalized” under the agencies’ prompt corrective action framework. The final rule is effective January 1, 2018. Voting for this action: Chair Yellen and Governors Tarullo, Stein, and Powell. Rules and Regulations Regulation H (Membership of State Banking Institutions in the Federal Reserve System) and Regulation Q (Capital Adequacy of Bank Holding Companies, Savings and Loan Holding Companies, and State Member Banks) On April 8, 2014, the Board approved a final rule (Docket No. R-1460) to strengthen the supplementary leverage ratio standards for large, interconnected U.S. banking organizations. The rule was published jointly with the Federal Deposit Insurance Corpora- 1 Chairman Bernanke’s term expired on January 31, and Vice Chair Yellen took office as Chair on February 3, 2014. Governor Raskin resigned on March 13, and Governor Stein resigned on May 28, 2014. Governor Fischer joined the Board on May 28 and took office as Vice Chairman on June 16, 2014. Governor Brainard joined the Board on June 16, 2014. Regulation Q (Capital Adequacy of Bank Holding Companies, Savings and Loan Holding Companies, and State Member Banks) On July 14, 2014, the Board approved a final rule (Docket No. R-1488) to revise the definition of “eligible guarantee” to remove the requirement that this type of guarantee be made by an eligible guarantor for purposes of calculating a banking organization’s regulatory capital under the advanced approaches risk-based capital rule.3 Banking organizations use eligible guarantees to reduce the credit risk of certain exposures. The final rule, published jointly with the Federal Deposit Insurance Corporation and Office of 2 3 See Federal Register notice at www.gpo.gov/fdsys/pkg/FR-201405-01/html/2014-09367.htm. See Federal Register notice at www.gpo.gov/fdsys/pkg/FR-201407-30/html/2014-17858.htm. 122 101st Annual Report | 2014 the Comptroller of the Currency, is effective October 1, 2014. notice of proposed rulemaking with the same modifications.) Voting for this action: Chair Yellen, Vice Chairman Fischer, and Governors Tarullo, Powell, and Brainard. On September 3, 2014, the Board approved a final rule (Docket No. R-1487) to revise the definition of total leverage exposure used in the calculation of the supplementary leverage ratio in the agencies’ 2013 revised capital rule.4 The final rule modifies the methodology for including off-balance-sheet items, such as credit derivatives, repo-style transactions, and lines of credit, in the denominator of the supplementary leverage ratio to more appropriately capture a banking organization’s on- and off-balance-sheet exposures. The revised supplementary leverage ratio applies to all banking organizations subject to the advanced approaches risk-based capital rule. The final rule, published jointly with the Federal Deposit Insurance Corporation and Office of the Comptroller of the Currency, is effective January 1, 2015. Voting for this action: Chair Yellen, Vice Chairman Fischer, and Governors Tarullo, Powell, and Brainard. Regulation Q (Capital Adequacy of Bank Holding Companies, Savings and Loan Holding Companies, and State Member Banks) and Regulation WW (Liquidity Risk Measurement Standards) On December 15, 2014, the Board approved an interim final rule (Docket No. R-1507) revising the definition of “qualifying master netting agreement” and related definitions in the regulatory capital and the liquidity coverage ratio rules.5 The changes are designed to ensure that the regulatory capital and liquidity treatment of certain financial transactions is not affected by the implementation of special resolution regimes in foreign jurisdictions or by contractual provisions that incorporate stays of special resolution regimes. The interim final rule, published jointly with the Office of the Comptroller of the Currency, is effective January 1, 2015. (Note: The Federal Deposit Insurance Corporation issued a separately published 4 5 See Federal Register notice at www.gpo.gov/fdsys/pkg/FR-201409-26/html/2014-22083.htm. See Federal Register notice at www.gpo.gov/fdsys/pkg/FR-201412-30/html/2014-30218.htm. Voting for this action: Chair Yellen, Vice Chairman Fischer, and Governors Tarullo, Powell, and Brainard. Regulation Y (Bank Holding Companies and Change in Bank Control) and Regulation YY (Enhanced Prudential Standards) On February 20, 2014, the Board approved a final rule (Docket Nos. R-1463 and R-1464) revising the capital plan and stress testing rules to defer until October 1, 2015, use of the advanced approaches framework in the Board’s capital plan and stress testing rules.6 In addition, the Board and Office of the Comptroller of the Currency permitted eight banking organizations to begin using the advanced approaches framework to determine their risk-based capital requirements. Except for the advanced approaches deferral, the final rule also maintains all the changes to the Board’s capital plan rule and stress testing rules contained in two interim final rules issued in September 2013. The final rule is effective April 15, 2014. Voting for this action: Chair Yellen and Governors Tarullo, Raskin, Stein, and Powell. On October 16, 2014, the Board approved a final rule (Docket No. R-1492) revising the capital plan and stress testing rules to adjust the timeframe for annual submissions of capital plans and for the conduct of company-run and supervisory stress tests.7 For the 2015 capital plan cycle, bank holding companies with total consolidated assets of $50 billion or more are required to submit capital plans on or before January 5, 2015, which is unchanged from prior years. For subsequent cycles, beginning in 2016, participating bank holding companies will be required to submit their capital plans and stress testing results to the Federal Reserve on or before April 5. The final rule also includes other modifications to the capital plan and stress testing rules, including a limitation on the ability of a bank holding company with $50 billion or more in total consolidated assets to make capital distributions under the capital plan rule if the bank 6 7 See Federal Register notice at www.gpo.gov/fdsys/pkg/FR-201403-11/html/2014-05053.htm. See Federal Register notice at www.gpo.gov/fdsys/pkg/FR-201410-27/html/2014-25170.htm. Record of Policy Actions of the Board of Governors holding company’s net capital issuances are less than the amount indicated in its capital plan. The final rule is effective November 26, 2014, except for the limit on net capital distributions, which is effective on April 1, 2015. Voting for this action: Chair Yellen, Vice Chairman Fischer, and Governors Tarullo, Powell, and Brainard. Regulation DD (Truth in Savings), Regulation P (Privacy of Consumer Information), and Regulation V (Fair Credit Reporting) On May 20, 2014, the Board approved final rules (Docket Nos. R-1482 and R-1483) to repeal Regulations DD and P, in accordance with the transfer of rulemaking authority for a number of consumer protection laws to the Consumer Financial Protection Bureau (CFPB) under the Dodd-Frank Act.8 The CFPB has issued interim final rules that are substantially identical to those regulations. While the Board retains authority to issue rules for certain motor vehicle dealers, there is no evidence that any motor vehicle dealers subject to the Board’s jurisdiction engage in activities covered by the Truth in Savings Act. Furthermore, pursuant to the Dodd-Frank Act, entities supervised by the Board that were previously covered by the Board’s Regulation P are now subject to the privacy rules issued by the CFPB. In addition, the Board amended (Docket No. R-1484) Regulation V to reflect changes to the Fair Credit Reporting Act that limit the application of the Identity Theft Red Flags rule to only certain creditors.9 The final rules are effective June 30, 2014. Voting for this action: Chair Yellen and Governors Tarullo, Stein, and Powell. Regulation HH (Designated Financial Market Utilities) and Federal Reserve Policy on Payment System Risk On October 24, 2014, the Board approved final amendments to Regulation HH (Docket No. R-1477) regarding the risk-management standards for financial market utilities that have been designated as systemically important by the Financial Stability Over- sight Council and for which the Board has standardsetting authority under the Dodd-Frank Act.10 The Board also approved revisions to part I of the Federal Reserve Policy on Payment System Risk (Docket No. OP-1478), which applies to financial market infrastructures more generally, including those operated by the Federal Reserve Banks.11 The amendments and revisions are based on 2012 international risk-management standards for financial market infrastructures. Key amendments and revisions include separate standards to address credit risk and liquidity risk, new requirements on recovery and orderly wind-down planning, a new standard on general business risk, a new standard on tiered participation arrangements, and heightened requirements on transparency and disclosure. The amendments and revisions are effective on December 31, 2014, except several of the new requirements have a later compliance date, as described in the Federal Register notices. Voting for this action: Chair Yellen, Vice Chairman Fischer, and Governors Tarullo, Powell, and Brainard. Regulation RR (Credit Risk Retention) On October 22, 2014, the Board approved a final rule (Docket No. R-1411) to implement the credit risk retention requirements in the Dodd-Frank Act.12 The final rule generally requires the sponsors of securitization transactions to retain not less than 5 percent of the credit risk of the assets they securitize. The rule also includes prohibitions on transferring or hedging the retained credit risk. The final rule provides exemptions for asset-backed securities that are collateralized exclusively by residential mortgages that qualify as qualified residential mortgages (QRMs). Under the rule, the QRM definition is aligned with that of a “qualified mortgage,” as adopted by the Consumer Financial Protection Bureau. Exemptions are also available for certain other types of residential mortgage securitizations, including those guaranteed or insured by agencies of the U.S. government and those originated by state housing finance agencies. In addition, the final rule does not require risk retention for securitizations of commercial loans, commercial mortgages, or auto10 8 9 See Federal Register notices at www.gpo.gov/fdsys/pkg/FR2014-05-29/html/2014-12356.htm and www.gpo.gov/fdsys/pkg/ FR-2014-05-29/html/2014-12357.htm. See Federal Register notice at www.gpo.gov/fdsys/pkg/FR-201405-29/html/2014-12358.htm. 123 11 12 See Federal Register notice at www.gpo.gov/fdsys/pkg/FR-201411-05/html/2014-26090.htm. See Federal Register notice at www.gpo.gov/fdsys/pkg/FR-201411-13/html/2014-26791.htm. See Federal Register notice at www.gpo.gov/fdsys/pkg/FR-201412-24/html/2014-29256.htm. 124 101st Annual Report | 2014 mobile loans, provided that the transactions meet specific standards for high-quality underwriting. The final rule was also approved by the Federal Deposit Insurance Corporation, Office of the Comptroller of the Currency, Federal Housing Finance Agency, Securities and Exchange Commission, and Department of Housing and Urban Development. The implementing agencies have agreed to review the QRM definition and its effect on the residential mortgage market no later than four years after the rule’s effective date and periodically thereafter. The final rule is effective February 23, 2015, with compliance dates of December 24, 2015, for asset-backed securities collateralized by residential mortgages and December 24, 2016, for other types of asset-backed securities. Voting for this action: Chair Yellen, Vice Chairman Fischer, and Governors Tarullo, Powell, and Brainard. Regulation VV (Proprietary Trading and Certain Interests in and Relationships with Covered Funds) On January 14, 2014, the Board approved an interim final rule (Docket No. R-1480) permitting banking entities to retain interests in, and act as sponsors to, certain collateralized debt obligations backed primarily by trust preferred securities that meet the definition of covered funds, as permitted under the grandfathering provisions for certain trust preferred securities in the Dodd-Frank Act.13 The interim final rule, a companion rule to the so-called Volcker rule approved in December 2013, establishes specific qualifications for the type of covered funds that may be retained. The interim final rule was published jointly with the Federal Deposit Insurance Corporation, Office of the Comptroller of the Currency, Commodity Futures Trading Commission, and Securities and Exchange Commission, and is effective April 1, 2014. Voting for this action: Chairman Bernanke, Vice Chair Yellen, and Governors Tarullo, Raskin, Stein, and Powell. 2017) to conform their investments in and sponsorship of certain collateralized loan obligations that were in place before December 31, 2013, and are considered to be covered funds under section 13 of the Bank Holding Company Act.14 On December 17, 2014, the Board approved an extension, until July 21, 2016, for banking entities to conform their investments in and relationships with covered funds and foreign funds that were in place before December 31, 2013 (legacy covered funds) with the requirements of the Volcker rule.15 The Board also announced its intention to act next year to extend the conformance period for legacy covered funds for one additional year, until July 21, 2017. Regulation WW (Liquidity Risk Measurement Standards) On September 3, 2014, the Board approved a final rule (Docket No. R-1466) implementing the liquidity coverage ratio (LCR), a quantitative liquidity requirement for large and internationally active banking organizations.16 The LCR is based on liquidity standards promulgated under the Basel III reform measures and also establishes an enhanced prudential liquidity standard consistent with the Dodd-Frank Act. Under the final rule, covered banking firms will be required to maintain a minimum amount of high-quality liquid assets sufficient to cover their net cash outflows over a 30-calendar-day stress period. The rule applies a less stringent LCR requirement to certain smaller depository institution holding companies. In addition, the final rule does not allow municipal securities to be designated as high-quality liquid assets. The rule does not apply to bank holding companies and savings and loan holding companies with less than $50 billion in total consolidated assets or to nonbank financial companies designated as systemically important by the Financial Stability Oversight Council (companies so designated will have their liquidity requirements established through a separate rule or order). The final rule, published jointly with the Federal Deposit Insurance Corporation and Office of the Comptroller of the Currency, is effective January 1, 2015. Note: On April 3, 2014, the Board approved a statement that it stands ready to grant banking entities covered by the Volcker rule two additional one-year extensions (which together would be until July 21, 14 13 16 See Federal Register notice at www.gpo.gov/fdsys/pkg/FR-201401-31/html/2014-02019.htm. 15 See press release at www.federalreserve.gov/newsevents/press/ bcreg/20140407a.htm. See press release at www.federalreserve.gov/newsevents/press/ bcreg/20141218a.htm. See Federal Register notice at www.gpo.gov/fdsys/pkg/FR-201410-10/html/2014-22520.htm. Record of Policy Actions of the Board of Governors Voting for this action: Chair Yellen, Vice Chairman Fischer, and Governors Tarullo, Powell, and Brainard. Regulation XX (Concentration Limit) On November 3, 2014, the Board approved a final rule (Docket No. R-1489) to implement the DoddFrank Act financial-sector concentration limit that generally prohibits a financial company from merging or consolidating with, or from acquiring, another company if the resulting company’s liabilities would exceed 10 percent of the aggregate liabilities of all financial companies.17 In addition, the final rule establishes reporting requirements for financial companies that do not otherwise report consolidated financial information to the Board or another federal banking agency, in accordance with the Bank Holding Company Act. The final rule is effective January 1, 2015. Voting for this action: Chair Yellen, Vice Chairman Fischer, and Governors Tarullo, Powell, and Brainard. Regulation YY (Enhanced Prudential Standards) On February 18, 2014, the Board approved a final rule (Docket No. R-1438) to implement enhanced prudential standards under the Dodd-Frank Act for bank holding companies and foreign banking organizations with $50 billion or more in total consolidated assets.18 The enhanced prudential standards include risk-based and leverage capital requirements, liquidity standards, risk-management requirements, stress testing requirements, and a debt-to-equity limit for companies that the Financial Stability Oversight Council has determined pose a grave threat to financial stability. Foreign banking organizations with U.S. nonbranch assets of $50 billion or more are also required to form a U.S. intermediate holding company that will generally be subject to the same prudential standards as U.S. bank holding companies, including capital planning and stress testing requirements. The final rule is effective June 1, 2014. Policy Statements and Other Actions Supervisory Guidance on Implementing Dodd-Frank Act Company-Run Stress Tests for Medium-Sized Institutions On February 25, 2014, the Board approved final guidance (Docket No. OP-1485), published jointly with the Federal Deposit Insurance Corporation (FDIC) and Office of the Comptroller of the Currency (OCC), describing supervisory expectations and providing examples of sound practices for stress tests conducted by financial institutions with between $10 billion and $50 billion in total consolidated assets.19 These medium-sized companies are required to conduct annual, company-run stress tests under the agencies’ rules and the Dodd-Frank Act. Consistent with the flexibility of these rules, the guidance takes into account the different risk profiles, sizes, business mixes, and levels of complexity in mediumsized institutions. Further, the final guidance confirms that companies in the $10 billion to $50 billion asset range are not subject to the Federal Reserve’s capital plan rule, comprehensive capital analysis and review, stress tests conducted by the supervisory agencies, or related data collection requirements applicable to bank holding companies with assets of at least $50 billion. The Board’s guidance is effective April 1, 2014, and final guidance from the FDIC and OCC is effective March 31, 2014. Voting for this action: Chair Yellen and Governors Tarullo, Raskin, Stein, and Powell. Term Deposit Facility Testing On May 1, 2014, the Board approved a series of eight consecutive offerings through its Term Deposit Facility (TDF), with a gradually increasing individual award cap for each auction of up to $10 billion and an increase in offering rates of up to 5 basis points over the interest rate on excess reserves.20 The offerings are part of the Board’s ongoing TDF test operations and are also intended to familiarize eligible institutions with TDF procedures. Voting for this action: Chair Yellen and Governors Tarullo, Stein, and Powell. Voting for this action: Chair Yellen and Governors Tarullo, Raskin, Stein, and Powell. 17 18 See Federal Register notice at www.gpo.gov/fdsys/pkg/FR-201411-14/html/2014-26747.htm. See Federal Register notice at www.gpo.gov/fdsys/pkg/FR-201403-27/html/2014-05699.htm. 125 19 20 See Federal Register notice at www.gpo.gov/fdsys/pkg/FR-201403-13/html/2014-05518.htm. See press release at www.federalreserve.gov/newsevents/press/ monetary/20140509a.htm. 126 101st Annual Report | 2014 On August 18, 2014, the Board approved additional changes to the terms of its TDF testing to authorize (1) offerings of term deposits with an early withdrawal feature that allows depository institutions to obtain a return of funds before maturity, subject to forfeiture of all interest on the withdrawn term deposit plus an early withdrawal penalty, and (2) an increase of up to $20 billion in the individual award cap for TDF test operations.21 Voting for this action: Chair Yellen, Vice Chairman Fischer, and Governors Tarullo, Powell, and Brainard. Addendum to the Interagency Policy Statement on Income Tax Allocation in a Holding Company Structure On June 10, 2014, the Board approved a final addendum (Docket No. OP-1474) to the Interagency Policy Statement on Income Tax Allocation in a Holding Company Structure to ensure that insured depository institutions in a consolidated group maintain an appropriate relationship regarding the payment of taxes and treatment of tax refunds.22 The addendum, published jointly with the Federal Deposit Insurance Corporation and Office of the Comptroller of the Currency, supplements a 1998 policy statement on income tax allocation by instructing insured depository institutions and their holding companies to review their tax allocation agreements in order to confirm that the agreements expressly acknowledge the holding company receives any tax refunds as an agent for the insured depository institutions, consistent with sections 23A and 23B of the Federal Reserve Act. In addition, the addendum includes specific language that banking organizations could include in their tax allocation agreements to facilitate the agencies’ instructions. Institutions and holding companies are expected to implement the addendum not later than October 31, 2014. Voting for this action: Chair Yellen, and Governors Tarullo, Powell, and Fischer. Federal Reserve Policy on Payment System Risk and Regulation J (Collection of Checks and Other Items by Federal Reserve Banks and Funds Transfers through Fedwire) On November 26, 2014, the Board approved revisions to part II of the Federal Reserve Policy on Payment System Risk (PSR policy) (Docket No. OP-1472) related to the procedures for posting debit and credit entries to institutions’ accounts at Federal Reserve Banks for automated clearinghouse (ACH) debit and commercial check transactions.23 The PSR policy revisions also set principles for establishing future posting rules for Reserve Banks’ same-day ACH service, clarified the Reserve Banks’ administration of the policy for U.S. branches and agencies of foreign banking organizations, and made other technical corrections. In addition, the Board approved related amendments to Regulation J (Docket No. R-1473) regarding the timing of when paying banks must settle for the check transactions presented to them by the Reserve Banks.24 The revisions are effective December 5, 2014, except for the policy changes to the Board’s posting procedures for ACH debit and commercial check transactions and the related amendments to Regulation J, all of which are effective July 23, 2015.25 Voting for this action: Chair Yellen, Vice Chairman Fischer, and Governors Tarullo, Powell, and Brainard. Discount Rates for Depository Institutions in 2014 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. 23 21 22 See press release at www.federalreserve.gov/newsevents/press/ monetary/20140904a.htm. See Federal Register notice at www.gpo.gov/fdsys/pkg/FR-201406-19/html/2014-14325.htm. 24 25 See Federal Register notice at www.gpo.gov/fdsys/pkg/FR-201412-05/html/2014-28664.htm. See Federal Register notice at www.gpo.gov/fdsys/pkg/FR-201412-05/html/2014-28516.htm. A technical amendment to section 210.2(c) of Regulation J is effective December 5, 2014. Record of Policy Actions of 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 depository institutions that, in the judgment of the lending Federal Reserve Bank, are in generally sound financial condition. Throughout 2014, 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 2014, the spread was set at 50 basis points resulting in a secondary credit rate of 1¼ percent. Seasonal 127 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 0.15 percent.26 Votes on Changes to Discount Rates for Depository Institutions About every two weeks during 2014, the Board approved proposals by the 12 Reserve Banks to maintain the formulas for computing the secondary and seasonal credit rates. In 2014, the Board did not approve any changes in the primary credit rate. 26 For current and historical discount rates, see www .frbdiscountwindow.org/. 129 9 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 is published as an addendum to the minutes. 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 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.1 1 As of January 1, 2014, the Federal Reserve Bank of New York was operating under the Domestic Policy Directive approved at the December 17–18, 2013, 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, 2014, were approved at the January 29–30, 2013, meeting. 130 101st Annual Report | 2014 Meeting Held on January 28–29, 2014 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, January 28, 2014, at 2:00 p.m. and continued on Wednesday, January 29, 2014, at 9:00 a.m. Present Ben Bernanke Chairman William C. Dudley Vice Chairman Richard W. Fisher Narayana Kocherlakota Sandra Pianalto Charles I. Plosser Jerome H. Powell Jeremy C. Stein Daniel K. Tarullo Janet L. Yellen Christine Cumming, Charles L. Evans, Jeffrey M. Lacker, Dennis P. Lockhart, and John C. Williams Alternate Members of the Federal Open Market Committee James A. Clouse, Thomas A. Connors, Evan F. Koenig, Thomas Laubach, Michael P. Leahy, Loretta J. Mester, Paolo A. Pesenti, Samuel Schulhofer-Wohl, Mark E. Schweitzer, and William Wascher Associate Economists Simon Potter Manager, System Open Market Account Lorie K. Logan Deputy 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 Stephen A. Meyer and William Nelson Deputy Directors, Division of Monetary Affairs, Board of Governors Jon W. Faust Special Adviser to the Board, Office of Board Members, Board of Governors Linda Robertson and David W. Skidmore Assistants to the Board, Office of Board Members, Board of Governors Trevor A. Reeve Senior Associate Director, Division of International Finance, Board of Governors James Bullard, Esther L. George, and Eric Rosengren Presidents of the Federal Reserve Banks of St. Louis, Kansas City, and Boston, respectively Joyce K. Zickler Senior Adviser, Division of Monetary Affairs, Board of Governors William B. English Secretary and Economist Daniel M. Covitz and Michael T. Kiley Associate Directors, Division of Research and Statistics, Board of Governors Matthew M. Luecke Deputy 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 Jane E. Ihrig Deputy Associate Director, Division of Monetary Affairs, Board of Governors Edward Nelson Assistant Director, Division of Monetary Affairs, Board of Governors John J. Stevens Assistant Director, Division of Research and Statistics, Board of Governors Jeremy B. Rudd Adviser, Division of Research and Statistics, Board of Governors Minutes of Federal Open Market Committee Meetings | January 131 Dana L. Burnett Section Chief, Division of Monetary Affairs, Board of Governors William C. Dudley President of the Federal Reserve Bank of New York, with Burcu Duygan-Bump Senior Project Manager, Division of Monetary Affairs, Board of Governors Christine Cumming First Vice President of the Federal Reserve Bank of New York, as alternate. David H. Small Project Manager, Division of Monetary Affairs, Board of Governors Charles I. Plosser President of the Federal Reserve Bank of Philadelphia, with Andrew Figura Group Manager, Division of Research and Statistics, Board of Governors Jeffrey M. Lacker President of the Federal Reserve Bank of Richmond, as alternate. Michele Cavallo Senior Economist, Division of International Finance, Board of Governors Sandra Pianalto President of the Federal Reserve Bank of Cleveland, with Yuriy Kitsul Economist, Division of Monetary Affairs, Board of Governors Charles L. Evans President of the Federal Reserve Bank of Chicago, as alternate. Randall A. Williams Records Project Manager, Division of Monetary Affairs, Board of Governors Richard W. Fisher President of the Federal Reserve Bank of Dallas, with Kenneth C. Montgomery First Vice President, Federal Reserve Bank of Boston Dennis P. Lockhart President of the Federal Reserve Bank of Atlanta, as alternate. David Altig, Glenn D. Rudebusch, and Daniel G. Sullivan Executive Vice Presidents, Federal Reserve Banks of Atlanta, San Francisco, and Chicago, respectively Troy Davig, Geoffrey Tootell, and Christopher J. Waller Senior Vice Presidents, Federal Reserve Banks of Kansas City, Boston, and St. Louis, respectively Robert L. Hetzel Senior Economist, Federal Reserve Bank of Richmond Annual Organizational Matters1 In the agenda for this meeting, it was reported that advices of the election of the following members and alternate members of the Federal Open Market Committee (the “Committee”) for a term beginning January 28, 2014, had been received and that these individuals had executed their oaths of office. The elected members and alternate members were as follows: 1 Versions of the current Committee documents are available at www.federalreserve.gov/monetarypolicy/rules_authorizations .htm. Narayana Kocherlakota President of the Federal Reserve Bank of Minneapolis, with John C. Williams President of the Federal Reserve Bank of San Francisco, as alternate. By unanimous vote, the Committee selected Ben Bernanke to serve as Chairman through January 31, 2014, and Janet L. Yellen to serve as Chairman, effective February 1, 2014, until the selection of her successor at the first regularly scheduled meeting of the Committee in 2015. By unanimous vote, the following officers of the Committee were selected to serve until the selection of their successors at the first regularly scheduled meeting of the Committee in 2015: William C. Dudley Vice Chairman William B. English Secretary and Economist Matthew M. Luecke Deputy Secretary 132 101st Annual Report | 2014 Michelle A. Smith Assistant Secretary Scott G. Alvarez General Counsel Thomas C. Baxter Deputy General Counsel Richard M. Ashton Assistant General Counsel Steven B. Kamin Economist David W. Wilcox Economist James A. Clouse Thomas A. Connors Evan F. Koenig Thomas Laubach Michael P. Leahy Loretta J. Mester Paolo A. Pesenti Samuel Schulhofer-Wohl Mark E. Schweitzer William Wascher 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, the Authorization for Domestic Open Market Operations was approved with an amendment that makes the structure of paragraphs 1.A and 1.B more similar. The Guidelines for the Conduct of System Open Market Operations in Federal-Agency Issues remained suspended. Authorization for Domestic Open Market Operations (As Amended Effective January 28, 2014) 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 in the open market 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, 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; and 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. The Federal Open Market Committee authorizes the Federal Reserve Bank of New York to undertake transactions of the type described in paragraphs 1.A and 1.B from time to time for the purpose of testing operational readiness. The aggregate par value of such transactions of the type described in paragraph 1.A shall not exceed $5 billion per calendar year. The outstanding amount of such transactions of the type described in paragraph 1.B shall not exceed $5 billion at any given time. These transactions shall be conducted with prior notice to the Committee. 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 use agents in agency MBS-related transactions. 4. 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. Minutes of Federal Open Market Committee Meetings | January 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 that 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. 5. In order to ensure the effective conduct of open market operations, while assisting in the provision of short-term investments or other authorized services 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 the 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; B. For the 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 arrange corresponding sale and repurchase agreements between its own account and such foreign, international, and 133 fiscal agency accounts maintained at the Federal Reserve Bank; and C. For the New York Bank account, when appropriate, to buy U.S. government securities and obligations that are direct obligations of, or fully guaranteed as to principal and interest by, any agency of the United States from such foreign and international accounts maintained at the Federal Reserve Bank under agreements providing for the repurchase by such accounts of those securities on the same business day. Transactions undertaken with such accounts under the provisions of this paragraph may provide for a service fee when appropriate. 6. 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 (i) 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 or (ii) undertake transactions of the type described in paragraphs 1.A and 1.B in order to appropriately address temporary disruptions of an operational or highly unusual nature in U.S. dollar funding markets. Any such adjustment as described in clause (i) shall be made in the context of the Committee’s discussion and decision at its most recent meeting and the Committee’s longrun objectives to foster maximum employment and price stability, 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 instruction under this paragraph. The Committee voted unanimously to amend the Authorization for Foreign Currency Operations, the Foreign Currency Directive, and the Procedural Instructions with Respect to Foreign Currency Operations in the form shown below. The approval of these documents included approval of the System’s warehousing agreement with the U.S. Treasury. These 134 101st Annual Report | 2014 documents were modified to incorporate the dollar and foreign currency liquidity swap arrangements authorized by a resolution on October 29, 2013. Changes were made to the Authorization for Foreign Currency Operations and the Procedural Instructions with Respect to Foreign Currency Operations to align the treatment of the liquidity swap arrangements and that of the reciprocal currency arrangements that have been in place with the central banks of Mexico and Canada since 1994 as part of the North American Framework Agreement. The Authorization for Foreign Currency Operations was amended to remove language regarding the transmission of pertinent information on System foreign currency operations to appropriate officials of the Treasury Department because this language duplicated language in the Program for Security of FOMC Information. Authorization for Foreign Currency Operations (As Amended Effective January 28, 2014) 1. The Federal Open Market Committee authorizes and directs the Federal Reserve Bank of New York, for the 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: 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 arrangements listed in paragraph 2 below, in accordance with the Procedural Instructions with Respect to Foreign Currency Operations. 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 for the System Open Market Account (subject to the requirements of section 214.5 of Regulation N, Relations with Foreign Banks and Bankers): A. Reciprocal currency arrangements with the following foreign banks: Foreign bank Australian dollars Brazilian reais Canadian dollars Danish kroner euro Japanese yen Korean won Mexican pesos New Zealand dollars Norwegian kroner Pounds sterling Singapore dollars Amount of arrangement (millions of dollars equivalent) Bank of Canada Bank of Mexico 2,000 3,000 B. Standing dollar liquidity swap arrangements with the following foreign banks: Bank of Canada Bank of England Bank of Japan European Central Bank Swiss National Bank Minutes of Federal Open Market Committee Meetings | January C. Standing foreign currency liquidity swap arrangements with the following foreign banks: Bank of Canada Bank of England Bank of Japan European Central Bank Swiss National Bank Dollar and foreign currency liquidity swap arrangements have no pre-set size limits. Any new swap arrangements shall be referred for review and approval to the Committee. All swap arrangements are subject to annual review and approval by 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 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 135 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 member, 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. 136 101st Annual Report | 2014 8. 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. 9. The Federal Open Market Committee authorizes the Federal Reserve Bank of New York to undertake transactions of the type described in paragraphs 1, 2, and 5, and foreign exchange and investment transactions that it may be otherwise authorized to undertake from time to time for the purpose of testing operational readiness. The aggregate amount of such transactions shall not exceed $2.5 billion per calendar year. These transactions shall be conducted with prior notice to the Committee. Foreign Currency Directive (As Amended Effective January 28, 2014) 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 arrangements with foreign central banks in accordance with the Authorization for Foreign Currency Operations. C. Maintain standing dollar liquidity swap arrangements with foreign banks in accordance with the Authorization for Foreign Currency Operations. D. Maintain standing foreign currency liquidity swap arrangements with foreign banks in accordance with the Authorization for Foreign Currency Operations. E. 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 (As Amended Effective January 28, 2014) In conducting operations pursuant to the authorization and direction of the Federal Open Market Committee (the “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 (the “Subcommittee”), and the Chairman of the Committee, unless otherwise directed by the Committee. All operations undertaken pursuant to such clearances shall be reported promptly to the Committee. 1. For the reciprocal currency arrangements authorized in paragraphs 2.A of the Authorization for Foreign Currency Operations: A. Drawings must be approved by the Subcommittee (or by the Chairman, if the Chairman believes that consultation with the Subcommittee is not feasible in the time available) if the swap drawing proposed by a foreign bank does not exceed the larger of (i) $200 million Minutes of Federal Open Market Committee Meetings | January or (ii) 15 percent of the size of the swap arrangement. B. Drawings must be approved by the Committee (or by the Subcommittee, if the Subcommittee believes that consultation with the full Committee is not feasible in the time available, or by the Chairman, if the Chairman believes that consultation with the Subcommittee is not feasible in the time available) if the swap drawing proposed by a foreign bank exceeds the larger of (i) $200 million or (ii) 15 percent of the size of the swap arrangement. C. The manager shall also consult with the Subcommittee or the Chairman about proposed swap drawings by the System. D. Any changes in the terms of existing swap arrangements shall be referred for review and approval to the Chairman. The Chairman shall keep the Committee informed of any changes in terms, and the terms shall be consistent with principles discussed with and guidance provided by the Committee. 2. For the dollar and foreign currency liquidity swap arrangements authorized in paragraphs 2.B and 2.C of the Authorization for Foreign Currency Operations: A. Drawings must be approved by the Chairman in consultation with the Subcommittee. The Chairman or the Subcommittee will consult with the Committee prior to the initial drawing on the dollar or foreign currency liquidity swap lines if possible under the circumstances then prevailing; authority to approve subsequent drawings for either the dollar or foreign currency liquidity swap lines may be delegated to the manager by the Chairman. B. Any changes in the terms of existing swap arrangements shall be referred for review and approval to the Chairman. The Chairman shall keep the Committee informed of any changes in terms, and the terms shall be consistent with principles discussed with and guidance provided by the Committee. 3. Any operation must be approved by: 137 A. The Subcommittee (or by the Chairman, if the Chairman believes that consultation with the Subcommittee is not feasible in the time available) if it: i. 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. ii. 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. iii. 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 (as defined in paragraph 1.D of the Authorization for Foreign Currency Operations) might be less than the limits specified in 3.A.ii. B. The Committee (or by the Subcommittee, if the Subcommittee believes that consultation with the full Committee is not feasible in the time available, or by the Chairman, if the Chairman believes that consultation with the Subcommittee is not feasible in the time available) if it 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. 4. The Committee authorizes the Federal Reserve Bank of New York to undertake transactions of the type described in paragraphs 1, 2, and 5 of the Authorization for Foreign Currency Operations and foreign exchange and investment transactions that it may be otherwise authorized to undertake from time to time for the purpose of testing operational readiness. The aggregate amount of such transactions shall not exceed $2.5 billion per calendar year. These transactions shall be conducted with prior notice to the Committee. In its annual reconsideration of the Statement on Longer-Run Goals and Monetary Policy Strategy, participants generally agreed that only minor updates 138 101st Annual Report | 2014 were required at this meeting. It was noted, however, that because this was the third year in which the statement was being issued, the coming year would be an appropriate time to consider whether the statement could be enhanced in any way. For example, some participants advocated an explicit indication that inflation persistently below the Committee’s 2 percent longer-run objective and inflation persistently above that objective would be equally undesirable. Some others suggested that the statement could more clearly describe how the mandated goals of maximum employment and price stability are linked with the objective of financial stability. Following the discussion, the Committee voted to approve minor wording changes to the statement and to update the statement’s reference to participants’ estimates of the longer-run normal unemployment rate. Mr. Tarullo abstained from the vote because he continued to think that the statement had not advanced the cause of communicating or achieving greater consensus in the policy views of the Committee. Statement on Longer-Run Goals and Monetary Policy Strategy (As Amended Effective January 28, 2014) “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 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 reaffirms its judgment 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 5.8 percent. 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. Minutes of Federal Open Market Committee Meetings | January The Committee intends to reaffirm these principles and to make adjustments as appropriate at its annual organizational meeting each January.” By unanimous vote, the Committee amended its Rules of Organization to add the position of deputy manager of the System Open Market Account. By unanimous vote, the Committee amended its Program for Security of FOMC Information with minor changes to the review and reporting process for breaches in the information security rules and with several other minor updates and clarifications. By unanimous vote, the Committee selected Simon Potter and Lorie K. Logan to serve at the pleasure of the Committee as manager and deputy manager of the System Open Market Account, respectively, on the understanding that their selection was subject to their being satisfactory to the Federal Reserve Bank of New York. Secretary’s note: Advice subsequently was received that the manager and deputy manager selections indicated above were satisfactory to the 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 as well as System open market operations during the period since the Federal Open Market Committee met on December 17–18, 2013. The manager also presented an update on the ongoing overnight reverse repurchase agreement (ON RRP) exercise. All operations to date had proceeded smoothly. The number of participating counterparties and total allotment in the daily operations increased in late December, in part reflecting the fact that overnight secured rates were low compared with the fixed rate offered in the operations as well as the increase in the cap on individual counterparty bids to $3 billion from $1 billion that was implemented on December 23, 2013. Counterparties’ year-end balance sheet adjustments also boosted participation for a time; the ON RRP operations reportedly helped limit downward pressure on money market rates around year-end. Following the manager’s report, meeting participants discussed a proposal to extend the Desk’s authority to conduct the ON RRP exercise for 12 months and 139 to lift the per-counterparty bid limit. Under the terms of the proposal, the interest rate on ON RRPs would remain between 0 and 5 basis points. The Chair of the FOMC would authorize any changes in the offered rate or per-counterparty bid limit. Adjustments to the bid limit would be made in gradual steps, and the Committee would be consulted before the exercise would move to full allotment. The proposed changes were intended to allow the Committee to obtain additional information about the potential usefulness of ON RRP operations for affecting market interest rates when that step becomes appropriate. Most meeting participants supported the proposal, with a couple emphasizing that the period for which the exercise would be extended was likely sufficiently long that counterparties would be willing to adjust their current money market practices, thereby providing better information on the possible market effects of such operations. It was remarked that the additional insights obtained from the exercise could be useful in the context of the Committee’s future discussions about monetary policy implementation over the medium and longer term. A number of participants, however, indicated a preference for retaining a cap on the per-counterparty bid limit until the Committee has discussed possible approaches to mediumterm policy implementation, and a few of these participants preferred to extend the exercise for a shorter period. Following the discussion, the Committee approved the following resolution: “The Federal Open Market Committee (FOMC) authorizes the Federal Reserve Bank of New York to conduct a series of fixed-rate, overnight reverse repurchase operations involving 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 purpose of further assessing the potential role for such operations in supporting the implementation of monetary policy. The reverse repurchase operations authorized by this resolution shall be offered at a fixed rate that may vary from zero to five basis points, and for an overnight term, or such longer term as is warranted to accommodate weekend, holiday, and similar trading conventions. Any change to the offered rate within the range specified above or the per-counterparty bid limits will require approval of the Chairman. The System Open Market Account manager will notify the FOMC in advance about any changes to the terms of 140 101st Annual Report | 2014 operations. These operations shall be authorized through January 30, 2015.” Messrs. Fisher and Plosser dissented because of their preference for retaining a cap on the maximum size of counterparties’ offers during the extension; Mr. Plosser also preferred a shorter extension of the exercise. 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. Staff Review of the Economic Situation The information reviewed for the January 28–29 meeting indicated that the rate of economic growth picked up in the second half of 2013. Total payroll employment increased in December, but at a slower pace than in previous months, and the unemployment rate declined but was still elevated. Consumer price inflation continued to run below the Committee’s longer-run objective, while measures of longerterm inflation expectations remained stable. Overall, labor market indicators appeared consistent with a gradual ongoing improvement in labor market conditions. Total nonfarm payroll employment expanded by less in December than in the previous two months, perhaps partly because of unusually bad weather. The unemployment rate declined to 6.7 percent in December. The labor force participation rate also decreased, and the employment-to-population ratio was little changed. The rate of long-duration unemployment declined, but the share of workers employed part time for economic reasons was little changed, and both measures remained elevated. Among other indicators of labor market conditions, the rate of job openings edged up in recent months, and the share of small businesses reporting that they had hard-to-fill positions trended up. Measures of firms’ hiring plans were higher than a year earlier, but the rate of gross private-sector hiring was still low. Initial claims for unemployment insurance moved down, on balance, over the intermeeting period, and household expectations of the labor market situation improved, on net, in December and early January. Manufacturing production increased at a robust pace in the fourth quarter, with broad-based gains across industries. Indicators of manufacturing production, such as the readings on new orders from national and regional manufacturing surveys, were consistent with a further expansion in factory output early this year, but automakers’ production schedules indicated that the pace of light motor vehicle assemblies would decline in the first quarter. Real personal consumption expenditures (PCE) rose at a faster pace in October and November than in the third quarter. In December, the components of the nominal retail sales data used by the Bureau of Economic Analysis to construct its estimate of PCE increased strongly, although sales of light motor vehicles declined after posting a large gain in November. Recent information on several important factors that influence household spending was somewhat mixed. Households’ real disposable income was little changed in October and November, and the expiration of the emergency unemployment compensation program at the end of 2013 was expected to reduce aggregate income growth early this year. However, households’ net worth likely continued to expand in recent months as a result of rising equity prices and home values. Consumer sentiment in the Thomson Reuters/University of Michigan Surveys of Consumers improved, on balance, in December and early January after a decline in the fall of 2013. The pace of activity in the housing sector showed some tentative signs of stabilizing, as the effects of the past year’s rise in mortgage rates appeared to wane. Single-family housing starts increased in November and only partly reversed that gain in December, while permits for new construction rose a little, on balance, in the fourth quarter. New home sales declined in November and December but were nonetheless higher than in the third quarter, and existing home sales flattened out in December after decreasing for several months. Real private expenditures for business equipment and intellectual property products appeared to strengthen in the fourth quarter, as nominal shipments of nondefense capital goods rose at a solid pace. Although nominal new orders for these capital goods declined in December and November’s increase was revised down, the level of orders remained above that of shipments, pointing to further increases in shipments in subsequent months. Other forward-looking indicators, such as surveys of business conditions and capital spending plans, were also generally consistent with near-term gains in business equipment spending. Nominal expenditures for nonresidential construction, which had been flat in October, moved higher in Minutes of Federal Open Market Committee Meetings | January November. Data on book-value inventories suggested little change in the pace of nonfarm inventory investment in the fourth quarter, and the available information did not point to significant inventory imbalances in most industries. Real federal government purchases likely fell sharply in the fourth quarter because of continued declines in defense spending and the temporary partial shutdown of the federal government in October. Increases in real state and local government purchases appeared to have moderated in the fourth quarter. The payrolls of these governments were about unchanged during the fourth quarter, and nominal state and local construction expenditures for October and November increased at a slower pace, on net, than in the third quarter. The U.S. international trade deficit narrowed substantially in November, as exports increased and imports fell. The higher value of exports stemmed in large part from an increase in sales of petroleum products, while the fall in imports was primarily due to a decline in purchases of crude oil. Total U.S. consumer price inflation, as measured by the PCE price index, was a little under 1 percent over the 12 months ending in November, well below the Committee’s 2 percent longer-term objective. Over that period, consumer energy prices declined, consumer food prices rose modestly, and core PCE prices—which exclude consumer food and energy prices—increased slightly more than 1 percent. In December, the consumer price index (CPI) rose somewhat faster than in recent months, primarily reflecting an upturn in consumer energy prices; core CPI inflation remained low. Both near-term and longer-term inflation expectations from the Michigan survey were little changed, on net, in December and early January. Over the 12 months ending in December, nominal average hourly earnings for all employees increased slightly faster than consumer price inflation. Foreign economic activity continued to improve, with economic growth in the third quarter of 2013 higher than in the first half of the year and more recent indicators suggesting further gains. The pickup was widespread, as the euro area registered a second consecutive quarter of positive economic growth, the Mexican economy bounced back from a secondquarter contraction, and stronger external demand boosted growth in emerging market economies more generally. At the same time, inflation continued to 141 run below central bank targets in several advanced economies, and monetary policy remained expansionary in these economies. Inflation in emerging market economies remained moderate on average, although Brazil, India, and Turkey again tightened monetary policy during the intermeeting period in response to concerns about inflation and currency depreciation. The policy tightening in Turkey was particularly sharp and followed several days of heightened financial market pressures toward the end of the intermeeting period. Similar pressures were evident in some other emerging market economies as well. Staff Review of the Financial Situation Financial market conditions over the intermeeting period were importantly influenced by Federal Reserve communications, somewhat better-thanexpected economic data releases, and developments in emerging market economies. On net, financial conditions in the United States remained supportive of growth in economic activity and employment: Equity prices increased a bit, longer-term interest rates declined, and the dollar appreciated against most other currencies. While investors were somewhat surprised by the FOMC’s decision at its December meeting to reduce the pace of its asset purchases, the policy action and associated communications appeared to have only a limited effect on market participants’ outlook for the Federal Reserve’s balance sheet. Indeed, the Committee’s decision to cut the pace of purchases and its rationale for doing so seemed to increase investors’ confidence in the economic outlook, a shift that was further supported by subsequent U.S. economic data releases. However, those effects were reversed late in the period when investors appeared to pull back from riskier assets in reaction to rising concern about developments in some emerging market economies and their possible implications for global economic growth. Results from the Desk’s survey of primary dealers conducted prior to the January meeting indicated that dealers anticipated only minor changes to the Committee’s postmeeting statement. In addition, the median dealer expected a $10 billion reduction in the monthly pace of asset purchases to be announced at each meeting in the first three quarters of 2014, with the purchase program ending with a final $15 billion reduction at the October 2014 meeting. 142 101st Annual Report | 2014 On balance, 10-and 30-year nominal Treasury yields declined about 10 basis points and 20 basis points, respectively, over the intermeeting period, in part because of an increase in safe-haven demands toward the end of the period. The December policy action and subsequent muted market reaction led to decreased uncertainty about future longer-term interest rates, perhaps contributing to the decline in longer-term rates. The measure of 5-year inflation compensation based on Treasury inflation-protected securities increased a little, while inflation compensation 5 to 10 years ahead decreased somewhat. Conditions in short-term dollar funding markets generally remained stable. Year-end funding pressures were modest, and overnight money market rates declined about in line with their typical behavior in past years. Repo rates were quite low at the end of the year and remained low through most of January, leading to increased participation in the Federal Reserve’s ON RRP operations, with a substantial temporary increase in take-up at year-end. Primarily reflecting the increased participation in the exercise, reserve balances expanded more slowly and the rate of increase in the monetary base slowed in December. M2 continued to expand moderately. Reflecting the improved outlook for economic activity and despite mixed fourth-quarter earnings results, the stock prices of bank holding companies rose notably and spreads on credit default swaps for the largest bank holding companies narrowed somewhat. According to the January Senior Loan Officer Opinion Survey on Bank Lending Practices, domestic banks continued to ease their lending standards and some loan terms on balance; they also experienced an increase in demand, on net, in most major loan categories in the fourth quarter. Broad U.S. equity price indexes edged higher, on net, over the intermeeting period, and equity issuance by nonfinancial corporations increased. Credit remained widely available to large nonfinancial corporations. Corporate bond spreads continued to narrow over the intermeeting period, with investment-grade bond spreads reaching their lowest levels in several years and those on speculative-grade corporate bonds approaching pre-crisis levels. Bond issuance by domestic corporations generally stayed strong, commercial and industrial loans on banks’ books increased by a notable amount late in the fourth quarter, and issuance of leveraged loans and collateralized loan obligations generally continued apace. Conditions in the commercial real estate sector recovered further in the fourth quarter, with rising property prices and fewer distressed sales. In the market for commercial mortgage-backed securities, investor demand remained strong and spreads continued to be tight despite high issuance near year-end. Commercial real estate loans on banks’ books expanded moderately. Credit conditions in municipal bond markets generally remained stable, although a few issuers continued to experience substantial strain. Available data suggest that, for the first time in several years, the ratings agency Moody’s Investors Service made more upgrades than downgrades to municipal debt in the fourth quarter. However, Moody’s put Puerto Rico on watch for a downgrade. Households continued to face mixed credit conditions in the fourth quarter. Consumer credit expanded again in November, boosted by further gains in auto and student loans, and bank credit data indicate that this expansion likely continued through December. In contrast, credit card balances were little changed, on net, through November, as underwriting appeared to remain quite tight. The volume of mortgage applications for home purchases held about steady since the previous FOMC meeting while refinance applications remained at very low levels. Mortgage rates declined slightly, in line with modestly lower yields on agency mortgage-backed securities. Despite tight mortgage availability and subdued borrowing, house prices continued to increase in November, although not as quickly as earlier in 2013. Financial market conditions in the advanced foreign economies over the intermeeting period generally became more supportive of growth. Long-term government bond yields declined and headline equity indexes increased, on net, in most of these countries, with bank stock prices in the euro area rising more than broader indexes. In addition, debt issuance by both governments and banks in the European periphery picked up, and sovereign yield spreads in those countries were flat to down, on balance, over the period. In contrast, amid a ratcheting-up of financial market strains in some emerging market economies, headline stock price indexes in most emerging market economies declined, outflows from emerging market mutual funds continued, and yield spreads on dollar-denominated emerging market bonds increased. Local-currency yields rose in some emerging market economies, such as Brazil, South Minutes of Federal Open Market Committee Meetings | January Africa, and Turkey, and short-term interbank rates in China were volatile and trended higher over the period. The foreign exchange value of the dollar appreciated against most other currencies over the period, with particularly large increases against the Argentine peso and the Turkish lira. Staff Economic Outlook In the economic projection prepared by the staff for the January FOMC meeting, growth of real gross domestic product (GDP) in the second half of 2013 was estimated to have been stronger than the staff had expected, though some of the strength in inventory investment and net exports was possibly transitory. The staff’s medium-term forecast for real GDP growth was little revised, on balance, as the momentum implied by faster GDP growth in the second half of 2013 was largely offset by a higher projected path for the foreign exchange value of the dollar. In addition, the staff revised downward its view of the pace at which potential output had increased over recent years and would increase this year and next. The staff continued to project that real GDP would expand more quickly over the next few years than in 2013 and that real GDP would rise faster than potential output. This acceleration in economic activity was expected to be supported by still-accommodative monetary policy and an easing in the effects of fiscal policy restraint on economic growth, as well as by increases in consumer and business confidence, further improvements in credit availability and financial conditions, and continued gains in foreign economic growth. The expansion in economic activity was anticipated to lead to a slow reduction in resource slack over the projection period, and the unemployment rate was expected to decline gradually, reaching the staff’s estimate of its longer-run natural rate in 2016. The staff’s forecast for inflation was little changed from the projection prepared for the previous FOMC meeting, although the near-term forecast was revised down a little to reflect recent declines in energy prices. The staff continued to forecast that inflation would run well below the Committee’s 2 percent objective early this year but above the low level observed over much of 2013. Over the medium term, with longer-run inflation expectations assumed to remain stable, changes in commodity and import prices expected to be muted, and slack in labor and product markets receding gradually, inflation was projected to move back slowly toward the Committee’s objective. 143 In considering recent events in emerging market economies, the staff judged that the effects of recent financial market volatility had not been large enough to have a material effect on the overall outlook for those economies and, similarly, that the spillover effects on the United States of developments to date were likely to be modest. Because conditions were in flux, however, these markets would require careful monitoring. The staff continued to see a number of risks around its outlook. The downside risks to the forecast for real GDP growth were thought to have diminished, but the risks were still seen as tilted a little to the downside because, with the target federal funds rate at its effective lower bound, the economy was not well positioned to withstand future adverse shocks. At the same time, the staff viewed the risks around its outlook for the unemployment rate and for inflation as roughly balanced. Participants’ Views on Current Conditions and the Economic Outlook In their discussion of the economic situation and the outlook, participants generally noted that economic activity had strengthened more in the second half of 2013 than they had expected at the time of the December meeting. In particular, consumer spending had strengthened, and business investment appeared to be on a more solid uptrend. Although the government shutdown likely damped economic growth somewhat, the extent of restraint on growth from fiscal policy diminished late in the year. However, several participants observed that temporary factors had helped boost real GDP during the second half, pointing specifically to the substantial contributions from net exports and increased inventory investment. As a result, participants generally did not expect the recent pace of economic growth to be sustained, but they nonetheless anticipated that the economy would expand at a moderate pace in coming quarters. That expansion was expected to be supported by highly accommodative monetary policy, a further easing of fiscal restraint, and a modest additional pickup in global economic growth, as well as continued improvement in credit conditions and the ongoing strengthening in household balance sheets. A number of participants noted that recent economic news had reinforced their confidence in their projection of moderate economic growth over the medium run. It was also noted that recent developments in several emerging market economies, if they continued, could pose downside risks to the outlook. Overall, most 144 101st Annual Report | 2014 participants still viewed the risks to the outlook for the economy and the labor market as having become more nearly balanced in recent months. Consumer spending had advanced strongly in late 2013, contributing importantly to the pickup in growth of economic activity. This picture was reinforced by survey data that suggested that consumers had become more optimistic about future income gains. While noting that households remained cautious, participants cited a number of factors that were likely to continue to underpin gains in household spending, including rising house prices, growing confidence in the sustainability of the economic expansion, increasing payrolls, and the high ratio of household wealth to disposable income. Although the recovery in the housing sector had slowed somewhat in recent months, a number of participants reported solid activity in their Districts. Moreover, various factors were seen as likely to support stronger growth in the sector going forward, including favorable housing affordability, which was in turn partly due to still-low mortgage rates, and demographic trends. However, there were also reasons for being cautious about the prospects for housing construction, such as recent disappointing news on permits for new construction and the possibility that investors’ interest in purchasing properties for the rental market would recede. Business contacts in many parts of the country reported that they were guardedly optimistic about prospects for 2014. While inventory investment would likely come down from its recent unusually high level, participants heard more reports that the business sector was willing to increase spending on capital projects. A number of factors were cited as likely to support such an increase, including the high level of profits, the low level of interest rates, a reduction in policy uncertainty, the easing of lending standards, and large holdings of liquid assets by corporations. In discussing financial developments over the intermeeting period, several participants noted that the Committee’s December decision to make a modest reduction in the monthly pace of asset purchases had not resulted in an adverse market reaction. Several participants observed that current market expectations for asset purchases and the future course of the federal funds rate were reasonably well aligned with participants’ own expectations of the path for policy. However, one participant expressed concern that longer-term interest rates could rise sharply if market participants’ expectations of future monetary policy came to deviate from those of policymakers, as appeared to have happened last summer, while a couple of others argued that the current highly accommodative stance of monetary policy could lead investors to take on excessive risk and so undermine longer-term financial stability. Recent volatility in emerging markets appeared to have had only a limited effect to date on U.S. financial markets. Nevertheless, participants agreed that a number of developments in financial markets needed to be watched carefully, including the financing situation of the Puerto Rican government and particularly the unfolding events in emerging markets. In their discussion of recent labor market developments, many participants commented on the relatively small increase in payrolls in December and the further decline in the unemployment rate. A number of participants indicated that the December payrolls figure may have been an anomaly, perhaps importantly reflecting bad weather, and it was noted that the initial readings on payrolls in recent years had subsequently tended to be revised up. In addition, some participants reported that their business contacts had become more positive about hiring in the year ahead. Participants continued to debate the reliability of the unemployment rate as an indicator of overall labor market conditions, taking into account the further decline in labor force participation in recent quarters, still-elevated levels of underemployment and long-term unemployment, and the apparent absence of wage pressures. Much of the downward trend in the labor force participation rate since the start of the recession was seen as the result of shifts in the demographic composition of the workforce and the retirement of older workers; the extent of the cyclical portion of the decline was viewed by some as difficult to gauge at present. A few participants judged that the decline in participation for younger and prime-age workers likely reflected the slow recovery in jobs and wages and so might be reversed as labor market conditions strengthened. In addition, several others pointed out that broader concepts of the unemployment rate, such as those that include nonparticipants who report that they want a job and those working part time who want full-time work, remained well above the official unemployment rate, suggesting that considerable labor market slack remained despite the reduction in the unemployment rate. A few participants noted worker shortages in specific regions and occupations, with one District reporting widespread shortages of Minutes of Federal Open Market Committee Meetings | January skilled labor leading to emerging labor cost pressures. However, a number of participants saw the low rates of increase in most measures of wages as consistent with continued labor market slack. Inflation remained below the Committee’s longer-run objective over the intermeeting period. Participants still anticipated that, with longer-run inflation expectations stable, transitory factors that had been damping inflation likely to recede, and economic activity picking up, inflation would move back toward the Committee’s 2 percent objective over the medium run. However, several factors that cast doubt on this outcome were also mentioned, including slow growth in labor costs, the lack of pricing power reported by business contacts in various parts of the country, the low level of inflation in other advanced economies, and the danger that inflation expectations at short and medium horizons might not be as well anchored as longer-run inflation expectations. Participants noted that inflation persistently below the Committee’s objective would pose risks to economic performance and that inflation developments would need to be monitored carefully. In their discussion of the path for monetary policy, most participants judged that the incoming information about the economy was broadly in line with their expectations and that a further modest step down in the pace of purchases was appropriate. A couple of participants observed that continued low readings on inflation and considerable slack in the labor market raised questions about the desirability of reducing the pace of purchases; these participants judged, however, that a pause in the reduction of purchases was not justified at this stage, especially in light of the strength of the economy in the second half of 2013. Several participants argued that, in the absence of an appreciable change in the economic outlook, there should be a clear presumption in favor of continuing to reduce the pace of purchases by a total of $10 billion at each FOMC meeting. That said, a number of participants noted that if the economy deviated substantially from its expected path, the Committee should be prepared to respond with an appropriate adjustment to the trajectory of its purchases. Participants agreed that, with the unemployment rate approaching 6½ percent, it would soon be appropriate for the Committee to change its forward guidance in order to provide information about its decisions regarding the federal funds rate after that threshold was crossed. A range of views was expressed about 145 the form that such forward guidance might take. Some participants favored quantitative guidance along the lines of the existing thresholds, while others preferred a qualitative approach that would provide additional information regarding the factors that would guide the Committee’s policy decisions. Several participants suggested that risks to financial stability should appear more explicitly in the list of factors that would guide decisions about the federal funds rate once the unemployment rate threshold is crossed, and several participants argued that the forward guidance should give greater emphasis to the Committee’s willingness to keep rates low if inflation were to remain persistently below the Committee’s 2 percent longer-run objective. Additional proposals included relying to a greater extent on the Summary of Economic Projections as a communications device and including in the guidance an indication of the Committee’s willingness to adjust policy to lean against undesired changes in financial conditions. A few participants raised the possibility that it might be appropriate to increase the federal funds rate relatively soon. One participant cited evidence that the equilibrium real interest rate had moved higher, and a couple of them noted that some standard policy rules tended to suggest that the federal funds rate should be raised above its effective lower bound before the middle of this year. Other participants, however, suggested that prescriptions from standard policy rules were not appropriate in current circumstances, either because the target federal funds rate had been constrained by the lower bound for some time or because the equilibrium real rate of interest was likely still being held down by various factors, including the lingering effects of the financial crisis, and was significantly below the value of the longer-run rate built into standard policy rules. Committee Policy Action Committee members saw the information received over the intermeeting period as indicating that growth in economic activity had picked up in recent quarters. Labor market indicators were mixed but on balance showed further improvement. The unemployment rate had declined but remained elevated when judged against members’ estimates of the longer-run normal rate of unemployment. Household spending and business fixed investment had advanced more quickly in recent months than earlier in 2013, while the recovery in the housing sector had slowed somewhat. Fiscal policy was restraining economic growth, although the extent of the restraint 146 101st Annual Report | 2014 had diminished. The Committee expected that, with appropriate policy accommodation, the economy would expand at a moderate pace and the unemployment rate would gradually decline toward levels consistent with the dual mandate. Moreover, members continued to judge that the risks to the outlook for the economy and the labor market had become more nearly balanced. Inflation was running below the Committee’s longer-run objective, and this was seen as posing possible risks to economic performance, but members anticipated that stable inflation expectations and strengthening economic activity would, over time, return inflation to the Committee’s 2 percent objective. However, in light of their concerns about the persistence of low inflation, many members saw a need for the Committee to monitor inflation developments carefully for evidence that inflation was moving back toward its longer-run objective. In considering forward guidance about the target federal funds rate, all members agreed to retain the thresholds-based language employed in recent statements. In addition, the Committee decided to repeat the qualitative guidance, introduced in December, clarifying that a range of labor market indicators would be used when assessing the appropriate stance of policy once the unemployment rate threshold had been crossed. Members also agreed to reiterate language indicating the Committee’s anticipation, based on its current assessment of additional measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments, that it would be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6½ percent, especially if projected inflation continues to run below the Committee’s longer-run objective. In their discussion of monetary policy in the period ahead, all members agreed that the cumulative improvement in labor market conditions and the likelihood of continuing improvement indicated that it would be appropriate to make a further measured reduction in the pace of its asset purchases at this meeting. Members again judged that, if the economy continued to develop as anticipated, further reductions would be undertaken in measured steps. Members also underscored that the pace of asset purchases was not on a preset course and would remain contingent on the Committee’s outlook for the labor market and inflation as well as its assessment of the efficacy and costs of purchases. Accordingly, the Committee agreed that, beginning in February, it would add to its holdings of agency mortgagebacked securities at a pace of $30 billion per month rather than $35 billion per month, and would add to its holdings of longer-term Treasury securities at a pace of $35 billion per month rather than $40 billion per month. While making a further measured reduction in its pace of purchases, the Committee emphasized that its holdings of longer-term securities were sizable and would still be increasing, which would promote a stronger economic recovery by maintaining downward pressure on longer-term interest rates, supporting mortgage markets, and helping to make broader financial conditions more accommodative. The Committee also reiterated that it would continue its asset purchases, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability. Members also discussed other elements of the policy statement to be issued following the meeting. Members agreed on updating the description of the state of the economy to reflect the recent strength of household and business spending and to note that, although the labor market showed further improvement on balance, the recent indicators were mixed. Members did not see an appreciable change in the balance of risks and so left the statement’s description of risks unchanged. 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 SOMA in accordance with the following domestic policy directive: “Consistent with its statutory mandate, the Federal Open Market Committee seeks monetary and financial conditions that will foster maximum employment and price stability. In particular, 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 undertake open market operations as necessary to maintain such conditions. Beginning in February, the Desk is directed to purchase longer-term Treasury securities at a pace of about $35 billion per month and to purchase agency mortgage-backed securities at a pace of about $30 billion per month. The Committee also directs the Desk to engage in dollar roll and coupon swap transactions as Minutes of Federal Open Market Committee Meetings | January necessary to facilitate settlement of the Federal Reserve’s agency mortgage-backed securities transactions. The Committee directs the Desk to maintain its policy of rolling over maturing Treasury securities into new issues and its policy of reinvesting principal payments on all agency debt and agency mortgage-backed securities in agency mortgage-backed securities. 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 2:00 p.m.: “Information received since the Federal Open Market Committee met in December indicates that growth in economic activity picked up in recent quarters. Labor market indicators were mixed but on balance showed further improvement. The unemployment rate declined but remains elevated. Household spending and business fixed investment advanced more quickly in recent months, while the recovery in the housing sector slowed somewhat. Fiscal policy is restraining economic growth, although the extent of restraint is diminishing. Inflation has been running below the Committee’s longer-run objective, but 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 that, with appropriate policy accommodation, economic activity will expand at a moderate pace and the unemployment rate will gradually decline toward levels the Committee judges consistent with its dual mandate. The Committee sees the risks to the outlook for the economy and the labor market as having become more nearly balanced. The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, and it is monitoring inflation developments carefully for evidence that inflation will move back toward its objective over the medium term. Taking into account the extent of federal fiscal retrenchment since the inception of its current asset purchase program, the Committee contin- 147 ues to see the improvement in economic activity and labor market conditions over that period as consistent with growing underlying strength in the broader economy. In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions, the Committee decided to make a further measured reduction in the pace of its asset purchases. Beginning in February, the Committee will add to its holdings of agency mortgage-backed securities at a pace of $30 billion per month rather than $35 billion per month, and will add to its holdings of longerterm Treasury securities at a pace of $35 billion per month rather than $40 billion per month. The Committee is maintaining its existing policy 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’s sizable and still-increasing holdings of longer-term securities should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee’s dual mandate. The Committee will closely monitor incoming information on economic and financial developments in coming months and will continue its purchases of Treasury and agency mortgagebacked securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability. If incoming information broadly supports the Committee’s expectation of ongoing improvement in labor market conditions and inflation moving back toward its longer-run objective, the Committee will likely reduce the pace of asset purchases in further measured steps at future meetings. However, asset purchases are not on a preset course, and the Committee’s decisions about their pace will remain contingent on the Committee’s outlook for the labor market and inflation as well as its assessment of the likely efficacy and costs of such purchases. To support continued progress toward maximum employment and price stability, the Com- 148 101st Annual Report | 2014 mittee today reaffirmed its view that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens. The Committee also reaffirmed its expectation that the current exceptionally low target range for the federal funds rate of 0 to ¼ percent will 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 a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored. In determining how long to maintain a highly accommodative stance of monetary policy, the Committee will also consider other information, including additional measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6½ percent, especially if projected inflation continues to run below the Committee’s 2 percent longer-run goal. When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent.” Voting for this action: Ben Bernanke, William C. Dudley, Richard W. Fisher, Narayana Kocherlakota, Sandra Pianalto, Charles I. Plosser, Jerome H. Powell, Jeremy C. Stein, Daniel K. Tarullo, and Janet L. Yellen. Voting against this action: None. It was agreed that the next meeting of the Committee would be held on Tuesday–Wednesday, March 18–19, 2014. The meeting adjourned at 10:55 a.m. on January 29, 2014. Notation Vote By notation vote completed on January 7, 2014, the Committee unanimously approved the minutes of the Committee meeting held on December 17–18, 2013. William B. English Secretary Minutes of Federal Open Market Committee Meetings | March Meeting Held on March 18–19, 2014 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 18, 2014, at 2:00 p.m. and continued on Wednesday, March 19, 2014, at 8:30 a.m. Present Janet L. Yellen Chair William C. Dudley Vice Chairman Richard W. Fisher Narayana Kocherlakota Sandra Pianalto Charles I. Plosser Jerome H. Powell Jeremy C. Stein Daniel K. Tarullo Christine Cumming, Charles L. Evans, Jeffrey M. Lacker, Dennis P. Lockhart, and John C. Williams Alternate Members of the Federal Open Market Committee James Bullard, Esther L. George, and Eric Rosengren Presidents of the Federal Reserve Banks of St. Louis, Kansas City, and Boston, respectively William B. English Secretary and Economist Matthew M. Luecke Deputy 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 149 James A. Clouse, Thomas A. Connors, Evan F. Koenig, Thomas Laubach, Michael P. Leahy, Loretta J. Mester, Samuel Schulhofer-Wohl, Mark E. Schweitzer, and William Wascher Associate Economists Simon Potter Manager, System Open Market Account Lorie K. Logan Deputy Manager, System Open Market Account Michael S. Gibson Director, Division of Banking Supervision and Regulation, Board of Governors Louise L. Roseman Director, Division of Reserve Bank Operations and Payment Systems, Board of Governors Nellie Liang Director, Office of Financial Stability Policy and Research, Board of Governors Stephen A. Meyer and William Nelson Deputy Directors, Division of Monetary Affairs, Board of Governors Jon W. Faust Special Adviser to the Board, Office of Board Members, Board of Governors Trevor A. Reeve Special Adviser to the Chair, Office of Board Members, Board of Governors Ellen E. Meade Senior Adviser, Division of Monetary Affairs, Board of Governors Eric M. Engen, Michael G. Palumbo, and Wayne Passmore Associate Directors, Division of Research and Statistics, Board of Governors Brian J. Gross Special Assistant to the Board, Office of Board Members, Board of Governors Edward Nelson Assistant Director, Division of Monetary Affairs, Board of Governors Jeremy B. Rudd Adviser, Division of Research and Statistics, Board of Governors Stephanie Aaronson Section Chief, Division of Research and Statistics, Board of Governors 150 101st Annual Report | 2014 Laura Lipscomb Section Chief, Division of Monetary Affairs, Board of Governors David H. Small Project Manager, Division of Monetary Affairs, Board of Governors Peter M. Garavuso Records Management Analyst, Division of Monetary Affairs, Board of Governors David Altig, Jeff Fuhrer, Glenn D. Rudebusch, and Daniel G. Sullivan Executive Vice Presidents, Federal Reserve Banks of Atlanta, Boston, San Francisco, and Chicago, respectively Troy Davig, Christopher J. Waller, and John A. Weinberg Senior Vice Presidents, Federal Reserve Banks of Kansas City, St. Louis, and Richmond, respectively Jonathan P. McCarthy, Keith Sill, and Douglas Tillett Vice Presidents, Federal Reserve Banks of New York, Philadelphia, and Chicago, respectively 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 as well as the System open market operations during the period since the Federal Open Market Committee (FOMC) met on January 28–29, 2014. 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. Staff Review of the Economic Situation The information reviewed for the March 18–19 meeting indicated that economic growth slowed early this year, likely only in part because of the temporary effects of the unusually cold and snowy winter weather. Total payroll employment expanded further, while the unemployment rate held steady, on balance, and was still elevated. Consumer price inflation continued to run below the Committee’s longer-run objective, but measures of longer-run inflation expectations remained stable. Total nonfarm payroll employment rose in January and February at a slower pace than in the fourth quarter of last year. The unemployment rate was 6.7 percent in February, the same as in December of last year. The labor force participation rate, along with the employment-to-population ratio, increased, on net, in recent months. Both the share of workers employed part time for economic reasons and the rate of long-duration unemployment were lower in February than they were late last year, although both measures were still high. Initial claims for unemployment insurance were little changed over the intermeeting period. The rate of job openings stepped down, while the rate of hiring was unchanged in December and January. Manufacturing production was roughly flat, on balance, in January and February, in part because of the effects of the severe winter weather, which held down both motor vehicle output and production outside the motor vehicle sector. Automakers’ production schedules indicated that the pace of light motor vehicle assemblies would increase in the second quarter, and broader indicators of manufacturing production, such as the readings on new orders from national manufacturing surveys, were consistent with an expectation of moderate expansion in factory output in the coming months. Real personal consumption expenditures (PCE) increased a little, on net, in December and January. However, the components of the nominal retail sales data used by the Bureau of Economic Analysis to construct its estimate of PCE rose at a faster rate in February than in the previous couple of months, and light motor vehicle sales also moved up. Recent information on key factors that influence household spending, along with the expectation that the weather would return to seasonal norms, generally pointed toward additional gains in PCE in the coming months. Households’ net worth probably continued to expand as equity prices and home values increased further, and consumer sentiment in the Thomson Reuters/University of Michigan Surveys of Consumers during February and early March remained above its average last fall; however, real disposable incomes only edged up, on balance, in December and January. The pace of activity in the housing sector appeared to soften. Starts for both new single-family homes and multifamily units were lower in January and February than at the end of last year. Permits for singlefamily homes—which are typically less sensitive to fluctuations in the weather and a better indicator of the underlying pace of construction—also moved down in those months and had not shown a sus- Minutes of Federal Open Market Committee Meetings | March tained improvement since last spring when mortgage rates began to rise. Sales of existing homes decreased in January and pending home sales were little changed, although new home sales expanded. Growth in real private expenditures for business equipment and intellectual property products stepped up in the fourth quarter to a faster rate than in the third quarter. In January, nominal shipments of nondefense capital goods excluding aircraft decreased slightly. However, new orders for these capital goods increased and remained above the level of shipments in January, pointing to increases in shipments in subsequent months. Other forward-looking indicators, such as surveys of business conditions, also were generally consistent with modest increases in business equipment spending in the near term. Real business spending for nonresidential structures was essentially unchanged in the fourth quarter, and nominal expenditures for such structures were flat in January. Real nonfarm inventory investment increased at a significantly slower pace in the fourth quarter than in the preceding quarter, and recent data on the book value of inventories, along with readings on inventories from national and regional manufacturing surveys, did not point to significant inventory imbalances in most industries; however, days’ supply of light motor vehicles in January and February exceeded the automakers’ targets. Federal spending data in January and February pointed toward real federal government purchases being roughly flat in the first quarter, as the general downtrend in purchases seemed likely to be about offset by a reversal of the effects of the partial government shutdown during the fourth quarter. Total real state and local government purchases also appeared to be about flat going into the first quarter. The payrolls of these governments expanded somewhat, on balance, in January and February, but nominal state and local construction expenditures declined a little in January. The U.S. international trade deficit, after widening in December, remained about unchanged in January. Exports increased in January, but the gains were modest as decreases in sales of cars, petroleum products, and agricultural goods were just offset by gains in other major categories. Imports also rose in January as the increase in the volume of oil imports more than offset declines in imports of non-oil goods and services. 151 Total U.S. consumer price inflation, as measured by the PCE price index, was about 1¼ percent over the 12 months ending in January, continuing to run below the Committee’s longer-run objective of 2 percent. Over the same 12-month period, consumer energy prices rose faster than total consumer prices while consumer food prices only edged up, and core PCE prices—which exclude food and energy prices— increased just a bit more than 1 percent. In February, the consumer price index (CPI) rose at a pace similar to that seen in recent months, as food prices rose more quickly, energy prices declined, and the increase in the core CPI remained slow. Both near- and longer-term inflation expectations from the Michigan survey were little changed in February and early March. Measures of labor compensation indicated that increases in nominal wages remained subdued. Compensation per hour in the nonfarm business sector increased slightly over the year ending in the fourth quarter, and, with some gains in labor productivity, unit labor costs declined a little. Over the same year-long period, the employment cost index and average hourly earnings for all employees rose only a little faster than consumer price inflation. Foreign real gross domestic product (GDP) expanded at a moderate pace in the fourth quarter of 2013, with weak economic growth in Japan and Mexico offsetting stronger gains in many other economies. Recent indicators suggested that total foreign real GDP was expanding at a similar pace in the first quarter of 2014. The economic recovery in the euro area appeared to be continuing, and the pace of Japanese economic growth looked to have picked up. In Canada, however, severe winter weather appeared to have held down economic activity in early 2014. Among the emerging market economies (EMEs), recent data suggested that economic growth in China was slowing in the first quarter, and that the rate of growth in the other Asian economies was also declining from a very robust fourth-quarter pace. Mexican real GDP growth slowed sharply in the fourth quarter, led by a contraction in the manufacturing sector, but recent indicators, such as auto production, suggested some rebound in the pace of economic activity in the current quarter. Inflation increased slightly in some advanced economies but remained well below central banks’ targets. At the same time, inflation declined in some emerging Asian economies. Monetary policy remained highly accommodative in the 152 101st Annual Report | 2014 advanced foreign economies. Across the EMEs, monetary policy adjustments varied according to economic and financial developments, with some central banks tightening policy and others loosening it. Staff Review of the Financial Situation Financial market conditions in the United States over the intermeeting period appeared to have been influenced by an easing of concerns about developments in the EMEs but relatively little affected by the generally weaker-than-expected economic data, which market participants appeared to attribute in large part to the temporary effects of unusually severe winter weather. On balance, U.S. financial conditions remained supportive of growth in economic activity and employment: The expected path of the federal funds rate was little changed, longer-term yields on Treasury securities edged down, equity prices rose, speculative-grade corporate bond spreads narrowed, and the foreign exchange value of the dollar depreciated slightly. FOMC communications over the intermeeting period were about in line with market expectations. The FOMC decision and statement in January were largely anticipated by market participants. The Monetary Policy Report and Chair Yellen’s accompanying congressional testimony in February were viewed as emphasizing continuity in the approach to monetary policy, solidifying expectations that the pace of the Committee’s asset purchases would be reduced by a further $10 billion at each upcoming meeting absent a material change in the economic outlook. Results from the Desk’s Survey of Primary Dealers for March indicated that the dealers’ expectations about both the likely future path of the federal funds rate and Federal Reserve asset purchases were largely unchanged since January. The survey results showed that most dealers expected the Committee to modify its forward rate guidance at the March meeting, with many anticipating a shift toward qualitative guidance. Yields on short- and intermediate-term Treasury securities were little changed, on balance, over the intermeeting period, as the effects of a waning of flight-to-quality demands early in the period roughly offset those of generally weaker-than-expected economic data. Yields on longer-term Treasury securities edged down. Measures of longer-horizon inflation compensation based on Treasury inflation-protected securities also declined somewhat. The Federal Reserve continued its fixed-rate overnight reverse repurchase agreement (ON RRP) exercise. Early in the intermeeting period, market rates on repurchase agreements were close to the fixed rate offered in the exercise, prompting high take-up in the ON RRP operations. The increases in the interest rate offered by the Federal Reserve in its ON RRP exercise, along with the increases in caps for individual bids, also may have contributed to higher levels of activity at daily operations. Later in the period, market rates on repurchase agreements moved higher, apparently in response to a rise in Treasury bill issuance, and ON RRP volumes moderated. Reflecting the larger size of the ON RRP exercises and the reduced pace of asset purchases, the rate of increase in the monetary base slowed over January and February. Conditions in unsecured short-term dollar funding markets remained stable over the intermeeting period. Responses to the March 2014 Senior Credit Officer Opinion Survey on Dealer Financing Terms suggested little change over the past three months in conditions in securities financing and over-thecounter derivatives markets and in credit terms applicable to most classes of counterparties. Broad stock price indexes rose over the intermeeting period, apparently boosted by a solid finish to the corporate earnings season. Equity prices were also supported by a broad increase in investors’ willingness to take riskier positions, in part likely reflecting an easing of concerns about EMEs early in the period. Credit flows to nonfinancial corporations remained robust. Following a slowdown in January, nonfinancial corporate bond issuance rebounded in February, with the majority of proceeds going to investmentgrade firms. The growth of commercial and industrial loans on banks’ balance sheets increased over the period. Institutional issuance of leveraged loans continued at a brisk pace. Financing conditions in the commercial real estate (CRE) sector continued to improve gradually. In the fourth quarter, banks’ CRE loans increased across all major loan categories, and CRE loans on banks’ books advanced at a solid pace in the first two months of the year. Issuance of commercial Minutes of Federal Open Market Committee Meetings | March mortgage-backed securities was robust in February after a slow start in January. Conditions in the municipal bond market remained favorable over the intermeeting period with the spread of municipal yields over yields on comparable-maturity Treasury securities little changed. Although Puerto Rico’s general obligation (GO) bonds were downgraded from investment grade to speculative grade, prices of these bonds held steady, albeit at depressed levels. Puerto Rico successfully brought to market a GO bond issue in early March, substantially easing its near-term liquidity pressures. House prices registered a further notable rise in January. Mortgage interest rates and their spreads over Treasury yields were little changed over the intermeeting period. Both mortgage applications for home purchases and refinancing applications remained at low levels through early March. Financing conditions in residential mortgage markets stayed tight, even as further incremental signs of easing emerged. Conditions in consumer credit markets were still mixed. Auto loans continued to be broadly available, while credit card limits for borrowers with subprime and prime credit scores remained at low levels in the fourth quarter. Partly reflecting these conditions, credit card balances stayed about flat through January, while auto and student loans continued to expand briskly. Issuance of auto and credit card asset-backed securities was robust again in January and February. Financial market sentiment abroad appeared to improve over the period, particularly with respect to the stresses that had developed in some EMEs just prior to the January FOMC meeting. Although global equity price indexes fell abruptly on March 3 amid the deepening of the political crisis in Ukraine, most markets quickly retraced those losses. Consistent with the general improvement in financial market sentiment, most foreign currencies appreciated against the dollar as flight-to-safety flows reversed. One notable exception was the Chinese renminbi, which depreciated against the dollar. The performance of foreign equity price indexes was mixed, on net: Stock prices rose in the EMEs, but they were flat in Europe and declined substantially in Japan. Longer-term sovereign bond yields in the advanced economies fell modestly over the period. 153 Staff Economic Outlook In the economic forecast prepared by the staff for the March FOMC meeting, real GDP growth in the first half of this year was somewhat lower than in the projection for the January meeting. The available readings on consumer spending, residential construction, and business investment pointed to less spending growth in the first quarter than the staff had previously expected. The staff’s assessment was that the unusually severe winter weather could account for some, but not all, of the recent unanticipated weakness in economic activity, and the staff lowered its projection for near-term output growth. Largely because of the combination of recent downward surprises in the unemployment rate and weaker-thanexpected real GDP growth, the staff lowered slightly the assumed pace of potential output growth in recent years and over the projection period. As a result, the staff’s medium-term forecast for real GDP growth also was revised down slightly. Nevertheless, the staff continued to project that real GDP would expand at a faster pace over the next few years than it did last year, and that real GDP growth would exceed the growth rate of potential output. The faster pace of real GDP growth was expected to be supported by an easing in the restraint from changes in fiscal policy, increases in consumer and business confidence, further improvements in credit availability and financial conditions, and a pickup in the rate of foreign economic growth. The expansion in economic activity was anticipated to lead to a slow reduction in resource slack over the projection period, and the unemployment rate was expected to decline gradually to the staff’s estimate of its longer-run natural rate. The staff’s forecast for inflation was basically unchanged from the projection prepared for the previous FOMC meeting. The staff continued to forecast that inflation would stay below the Committee’s longer-run objective of 2 percent over the next few years. Inflation was projected to rise gradually toward the Committee’s objective, as longer-run inflation expectations were assumed to remain stable, changes in commodity and import prices were expected to be subdued, and slack in labor and product markets was anticipated to diminish slowly. The staff’s economic projections for the March meeting were quite similar to its forecasts presented at the December meeting when the FOMC last prepared a Summary of Economic Projections (SEP). The staff’s March projections for both real GDP growth 154 101st Annual Report | 2014 and the unemployment rate over the next few years were just slightly lower than in its December forecasts, while the inflation projection was essentially unchanged. The staff viewed the extent of uncertainty around its March projections for real GDP growth and the unemployment rate as roughly in line with the average of the past 20 years. Nonetheless, the risks to the forecast for real GDP growth were viewed as tilted a little to the downside, especially because the economy was not well positioned to withstand adverse shocks while the target for the federal funds rate was at its effective lower bound. At the same time, the staff viewed the risks around its outlook for the unemployment rate and for inflation as roughly balanced. Participants’ Views on Current Conditions and the Economic Outlook In conjunction with this FOMC meeting, the meeting participants—the 4 members of the Board of Governors and the presidents of the 12 Federal Reserve Banks, all of whom participated in the deliberations—submitted their assessments of real output growth, the unemployment rate, inflation, and the target federal funds rate for each year from 2014 through 2016 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 the SEP, which is attached as an addendum to these minutes. In their discussion of the economic situation and the outlook, participants generally noted that data released since their January meeting had indicated somewhat slower-than-expected growth in economic activity during the winter months, in part reflecting adverse weather conditions. Labor market indicators were mixed. Inflation had continued to run below the Committee’s longer-run objective, but longer-term inflation expectations had remained stable. Several participants indicated that recent economic news, although leading them to mark down somewhat their estimates of economic growth in late 2013 as well as their assessments of likely growth in the first quarter of 2014, had not prompted a significant revision of their projections of moderate economic growth over coming quarters. Most participants noted that unusually severe winter weather had held down economic activity during the early months of the year. Business contacts in various parts of the country reported a number of weather-induced disruptions, including reduced manufacturing activity due to lost workdays, interruptions to supply chains of inputs and delivery of final products, and lower-than-expected retail sales. Participants expected economic activity to pick up as the weather-related disruptions to spending and production dissipated. A few participants, however, highlighted factors other than weather that had likely contributed to the slowdown during the first quarter, including slower growth in net exports following its unusually large positive contribution to growth in the fourth quarter of 2013. Moreover, it was noted that some of the pickup in economic growth that had appeared to have been indicated by the data available at the January meeting had been reversed by subsequent data revisions. For many participants, the outlook for economic activity over coming quarters had changed little, on balance, since the time of the December meeting. Housing activity remained slow over the intermeeting period. Although unfavorable weather had contributed to the recent disappointing performance of housing, a few participants suggested that last year’s rise in mortgage interest rates might have produced a larger-than-expected reduction in home sales. In addition, it was noted that the return of house prices to more-normal levels could be damping the pace of the housing recovery, and that home affordability has been reduced for some prospective buyers. Slackening demand from institutional investors was cited as another factor behind the decline in home sales. Nonetheless, the underlying fundamentals, including population growth and household formation, were viewed as pointing to a continuing recovery of the housing market. In their discussion of labor market developments, participants noted further improvement, on balance, in labor market conditions. The unemployment rate had moved down in recent months, as had broader measures of unemployment and underemployment. Other labor market indicators, such as payrolls and hiring and quit rates, while not all showing the same extent of improvement, also pointed to ongoing gains in labor markets. Going forward, participants continued to expect a gradual decline in the unemployment rate over the medium term, with judgments differing somewhat across participants about the likely pace of the decline. It was also noted that Minutes of Federal Open Market Committee Meetings | March uncertainty about the trend rate of productivity growth was making it difficult to ascertain the rate of real GDP growth that would be associated with progress in reducing the unemployment rate. While there was general agreement that slack remains in the labor market, participants expressed a range of views regarding the amount of slack and how well the unemployment rate performs as a summary indicator of labor market conditions. Several participants pointed to a number of factors—including the low labor force participation rate and the still-high rates of longer-duration unemployment and of workers employed part time for economic reasons—as suggesting that there might be considerably more labor market slack than indicated by the unemployment rate alone. A couple of other participants, however, saw reasons to believe that slack was more limited, viewing the decline in the participation rate as primarily reflecting demographic trends with little role for cyclical factors and observing that broader measures of unemployment had registered declines in the past year that were comparable with the decline in the standard measure. Several participants cited low nominal wage growth as pointing to the existence of continued labor market slack. Participants also noted the debate in the research literature and elsewhere concerning whether long-term unemployment differs materially from short-term unemployment in its implications for wage and price pressures. Inflation continued to run below the Committee’s 2 percent longer-run objective over the intermeeting period. A couple of participants expressed concern that inflation might not return to 2 percent in the next few years and suggested that a protracted period of inflation below 2 percent raised questions about whether the Committee was providing an appropriate degree of monetary accommodation. One of these participants suggested that persistently low inflation was a clear reflection of a sizable shortfall of employment from its maximum level. A number of participants noted that a pickup in nominal wage growth would be consistent with labor market conditions moving closer to normal and would support the return of consumer price inflation to the Committee’s 2 percent longer-run goal. However, a couple of other participants suggested that factors other than economic slack had played a notable role in holding down inflation of late, including unusually slow growth in prices of medical services. Most participants expected inflation to return to 2 percent over the next few years, supported by stable inflation 155 expectations and the continued gradual recovery in economic activity. Several participants pointed to international developments that bear watching. It was suggested that slower growth in China had likely already put some downward pressure on world commodity prices, and a couple of participants observed that a larger-thanexpected slowdown in economic growth in China could have adverse implications for global economic growth. In addition, it was noted that events in Ukraine were likely to have little direct effect on the U.S. economic outlook but might have negative implications for global growth if they escalated and led to a protracted period of geopolitical tensions in that region. In their discussion of recent financial developments, participants saw financial conditions as generally consistent with the Committee’s policy intentions. However, several participants mentioned trends that, if continued, could become a concern from the perspective of financial stability. A couple of participants pointed to the decline in credit spreads to relatively low levels by historical standards; one of these participants noted the risk of either a sharp rise in spreads, which could have negative repercussions for aggregate demand, or a continuation of the decline in spreads, which could undermine financial stability over time. One participant voiced concern about high levels of margin debt and of equity market valuations as well as a notable shift into commodity investments. Another participant stressed the growth in consumer credit to less credit-worthy households. In their discussion of monetary policy going forward, participants focused primarily on possible changes to the Committee’s forward guidance for the federal funds rate. Almost all participants agreed that it was appropriate at this meeting to update the forward guidance, in part because the unemployment rate was seen as likely to fall below its 6½ percent threshold value before long. Most participants preferred replacing the numerical thresholds with a qualitative description of the factors that would influence the Committee’s decision to begin raising the federal funds rate. One participant, however, favored retaining the existing threshold language on the grounds that removing it before the unemployment rate reached 6½ percent could be misinterpreted as a signal that the path of policy going forward would be less accommodative. Another participant favored introducing new quantitative thresholds 156 101st Annual Report | 2014 of 5½ percent for the unemployment rate and 2¼ percent for projected inflation. A few participants proposed adding new language in which the Committee would indicate its willingness to keep rates low if projected inflation remained persistently below the Committee’s 2 percent longer-run objective; these participants suggested that the inclusion of this quantitative element in the forward guidance would demonstrate the Committee’s commitment to defend its inflation objective from below as well as from above. Other participants, however, judged that it was already well understood that the Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance. Most participants therefore did not favor adding new quantitative language, preferring to shift to qualitative language that would describe the Committee’s likely reaction to the state of the economy. Most participants also believed that, as part of the process of clarifying the Committee’s future policy intentions, it would be appropriate at this time for the Committee to provide additional guidance in its postmeeting statement regarding the likely behavior of the federal funds rate after its first increase. For example, the statement could indicate that the Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run. Participants observed that a number of factors were likely to have contributed to a persistent decline in the level of interest rates consistent with attaining and maintaining the Committee’s objectives. In particular, participants cited higher precautionary savings by U.S. households following the financial crisis, higher global levels of savings, demographic changes, slower growth in potential output, and continued restraint on the availability of credit. A few participants suggested that new language along these lines could instead be introduced when the first increase in the federal funds rate had drawn closer or after the Committee had further discussed the reasons for anticipating a relatively low federal funds rate during the period of policy firming. A number of participants noted the overall upward shift since December in participants’ projections of the federal funds rate included in the March SEP, with some expressing concern that this component of the SEP could be misconstrued as indicating a move by the Committee to a less accommodative reaction function. However, several participants noted that the increase in the median projection overstated the shift in the projec- tions. In addition, a number of participants observed that an upward shift was arguably warranted by the improvement in participants’ outlooks for the labor market since December and therefore need not be viewed as signifying a less accommodative reaction function. Most participants favored providing an explicit indication in the statement that the new forward guidance, taken as a whole, did not imply a change in the Committee’s policy intentions, on the grounds that such an indication could help forestall misinterpretation of the new forward guidance. Committee Policy Action Committee members saw the information received over the intermeeting period as indicating that growth in economic activity slowed during the winter months, in part reflecting adverse weather conditions. Labor market indicators were mixed but on balance showed further improvement. The unemployment rate, however, remained elevated when judged against members’ estimates of the longer-run normal rate of unemployment. Household spending and business fixed investment continued to advance, while the recovery in the housing sector remained slow. Fiscal policy was restraining economic growth, although the extent of restraint had diminished. The Committee expected that, with appropriate policy accommodation, the economy would expand at a moderate pace and labor market conditions would continue to improve gradually, moving toward those the Committee judges consistent with the dual mandate. Moreover, members judged that the risks to the outlook for the economy and the labor market were nearly balanced. Inflation was running below the Committee’s longer-run objective, and this was seen as posing possible risks to economic performance, but members anticipated that stable inflation expectations and strengthening economic activity would, over time, return inflation to the Committee’s 2 percent objective. However, in light of their concerns about the possible persistence of low inflation, members agreed that inflation developments should be monitored carefully for evidence that inflation was moving back toward the Committee’s longer-run objective. In their discussion of monetary policy in the period ahead, members agreed that there was sufficient underlying strength in the broader economy to support ongoing improvement in labor market conditions. In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions since the incep- Minutes of Federal Open Market Committee Meetings | March tion of the current asset purchase program, members decided that it would be appropriate to make a further measured reduction in the pace of its asset purchases at this meeting. Members again judged that, if the economy continued to develop as anticipated, the Committee would likely reduce the pace of asset purchases in further measured steps at future meetings. Members also underscored that the pace of asset purchases was not on a preset course and would remain contingent on the Committee’s outlook for the labor market and inflation as well as its assessment of the likely efficacy and costs of purchases. Accordingly, the Committee agreed that, beginning in April, it would add to its holdings of agency mortgage-backed securities at a pace of $25 billion per month rather than $30 billion per month, and would add to its holdings of longer-term Treasury securities at a pace of $30 billion per month rather than $35 billion per month. While making a further measured reduction in its pace of purchases, the Committee emphasized that its holdings of longerterm securities were sizable and would still be increasing, which would promote a stronger economic recovery by maintaining downward pressure on longer-term interest rates, supporting mortgage markets, and helping to make broader financial conditions more accommodative. The Committee also reiterated that it would continue its asset purchases, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability. One member, while concurring with this policy action, suggested that in future statements the Committee might provide further information about the trajectory of the Federal Reserve’s balance sheet, including information about when the Committee might discontinue its policy of reinvesting principal payments on all agency debt and agency mortgage-backed securities in agency mortgage-backed securities. With respect to forward guidance about the federal funds rate, all members judged that, as the unemployment rate was likely to fall below 6½ percent before long, it was appropriate to replace the existing quantitative thresholds at this meeting. Almost all members judged that the new language should be qualitative in nature and should indicate that, in determining how long to maintain the current 0 to ¼ percent target range for the federal funds rate, the Committee would assess progress, both realized and expected, toward its objectives of maximum employment and 2 percent inflation. However, a couple of members preferred to include language in the statement indicating that the Committee would keep rates low if 157 projected inflation remained persistently below the Committee’s 2 percent longer-run objective. One of these members argued that the Committee should continue to provide quantitative thresholds for both the unemployment rate and inflation. Members also considered statement language that would provide information about the anticipated behavior of the federal funds rate once it is raised above its effective lower bound. The Committee decided that it was appropriate to add language indicating that the Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run. In discussing this addition, a couple of members suggested that language along these lines might better be introduced at a later meeting. However, another member indicated that adding the new language at this stage could be beneficial for the effectiveness of policy because financial conditions depend on both the length of time that the federal funds rate is at the effective lower bound and on the expected path that the federal funds rate will follow once policy firming begins. It was also noted that the postmeeting statements, rather than the SEP, provide the public with information on the Committee’s monetary policy decisions and that it was therefore appropriate for the postmeeting statement to convey the Committee’s position on the likely future behavior of the 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 SOMA in accordance with the following domestic policy directive: “Consistent with its statutory mandate, the Federal Open Market Committee seeks monetary and financial conditions that will foster maximum employment and price stability. In particular, 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 undertake open market operations as necessary to maintain such conditions. Beginning in April, the Desk is directed to purchase longer-term Treasury securities at a pace of about $30 billion per month and to purchase agency mortgage-backed securities at a pace of about $25 billion per month. The Committee also directs the Desk to engage in dollar 158 101st Annual Report | 2014 roll and coupon swap transactions as necessary to facilitate settlement of the Federal Reserve’s agency mortgage-backed securities transactions. The Committee directs the Desk to maintain its policy of rolling over maturing Treasury securities into new issues and its policy of reinvesting principal payments on all agency debt and agency mortgage-backed securities in agency mortgage-backed securities. 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 2:00 p.m.: “Information received since the Federal Open Market Committee met in January indicates that growth in economic activity slowed during the winter months, in part reflecting adverse weather conditions. Labor market indicators were mixed but on balance showed further improvement. The unemployment rate, however, remains elevated. Household spending and business fixed investment continued to advance, while the recovery in the housing sector remained slow. Fiscal policy is restraining economic growth, although the extent of restraint is diminishing. Inflation has been running below the Committee’s longer-run objective, but 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 that, with appropriate policy accommodation, economic activity will expand at a moderate pace and labor market conditions will continue to improve gradually, moving toward those the Committee judges consistent with its dual mandate. The Committee sees the risks to the outlook for the economy and the labor market as nearly balanced. The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, and it is monitoring inflation developments carefully for evidence that inflation will move back toward its objective over the medium term. The Committee currently judges that there is sufficient underlying strength in the broader economy to support ongoing improvement in labor market conditions. In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions since the inception of the current asset purchase program, the Committee decided to make a further measured reduction in the pace of its asset purchases. Beginning in April, the Committee will add to its holdings of agency mortgage-backed securities at a pace of $25 billion per month rather than $30 billion per month, and will add to its holdings of longerterm Treasury securities at a pace of $30 billion per month rather than $35 billion per month. The Committee is maintaining its existing policy 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’s sizable and still-increasing holdings of longer-term securities should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee’s dual mandate. The Committee will closely monitor incoming information on economic and financial developments in coming months and will continue its purchases of Treasury and agency mortgagebacked securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability. If incoming information broadly supports the Committee’s expectation of ongoing improvement in labor market conditions and inflation moving back toward its longer-run objective, the Committee will likely reduce the pace of asset purchases in further measured steps at future meetings. However, asset purchases are not on a preset course, and the Committee’s decisions about their pace will remain contingent on the Committee’s outlook for the labor market and inflation as well as its assessment of the likely efficacy and costs of such purchases. Minutes of Federal Open Market Committee Meetings | March To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy remains appropriate. In determining how long to maintain the current 0 to ¼ percent target range for the federal funds rate, the Committee will assess progress—both realized and expected— toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the Committee’s 2 percent longerrun goal, and provided that longer-term inflation expectations remain well anchored. 159 increase inflation to the 2 percent target and by suggesting that the Committee views inflation persistently below 2 percent as an acceptable outcome. Moreover, he judged that the new guidance would act as a drag on economic activity because it provided little information about the desired rate of progress toward maximum employment and no quantitative measure of what constitutes maximum employment, and thus would generate uncertainty about the extent to which the Committee is willing to use monetary stimulus to foster faster growth. Mr. Kocherlakota strongly endorsed the sixth paragraph of the statement because providing information about the Committee’s intentions for the federal funds rate once employment and inflation are near mandateconsistent levels should help stimulate economic activity by reducing uncertainty. It was agreed that the next meeting of the Committee would be held on Tuesday–Wednesday, April 29–30, 2014. The meeting adjourned at 10:05 a.m. on March 19, 2014. Notation Vote When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent. The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run. With the unemployment rate nearing 6½ percent, the Committee has updated its forward guidance. The change in the Committee’s guidance does not indicate any change in the Committee’s policy intentions as set forth in its recent statements.” Voting for this action: Janet L. Yellen, William C. Dudley, Richard W. Fisher, Sandra Pianalto, Charles I. Plosser, Jerome H. Powell, Jeremy C. Stein, and Daniel K. Tarullo. Voting against this action: Narayana Kocherlakota. Mr. Kocherlakota dissented because, in his view, the new forward guidance in the fifth paragraph of the statement would weaken the credibility of the Committee’s commitment to its inflation goal by failing to communicate purposeful steps to more rapidly By notation vote completed on February 18, 2014, the Committee unanimously approved the minutes of the Committee meeting held on January 28–29, 2014. Videoconference meeting of March 4 The Committee met by videoconference on March 4, 2014, to discuss issues associated with its forward guidance for the federal funds rate. The Committee discussed possible changes to its forward guidance that could provide additional information about the factors likely to enter its decisions regarding the federal funds rate target as the unemployment rate approached its 6½ percent threshold and once that threshold was crossed. The agenda did not contemplate any policy decisions, and none were taken. Many participants noted that market expectations of the future course of the federal funds rate were currently reasonably well aligned with those of policymakers, and that a sizable change to the forward guidance could disturb this alignment. Nonetheless, participants generally saw the Committee’s upcoming meeting as an opportune occasion for a reformulation of the guidance language; one of these participants suggested that the reformulation could be accompanied by a statement that the new language was intended to be consistent with current market expectations. A few participants stressed that the 160 101st Annual Report | 2014 Committee had several other vehicles, including the Chair’s postmeeting press conference, through which it could clarify its future policy intentions. Participants agreed that the existing forward guidance, with its reference to a 6½ percent threshold for the unemployment rate, was becoming outdated as the unemployment rate continued its expected gradual decline. Most participants felt that the quantitative thresholds had been very useful in communicating policy intentions when employment was far from mandate-consistent levels, but, with the economy having moved appreciably closer to maximum employment, the forward guidance should emphasize that the Committee is focusing more on a broader set of economic indicators. Thus, most participants felt that quantitative thresholds, triggers, or floors should not be a part of future statement language, with a number of participants noting the uncertainty associated with defining and measuring the unemployment rate and the level of employment that would be most consistent with the Committee’s maximum employment objective, or other similar concepts. These participants generally favored qualitative language describing the economic factors that would influence the Committee’s decision regarding the first increase in the federal funds rate target. Participants put forward a number of suggestions for such qualitative language. One participant favored linking the length of time that the federal funds rate would remain at the lower bound to the period over which complete recovery of the labor market was projected to occur, while another advocated qualitative forward guidance expressed in terms of the Committee’s projections of real output growth, arguing that such an approach would avoid the uncertainties associated with estimates of potential output or maximum employment. Yet another participant argued that it would be desirable for the statement to describe the Committee’s reasons for keeping the federal funds rate at the lower bound when standard policy rules were prescribing that the rate should be increased and noted that one possible reason for doing so is that the effective lower bound on the federal funds rate limits the Committee’s scope to provide accommodation in response to adverse shocks. In contrast, some participants expressed a preference for quantitative guidance. A few participants saw merit in stating explicitly that the Committee would provide accommodation to the extent necessary to prevent inflation from running persistently below its 2 percent longer-run goal. One of these participants argued that such forward guidance would strengthen the credibility of the Committee’s inflation objective as well as encourage employment outcomes that were most consistent with the Committee’s other objective of maximum employment. Another participant suggested that the Committee state that it would adjust policy to keep projected inflation near 2 percent over the medium term, and that it would balance deviations from its objectives in the near term. Still another participant expressed a preference for stating explicit quantitative criteria for some labor market variable or variables. Most participants favored providing information about the likely behavior of the federal funds rate after its first increase. A few participants, however, viewed the period of policy firming as likely to be far enough in the future that the Committee did not need to provide such information at this stage. Committee participants also considered whether revised forward guidance should include a more prominent mention of financial developments or of potential risks to financial stability. Most participants felt that the Committee’s monitoring of financial conditions and of risks to financial stability was already well understood by markets and that, while some reference to financial developments might usefully be included in the statement, a lengthy addition did not seem necessary. One participant favored including a reference in the statement to “financial conditions,” rather than “financial stability,” emphasizing that, when factors other than monetary policy induce a change in financial conditions, the Committee may need to take that change in financial conditions into account when making its monetary policy decisions. William B. English Secretary Minutes of Federal Open Market Committee Meetings | March Addendum: Summary of Economic Projections 161 down a bit but remaining above its longer-run rate in 2016, and that the unemployment rate would decline gradually toward its longer-run normal level over the projection period (table 1 and figure 1). Almost all of the participants projected that inflation, as measured by the annual change in the price index for personal consumption expenditures (PCE), would rise steadily to a level at or slightly below the Committee’s 2 percent objective in 2016. In conjunction with the March 18–19, 2014, Federal Open Market Committee (FOMC) meeting, meeting participants—the 4 members of the Board of Governors and the 12 presidents of the Federal Reserve Banks, all of whom participated in the deliberations—submitted their assessments of real output growth, the unemployment rate, inflation, and the target federal funds rate for each year from 2014 through 2016 and over the longer run. Each participant’s assessment was based on information available at the time of the meeting plus his or her judgment of appropriate monetary policy and assumptions about the factors likely to affect economic outcomes. The longer-run projections represent each participant’s judgment of the value 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 each participant deems most likely to foster outcomes for economic activity and inflation that best satisfy his or her individual interpretation of the Federal Reserve’s objectives of maximum employment and stable prices. Most participants expected that highly accommodative monetary policy would remain warranted over the next few years to foster progress toward the Federal Reserve’s longer-run objectives. As shown in figure 2, all but one of the participants projected that it would be appropriate to wait until 2015 or later before beginning to increase the federal funds rate, and a large majority projected that it would then be appropriate to raise the target federal funds rate fairly gradually. Almost all participants viewed appropriate policy as broadly consistent with continued gradual slowing in the pace of the Committee’s purchases of longer-term securities and the completion of the program in the second half of this year. Most participants saw the uncertainty associated with their outlooks for economic growth and the unemployment rate as similar to that of the past 20 years, and a majority saw the uncertainty associated with their projections for inflation as similar to that of the past 20 years. In addition, most participants considered the risks to the outlook for real Overall, FOMC participants expected that, under appropriate monetary policy, economic growth would pick up this year and next, before moving Table 1. Economic projections of Federal Reserve Board members and Federal Reserve Bank presidents, March 2014 Percent Central tendency1 Range2 Variable Change in real GDP December projection Unemployment rate December projection PCE inflation December projection Core PCE inflation3 December projection 2014 2015 2016 Longer run 2014 2015 2016 Longer run 2.8 to 3.0 2.8 to 3.2 6.1 to 6.3 6.3 to 6.6 1.5 to 1.6 1.4 to 1.6 1.4 to 1.6 1.4 to 1.6 3.0 to 3.2 3.0 to 3.4 5.6 to 5.9 5.8 to 6.1 1.5 to 2.0 1.5 to 2.0 1.7 to 2.0 1.6 to 2.0 2.5 to 3.0 2.5 to 3.2 5.2 to 5.6 5.3 to 5.8 1.7 to 2.0 1.7 to 2.0 1.8 to 2.0 1.8 to 2.0 2.2 to 2.3 2.2 to 2.4 5.2 to 5.6 5.2 to 5.8 2.0 2.0 2.1 to 3.0 2.2 to 3.3 6.0 to 6.5 6.2 to 6.7 1.3 to 1.8 1.3 to 1.8 1.3 to 1.8 1.3 to 1.8 2.2 to 3.5 2.2 to 3.6 5.4 to 5.9 5.5 to 6.2 1.5 to 2.4 1.4 to 2.3 1.5 to 2.4 1.5 to 2.3 2.2 to 3.4 2.1 to 3.5 5.1 to 5.8 5.0 to 6.0 1.6 to 2.0 1.6 to 2.2 1.6 to 2.0 1.6 to 2.2 1.8 to 2.4 1.8 to 2.5 5.2 to 6.0 5.2 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 December projections were made in conjunction with the meeting of the Federal Open Market Committee on December 17–18, 2013. 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. 162 101st Annual Report | 2014 Figure 1. Central tendencies and ranges of economic projections, 2014–16 and over the longer run Percent Change in real GDP 4 Central tendency of projections Range of projections 3 2 1 + 0 - Actual 2009 2010 2011 2012 2013 2014 2015 2016 Longer run Percent Unemployment rate 10 9 8 7 6 5 2009 2010 2011 2012 2013 2014 2015 2016 Longer run Percent PCE inflation 3 2 1 2009 2010 2011 2012 2013 2014 2015 2016 Longer run Percent Core PCE inflation 3 2 1 2009 2010 2011 2012 2013 2014 2015 Note: Definitions of variables are in the general note to table 1. The data for the actual values of the variables are annual. 2016 Longer run Minutes of Federal Open Market Committee Meetings | March 163 Figure 2. Overview of FOMC participants’ assessments of appropriate monetary policy Number of participants Appropriate timing of policy firming 14 13 13 12 11 10 9 8 7 6 5 4 3 2 1 2 1 2014 2015 2016 Appropriate pace of policy firming Percent Target federal funds rate at year-end 6 5 4 3 2 1 0 2014 2015 2016 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 December 2013, the numbers of FOMC participants who judged that the first increase in the target federal funds rate would occur in 2014, 2015, and 2016 were, respectively, 2, 12, and 3. 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. 164 101st Annual Report | 2014 gross domestic product (GDP), the unemployment rate, and inflation to be broadly balanced, although some saw the risks to their inflation forecasts as tilted to the downside. The Outlook for Economic Activity Participants generally projected that, conditional on their individual assumptions about appropriate monetary policy, real GDP growth would pick up gradually this year and next to a pace somewhat exceeding their estimates of the longer-run normal rate of output growth. Subsequently, in 2016, real GDP growth was projected to begin to move back toward its longer-run rate. Most participants revised down a bit their projections of real GDP growth for 2014, compared with their projections in December 2013, and the top end of the central tendencies for output growth in each year and over the longer run moved down slightly. Nonetheless, participants pointed to a number of factors that they expected would contribute to a pickup in economic growth this year, such as an easing of the headwinds that have been weighing on growth, including diminished restraint from fiscal policy; rising household net worth and highly accommodative monetary policy also were expected to contribute. In addition, many attributed some of the softness in recent economic data to the transitory effects of unusually severe winter weather. The central tendencies of participants’ projections for real GDP growth were 2.8 to 3.0 percent in 2014, 3.0 to 3.2 percent in 2015, and 2.5 to 3.0 percent in 2016. The central tendency for the longer-run normal rate of growth of real GDP was 2.2 to 2.3 percent. Participants anticipated a gradual decline in the unemployment rate over the projection period. The central tendencies of participants’ forecasts for the unemployment rate in the fourth quarter of each year were 6.1 to 6.3 percent in 2014, 5.6 to 5.9 percent in 2015, and 5.2 to 5.6 percent in 2016. Nearly all participants revised down their projected paths for the unemployment rate relative to their December projections, with some pointing to the decline in the unemployment rate in recent months. The central tendency of participants’ estimates of the longer-run normal rate of unemployment that would prevail under appropriate monetary policy and in the absence of further shocks to the economy also moved lower, to 5.2 to 5.6 percent. A majority of participants projected that the unemployment rate would be close to their individual estimates of its longer-run level at the end of 2016. Figures 3.A and 3.B show that participants continued to hold a range of views regarding the likely outcomes for real GDP growth and the unemployment rate over the next two years. The diversity of views reflected their individual assessments of the rate at which the headwinds that have been holding back the pace of the economic recovery would abate, the anticipated path for foreign economic activity, the trajectory for growth in household net worth, and the appropriate path of monetary policy. Relative to December, the dispersions of participants’ projections for real GDP growth and the unemployment rate over the period from 2014 to 2016 narrowed slightly. The Outlook for Inflation Participants’ views on the broad outlook for inflation under the assumption of appropriate monetary policy were nearly unchanged, on balance, from those in their December projections. All participants anticipated that, on average, both headline and core inflation would rise gradually over the next few years, and a large majority of participants expected headline inflation to be at or slightly below the Committee’s 2 percent objective in 2016. Specifically, the central tendencies for PCE inflation were 1.5 to 1.6 percent in 2014, 1.5 to 2.0 percent in 2015, and 1.7 to 2.0 percent in 2016. The central tendencies of the forecasts for core inflation were broadly similar to those for the headline measure. A number of participants viewed the combination of stable inflation expectations and steadily diminishing resource slack as likely to contribute to a gradual rise of inflation back toward the Committee’s longer-run objective. Figures 3.C and 3.D provide information on the diversity of participants’ views about the outlook for inflation. The ranges of participants’ projections for overall inflation were little changed relative to December. The forecasts for PCE inflation in 2016 were at or below the Committee’s longer-run objective. Similar to the projections for headline inflation, the projections for core inflation in 2016 were also concentrated near 2 percent. Appropriate Monetary Policy As indicated in figure 2, most participants judged that very low levels of the federal funds rate would remain appropriate for the next few years. In particular, 13 participants thought that the first increase in the target federal funds rate would not be warranted until sometime in 2015, and two judged that policy Minutes of Federal Open Market Committee Meetings | March 165 Figure 3.A. Distribution of participants’ projections for the change in real GDP, 2014–16 and over the longer run Number of participants 2014 20 18 16 14 12 10 8 6 4 2 March projections December projections 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 Percent range Number of participants 2015 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 Percent range Number of participants 2016 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 Percent range Number of participants Longer run 1.8 1.9 20 18 16 14 12 10 8 6 4 2 2.0 2.1 2.2 2.3 2.4 2.5 2.6 2.7 2.8 2.9 Percent range Note: Definitions of variables are in the general note to table 1. 3.0 3.1 3.2 3.3 3.4 3.5 3.6 3.7 166 101st Annual Report | 2014 Figure 3.B. Distribution of participants’ projections for the unemployment rate, 2014–16 and over the longer run Number of participants 2014 20 18 16 14 12 10 8 6 4 2 March projections December projections 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 Percent range Number of participants 2015 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 Percent range Number of participants 2016 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 Percent range Number of participants Longer run 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 Percent range Note: Definitions of variables are in the general note to table 1. 6.0 6.1 6.2 6.3 6.4 6.5 6.6 6.7 Minutes of Federal Open Market Committee Meetings | March 167 Figure 3.C. Distribution of participants’ projections for PCE inflation, 2014–16 and over the longer run Number of participants 2014 20 18 16 14 12 10 8 6 4 2 March projections December 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 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 2.1 2.2 2.3 2.4 Percent range Number of participants 2016 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 Longer run 1.3 1.4 20 18 16 14 12 10 8 6 4 2 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 2.4 168 101st Annual Report | 2014 Figure 3.D. Distribution of participants’ projections for core PCE inflation, 2014–16 Number of participants 2014 20 March projections December 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 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 2.1 2.2 2.3 2.4 Percent range Number of participants 2016 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 | March Table 2. Average historical projection error ranges Percentage points Variable Change in real GDP1 Unemployment rate1 Total consumer prices2 2014 2015 2016 ±1.6 ±0.6 ±0.9 ±2.1 ±1.2 ±1.0 ±2.0 ±1.7 ±1.1 Note: Error ranges shown are measured as plus or minus the root mean squared error of projections for 1994 through 2013 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. For more information, see 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), available at www.federalreserve.gov/ pubs/feds/2007/200760/200760abs.html; and Board of Governors of the Federal Reserve System, Division of Research and Statistics (2014), “Updated Historical Forecast Errors,” memorandum, April 9, http://www.federalreserve.gov/foia/files/ 20140409-historical-forecast-errors.pdf. 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. firming would likely not be appropriate until 2016. Only one participant thought that an increase in the federal funds rate would be appropriate in 2014. All participants but one projected that the unemployment rate would be below 6 percent at the end of the year in which they currently anticipate that it will become appropriate to raise the federal funds rate above its effective lower bound. Moreover, all but one projected that inflation would be at or below the Committee’s longer-run objective at that time. Most participants projected that the unemployment rate would remain above their estimates of its longer-run normal level at the end of the year in which they saw the federal funds rate increasing from its effective lower bound. 169 the end of 2016 would still be below their individual assessments of its longer-run level, with many pointing to subdued inflation pressures, below-mandate inflation, the still-noticeable effects of headwinds, or the need to maintain low rates to support the recovery as reasons to keep the federal funds rate low at that time. Estimates of the longer-run target for the federal funds rate ranged from 3½ to about 4¼ percent, reflecting the Committee’s inflation objective of 2 percent and participants’ individual judgments about the appropriate longer-run level of the real federal funds rate in the absence of further shocks to the economy. Participants also described their views regarding the appropriate path of the Federal Reserve’s balance sheet. Conditional on their respective economic outlooks, almost all participants judged that it would be appropriate to continue to reduce the pace of the Committee’s purchases of longer-term securities in measured steps and to conclude purchases in the second half of this year. Two participants projected a more rapid reduction in the pace of purchases and an earlier end to the asset purchase program. Participants’ views of the appropriate path for monetary policy were informed by their judgments about the state of the economy, including the values of the unemployment rate and other labor market indicators that would be consistent with maximum employment, the extent to which the economy was currently falling short of maximum employment, the prospects for inflation to reach the Committee’s longer-term objective of 2 percent, and the balance of risks around the outlook. A couple of participants also mentioned using various monetary policy rules to guide their thinking on the appropriate path for the federal funds rate. Uncertainty and Risks Figure 3.E provides the distribution of participants’ judgments regarding the appropriate level of the target federal funds rate at the end of each calendar year from 2014 to 2016 and over the longer run. As noted earlier, almost all participants judged that economic conditions would warrant maintaining the current exceptionally low level of the federal funds rate until 2015. The median value of the rate at the end of 2015 and 2016 increased 25 and 50 basis points, respectively, since December, while the mean values increased 7 and 25 basis points, respectively. The dispersion of projections for the value of the federal funds rate in each year narrowed slightly. Almost all participants expected that the federal funds rate at Nearly all participants continued to judge the levels of uncertainty about their projections for real GDP growth and the unemployment rate as broadly similar to the norm during the previous 20 years (figure 4).1 As in December, most participants continued to judge the risks to real GDP growth and the unemployment rate to be broadly balanced. Two partici1 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 1994 through 2013. 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. 170 101st Annual Report | 2014 Figure 3.E. Distribution of participants’ projections for the target federal funds rate, 2014–16 and over the longer run Number of participants 2014 20 March projections December projections 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 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 Percent range Number of participants 2016 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 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 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. 3.38 3.62 3.63 3.87 3.88 4.12 4.13 4.37 Minutes of Federal Open Market Committee Meetings | March 171 Figure 4. Uncertainty and risks in economic projections Number of participants Number of participants Uncertainty about GDP growth 20 18 16 14 12 10 8 6 4 2 March projections December projections Lower Broadly similar Risks to GDP growth Weighted to downside Higher 20 18 16 14 12 10 8 6 4 2 March projections December projections 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 Risks to the unemployment rate Weighted to downside Higher 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 20 18 16 14 12 10 8 6 4 2 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. 172 101st Annual Report | 2014 pants viewed risks to output growth as weighted to the downside, reflecting their concerns about possible geopolitical developments and the strength of external demand. Almost all participants saw the level of uncertainty and the balance of risks around their forecasts for overall PCE inflation and core inflation as little changed from December. The majority of participants continued to judge the levels of uncertainty associated with their forecasts for the two inflation measures to be broadly similar to historical norms and the risks to those projections to be broadly balanced. Five participants, however, saw the risks to their inflation forecasts as tilted to the downside, reflecting, for example, the possibility that the current low levels of inflation could prove more persistent than anticipated as well as elevated global risks to the outlook. Conversely, one participant cited upside risks to inflation stemming from uncertainty about the timing and efficacy of the Committee’s withdrawal of accommodation. Minutes of Federal Open Market Committee Meetings | March 173 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 1.4 to 4.6 percent in the current year, 0.9 to 5.1 percent in the second year, and 1.0 to 5.0 percent 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, 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. 174 101st Annual Report | 2014 Meeting Held on April 29–30, 2014 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 29, 2014, at 10:30 a.m. and continued on Wednesday, April 30, 2014, at 9:00 a.m. James A. Clouse, Thomas A. Connors,1 Evan F. Koenig, Thomas Laubach, Michael P. Leahy, Loretta J. Mester, Samuel Schulhofer-Wohl, Mark E. Schweitzer, and William Wascher Associate Economists Simon Potter Manager, System Open Market Account Present Lorie K. Logan Deputy Manager, System Open Market Account Janet L. Yellen Chair Robert deV. Frierson2 Secretary of the Board, Office of the Secretary, Board of Governors William C. Dudley Vice Chairman Richard W. Fisher Narayana Kocherlakota Sandra Pianalto Charles I. Plosser Jerome H. Powell Jeremy C. Stein Daniel K. Tarullo Charles L. Evans, Jeffrey M. Lacker, Dennis P. Lockhart, and John C. Williams Alternate Members of the Federal Open Market Committee James Bullard, Esther L. George, and Eric Rosengren Presidents of the Federal Reserve Banks of St. Louis, Kansas City, and Boston, respectively William B. English Secretary and Economist Matthew M. Luecke Deputy Secretary Michelle A. Smith Assistant Secretary Scott G. Alvarez General Counsel Steven B. Kamin Economist David W. Wilcox Economist 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 Matthew J. Eichner Deputy Director, Division of Research and Statistics, Board of Governors Stephen A. Meyer and William Nelson Deputy Directors, Division of Monetary Affairs, Board of Governors Jon W. Faust Special Adviser to the Board, Office of Board Members, Board of Governors Trevor A. Reeve Special Adviser to the Chair, Office of Board Members, Board of Governors Linda Robertson3 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 David Bowman4 and Beth Anne Wilson Associate Directors, Division of International Finance, Board of Governors 1 2 3 4 Attended Wednesday’s session only. Attended the discussion of monetary policy normalization. Attended Tuesday’s session only. Attended Tuesday’s session following the discussion of monetary policy normalization. Minutes of Federal Open Market Committee Meetings | April Daniel M. Covitz, David E. Lebow, and Michael G. Palumbo Associate Directors, Division of Research and Statistics, Board of Governors Fabio M. Natalucci2 and Gretchen C. Weinbach2 Associate Directors, Division of Monetary Affairs, Board of Governors Marnie Gillis DeBoer2 and Jane E. Ihrig2 Deputy Associate Directors, Division of Monetary Affairs, Board of Governors Brian J. Gross1 Special Assistant to the Board, Office of Board Members, Board of Governors Stacey Tevlin Assistant Director, Division of Research and Statistics, Board of Governors Robert J. Tetlow Adviser, Division of Monetary Affairs, Board of Governors Dana L. Burnett Section Chief, Division of Monetary Affairs, Board of Governors Patrick McCabe2 Senior Economist, Division of Research and Statistics, Board of Governors Penelope A. Beattie2 Assistant to the Secretary, Office of the Secretary, Board of Governors Randall A. Williams Records Project Manager, Division of Monetary Affairs, Board of Governors James M. Lyon First Vice President, Federal Reserve Bank of Minneapolis David Altig, James J. McAndrews, and Alberto G. Musalem Executive Vice Presidents, Federal Reserve Banks of Atlanta, New York, and New York, respectively Joshua L. Frost and Spencer Krane Senior Vice Presidents, Federal Reserve Banks of New York and Chicago, respectively George A. Kahn, Antoine Martin, Joe Peek, Keith Sill, Daniel L. Thornton, and Douglas Tillett Vice Presidents, Federal Reserve Banks of Kansas City, New York, Boston, Philadelphia, St. Louis, and Chicago, respectively 175 Andreas L. Hornstein Senior Advisor, Federal Reserve Bank of Richmond John Fernald Senior Research Adviser, Federal Reserve Bank of San Francisco Sean Savage Senior Associate, Federal Reserve Bank of New York Monetary Policy Normalization In a joint session of the Federal Open Market Committee (FOMC) and the Board of Governors of the Federal Reserve System, meeting participants discussed issues associated with the eventual normalization of the stance and conduct of monetary policy. The Committee’s discussion of this topic was undertaken as part of prudent planning and did not imply that normalization would necessarily begin sometime soon. A staff presentation outlined several approaches to raising short-term interest rates when it becomes appropriate to do so, and to controlling the level of short-term interest rates once they are above the effective lower bound, during a period when the Federal Reserve will have a very large balance sheet. The approaches differed in terms of the combination of policy tools that might be used to accomplish those objectives. In addition to the rate of interest paid on excess reserve balances, the tools considered included fixed-rate overnight reverse repurchase (ON RRP) operations, term reverse repurchase agreements, and the Term Deposit Facility (TDF). The staff presentation discussed the potential implications of each approach for financial intermediation and financial markets, including the federal funds market, and the possible implications for financial stability. In addition, the staff outlined options for additional operational testing of the policy tools. Following the staff presentation, meeting participants discussed a wide range of topics related to policy normalization. Participants generally agreed that starting to consider the options for normalization at this meeting was prudent, as it would help the Committee to make decisions about approaches to policy normalization and to communicate its plans to the public well before the first steps in normalizing policy become appropriate. Early communication, in turn, would enhance the clarity and credibility of monetary policy and help promote the achievement of the Committee’s statutory objectives. It was emphasized that the tools available to the Committee 176 101st Annual Report | 2014 will allow it to reduce policy accommodation when doing so becomes appropriate. Participants considered how various combinations of tools could have different implications for the degree of control over short-term interest rates, for the Federal Reserve’s balance sheet and remittances to the Treasury, for the functioning of the federal funds market, and for financial stability in both normal times and in periods of stress. Because the Federal Reserve has not previously tightened the stance of policy while holding a large balance sheet, most participants judged that the Committee should consider a range of options and be prepared to adjust the mix of its policy tools as warranted. Participants generally favored the further testing of various tools, including the TDF, to better assess their operational readiness and effectiveness. No decisions regarding policy normalization were taken; participants requested additional analysis from the staff and agreed that it would be helpful to continue to review these issues at upcoming meetings. The Board meeting concluded at the end of the discussion. 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 as well as the System open market operations during the period since the Committee met on March 18–19, 2014. 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. By unanimous vote, the Committee agreed to renew the reciprocal currency arrangements with the Bank of Canada and the Bank of Mexico; these arrangements are associated with the Federal Reserve’s participation in the North American Framework Agreement of 1994. In addition, by unanimous vote, the Committee agreed to renew the dollar and 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. The votes to renew the Federal Reserve’s participation in these arrangements were taken at this meeting because provisions in the arrangements specify that the Federal Reserve provide six months’ prior notice of an intention to terminate its participation. Staff Review of the Economic Situation The information reviewed for the April 29–30 meeting indicated that growth in economic activity paused in the first quarter as a whole, but that activity stepped up late in the quarter; this pattern reflected, in part, the temporary effects of the unusually cold and snowy weather earlier in the quarter and the unwinding of those effects later in the quarter. In March, payroll employment increased further, although the unemployment rate held steady and was still elevated. Consumer price inflation continued to run below the Committee’s longer-run objective, but measures of longer-run inflation expectations remained stable. The unemployment rate stayed at 6.7 percent in March, but both the labor force participation rate and the employment-to-population ratio increased slightly. The rate of long-duration unemployment declined somewhat, but the share of workers employed part time for economic reasons moved up; both of these measures were still well above their prerecession levels. Initial claims for unemployment insurance remained low over the intermeeting period. Although the rate of job openings moved up in February, the hiring rate was flat and continued to be subdued. Following a rebound in February that was partly weather related, manufacturing production rose further in March and the rate of manufacturing capacity utilization increased. The production of motor vehicles and parts declined in March, but factory output outside of the motor vehicle sector expanded. Automakers’ schedules indicated that the pace of motor vehicle assemblies in the coming months would be similar to the level in March. However, broad indicators of manufacturing production, such as the new orders indexes from the national and regional manufacturing surveys, were at levels consistent with moderate increases in factory output in the near term. Real personal consumption expenditures (PCE) expanded slightly less rapidly in the first quarter than in the fourth quarter. After moving roughly sideways, on net, in January and February, the component of nominal retail sales used by the Bureau of Economic Analysis (BEA) to construct its monthly estimate of PCE rose briskly in March, in part because the weather returned to more seasonal norms. Recent information on several important factors that influence household spending was positive. Real dispos- Minutes of Federal Open Market Committee Meetings | April able income continued to increase in the first quarter, further gains in house prices likely bolstered household net worth, and consumer sentiment in the Thomson Reuters/University of Michigan Surveys of Consumers improved, on balance, in March and April. The pace of activity in the housing sector remained soft, as real expenditures for residential investment decreased again in the first quarter. Starts of new single-family homes increased in March. However, permits for single-family homes—which are typically less sensitive to fluctuations in the weather and a better indicator of the underlying pace of construction—remained below their fourth-quarter level and had not shown a sustained improvement since last spring, when mortgage rates began to rise. Sales of both new and existing homes decreased in March of this year, but pending home sales rose. Real private expenditures on business equipment and intellectual property products declined in the first quarter. However, nominal shipments of nondefense capital goods excluding aircraft rose in February and in March, and new orders were somewhat above the level of shipments, pointing to modest gains in shipments in the near term. Other forward-looking indicators, such as surveys of business conditions and capital spending plans, were also consistent with increased outlays for business equipment in the coming months. Real spending for nonresidential construction was about flat in the first quarter after declining in the fourth quarter, while real inventory investment moved lower. Business inventories in most industries appeared to be broadly aligned with sales in recent months. Real federal government purchases rose slightly in the first quarter, as the increase from the reversal of the government shutdown in the fourth quarter was mostly offset by the ongoing downtrend in purchases. Real state and local government purchases decreased somewhat in the first quarter, as state and local construction expenditures declined. The U.S. international trade deficit widened in February as exports fell and imports rose. The export declines were concentrated in aircraft and petroleum products, while exports of consumer goods rose. Rising imports of services and automotive products offset declines in imports of oil and capital goods. In the 177 advance release of the national income and product accounts, the BEA estimated that net exports subtracted substantially from real gross domestic product (GDP) growth in the first quarter. U.S. consumer prices, as measured by the PCE price index, rose at a slow rate in the first quarter, though somewhat faster than the pace posted in the fourth quarter, and were about 1 percent higher than a year earlier. After falling in the fourth quarter, consumer energy prices increased markedly in the first quarter as natural gas prices moved higher on a sharp decline in inventories during the unusually cold winter months. The PCE price index for items excluding food and energy rose at the same rate in the first quarter as in the previous one and was around 1¼ percent higher than four quarters earlier. Both near- and longer-term inflation expectations from the Michigan survey were unchanged in March and April. Over the 12 months ending in March, both the employment cost index for private-sector workers and average hourly earnings for all employees increased only a little more than consumer price inflation. Indicators of foreign economic activity suggested continued expansion in the first quarter but at a rate somewhat below that in the fourth quarter. The deceleration was concentrated in emerging market economies (EMEs). Real GDP growth slowed markedly in China, largely reflecting lower investment growth and exports. Weaker exports also restrained economic activity in other emerging Asian economies. In Mexico, indicators of activity suggested some improvement from a lackluster fourth quarter. By contrast, economic growth remained near its solid fourth-quarter pace in the advanced foreign economies (AFEs). In the euro area, the United Kingdom, and Canada, average industrial production in the first two months of the year was up moderately from the fourth quarter; in Japan, industrial production rose robustly, and consumer demand was boosted by anticipation of the April increase in the consumption tax. Inflation developments were mixed. Inflation rebounded in Canada but remained very low in the euro area. In China and India, inflation fell in the first quarter, largely because of lower food prices. Monetary policy remained highly accommodative during the intermeeting period in the AFEs and also in many EMEs, although monetary policy in Brazil was tightened to contain inflation pressures. 178 101st Annual Report | 2014 Staff Review of the Financial Situation Despite some volatility in certain asset prices, financial conditions did not change appreciably, on net, over the intermeeting period. Asset prices moved in response to economic data releases that were, on balance, a little stronger than expected and to Federal Reserve communications. The anticipated path of the federal funds rate moved up somewhat, as did intermediate-dated Treasury yields, while corporate bond spreads narrowed and the S&P 500 increased slightly. The foreign exchange value of the dollar was little changed. Federal Reserve communications garnered significant attention from market participants over the period but appeared to have only a modest net effect on their expectations for monetary policy. The communications following the conclusion of the March FOMC meeting were interpreted as somewhat less accommodative than expected. However, subsequent communications—including the release of the minutes of the March FOMC meeting—appeared to mostly reverse the earlier change in expectations. Yields on short- and medium-term nominal Treasury securities rose, on balance, over the intermeeting period. In contrast, yields at the long end of the curve declined, continuing a downward trend evident over much of this year. Market participants cited a number of factors as contributing to the drop in long-term yields so far this year, including portfolio reallocation by large institutional investors, the trading strategies pursued by some investors, and safehaven flows. Some market participants reportedly also revised down their estimate of the average real federal funds rate over the longer term, reflecting in part changes in their assessments of long-run economic conditions. Measures of longer-horizon inflation compensation based on Treasury InflationProtected Securities were little changed. Conditions in short-term funding markets remained fairly stable over the intermeeting period. Take-up in the Federal Reserve’s fixed-rate ON RRP exercise continued to be sensitive to the spread between market rates and the rate offered in the exercise, with higher take-up occurring on days when the market rate on repurchase agreements was close to or below the ON RRP rate. As has been the case since the ON RRP exercise began, money market funds increased their usage at quarter-end; take-up reached a record level of about $240 billion at the end of March. Part of the increase in ON RRP usage at the end of March relative to the end of December likely reflected higher counterparty allotment limits, which were raised from $3 billion to $7 billion during the first quarter. The allotment limit was subsequently increased to $10 billion per counterparty in early April. The seasonal paydown of short-term Treasury debt following the April tax date was accompanied by a notable pickup in participation at ON RRP operations, but Treasury repo rates generally remained very close to the ON RRP rate of 5 basis points. The S&P 500 increased a bit, on net, over the intermeeting period, but broader stock market indexes edged down. The prices of social media and biotechnology stocks, which had risen substantially faster than the broader market over the previous year, fell sharply over the intermeeting period, leaving the gains on these shares about in line with those on broader indexes over the past 12 months. Some initial public offerings were reportedly put on hold as prices of small-capitalization stocks declined. By contrast, stocks that generally have more stable dividends, such as those of utility and telecommunications companies, advanced. First-quarter earnings reports for large banking organizations were mixed, and the stock prices of such firms generally underperformed broad equity indexes. Credit flows to nonfinancial corporations remained robust, on balance, notwithstanding subdued bond issuance in April that was attributed to typical constraints on issuance during the period when many firms are reporting their earnings. The growth in commercial and industrial loans on banks’ balance sheets remained robust, consistent with the increase in loan demand by large and middle-market firms reported in the April Senior Loan Officer Opinion Survey on Bank Lending Practices (SLOOS). Institutional issuance of leveraged loans continued at a brisk pace amid reports of an ongoing gradual easing of credit terms and deal structures. Financing conditions in the commercial real estate (CRE) sector improved further. In the first quarter, commercial mortgage loans held on banks’ books continued to grow solidly. According to the April SLOOS, banks again eased standards on CRE loans during the first quarter; they also reported an increase in loan demand, especially for construction Minutes of Federal Open Market Committee Meetings | April and land development loans. In contrast, issuance of commercial mortgage-backed securities in 2014 has been a bit slower than last year’s pace. Mortgage credit conditions generally remained tight over the intermeeting period, though signs of easing continued to emerge amid further gains in house prices. In particular, the April SLOOS indicated a net easing of banks’ credit standards for home-purchase loans to prime customers in the first quarter. Mortgage interest rates and their spreads over Treasury yields were little changed over the intermeeting period, and applications for refinancing and purchase mortgages remained tepid. Conditions in consumer credit markets continued to be mixed. Student and auto loans expanded at a robust pace, while credit card debt outstanding stayed flat, as it had been in recent months. Financing conditions in the consumer asset-backed securities market remained favorable, and issuance continued to be solid. Most foreign equity indexes rose over the period despite a global selloff of technology-related stocks, and 10-year sovereign bond yields in Canada, Germany, and the United Kingdom were nearly unchanged on net. Yield spreads on peripheral euroarea debt over German bonds of similar maturity continued to narrow. The broad nominal exchange rate index for the dollar was about unchanged, as the dollar appreciated against the euro, yen, and renminbi but depreciated against most other currencies. Investor sentiment toward EMEs continued to improve over the period despite incoming data that were somewhat weaker than expected. Increasing tensions between Ukraine and Russia, as well as the lowering of Russia’s sovereign debt rating by Standard & Poor’s, contributed to a rise in Russia’s 10-year sovereign bond yield and a sharp decline in its main equity index. Outside of that region, however, these building tensions left little imprint on global financial markets. The staff’s periodic report on potential risks to financial stability concluded that the vulnerability of the financial system to adverse shocks remained at moderate levels overall. Relatively strong capital profiles of large domestic banking firms, low levels of aggregate leverage in the nonfinancial sector, and moderate use of short-term wholesale funding across the financial sector were seen as the primary factors supporting overall financial stability. However, the staff report also highlighted valuation pressures in some 179 segments of the equity market, continued strong demand for corporate debt instruments and associated pressures on underwriting standards, and liquidity risks associated with fixed-income mutual funds. Staff Economic Outlook In the economic forecast prepared by the staff for the April FOMC meeting, real GDP growth in the first half of this year was somewhat slower than in the projection for the March meeting. The available readings on net exports and, to a lesser extent, residential investment pointed to less spending growth in the first quarter than the staff previously expected. However, the staff’s assessment was that the unanticipated weakness in economic activity in the first quarter would be largely transitory and implied little revision to its projection for second-quarter output growth. In addition, the medium-term forecast for real GDP growth was essentially unrevised. The staff continued to project that real GDP would expand at a faster pace over the next few years than it did last year, and that it would rise more quickly than the growth rate of potential output. The faster pace of real GDP growth was expected to be supported by an easing in the restraint from changes in fiscal policy, increases in consumer and business confidence, further improvements in credit availability and financial conditions, and a pickup in the rate of foreign economic growth. The expansion in economic activity was anticipated to slowly reduce resource slack over the projection period, and the unemployment rate was expected to decline gradually to the staff’s estimate of its longer-run natural rate. The staff’s forecast for inflation was basically unchanged from the projection prepared for the previous FOMC meeting. The staff continued to forecast that inflation would remain below the Committee’s longer-run objective of 2 percent over the next few years. With longer-run inflation expectations assumed to remain stable, changes in commodity and import prices expected to be subdued, and slack in labor and product markets anticipated to diminish slowly, inflation was projected to rise gradually toward the Committee’s objective. The staff viewed the extent of uncertainty around its April projections for real GDP growth, inflation, and the unemployment rate as roughly in line with the average over the past 20 years. Nonetheless, the risks to the forecast for real GDP growth were viewed as tilted a little to the downside, especially because the economy was not well positioned to withstand 180 101st Annual Report | 2014 adverse shocks while the target for the federal funds rate was at its effective lower bound. At the same time, the staff viewed the risks around its outlook for the unemployment rate and for inflation as roughly balanced. Participants’ Views on Current Conditions and the Economic Outlook In their discussion of the economic situation and the outlook, meeting participants generally indicated that their assessment of the economic outlook had not changed materially since the March meeting. Severe winter weather had contributed to a sharp slowing in activity during the first quarter, but recent indicators pointed to a rebound and suggested that the economy had returned to a trajectory of moderate growth. However, some participants remarked that it was too early to confirm that the bounceback in economic activity would put the economy on a path of sustained above-trend economic growth. In general, participants continued to view the risks to the outlook for the economy and the labor market as nearly balanced. However, a number of participants pointed to possible sources of downside risk to growth, including a persistent slowdown in the housing sector or potential international developments, such as a further slowing of growth in China or an increase in geopolitical tensions regarding Russia and Ukraine. Participants noted that business contacts in many parts of the country were generally optimistic about economic prospects, with reports of increased sales of automobiles, higher production in the aerospace industry, and increased usage of industrial power; in addition, a couple of firms with a global presence reported a notable increase in demand from customers in Europe. Contacts in several Districts pointed to plans for increasing capital expenditures or to stronger demand for commercial and industrial loans. In the agricultural sector, the planting season was under way, but there were concerns about the effects of drought on production in some areas. Most participants commented on the continuing weakness in housing activity. They saw a range of factors affecting the housing market, including higher home prices, construction bottlenecks stemming from a scarcity of labor and harsh winter weather, input cost pressures, or a shortage in the supply of available lots. Views varied regarding the outlook for the multifamily sector, with the large increase in multifamily units coming to market potentially putting downward pressure on prices and rents, but the demand for this type of housing expected to rise as the population ages. A couple of participants noted that mortgage credit availability remained constrained and lending standards were tight compared with historical norms, especially for purchase mortgages. However, reports from some Districts indicated that real estate and housingrelated business activity had strengthened recently, consistent with the solid gains in consumer spending registered in March. Conditions in the labor market continued to improve over the intermeeting period and participants generally expected further gradual improvement. Participants discussed a range of research and analysis bearing on the amount of available slack remaining in the labor market. A number of them argued that several indicators of labor underutilization—including the low labor force participation rate and the stillelevated rates of longer-duration unemployment and of workers employed part time for economic reasons—suggested that there is more slack in the labor market than is captured by the unemployment rate alone. Low nominal wage inflation was also viewed as consistent with slack in labor markets. However, some participants reported that labor markets were tight in their Districts or that contacts indicated some sectors or occupations were experiencing shortages of workers. Another participant observed that labor underutilization, as measured by an index that takes employment transition rates into account, was consistent with past periods in which the official unemployment rate had reached its current level, and had declined about as much relative to the official unemployment rate as it had in previous economic recoveries. In discussing the effect of labor market conditions on inflation, a number of participants expressed skepticism about recent studies suggesting that long-term unemployment provides less downward pressure on wage and price inflation than short-term unemployment does. A couple of participants cited other research findings that both short- and long-term unemployment rates exert pressure on wages, with the effects of long-term unemployment increasing as the level of short-term unemployment declines. Moreover, a few participants pointed out that because of downward nominal wage rigidity during the recession, wage increases are likely to remain relatively modest for some time during the recovery, even as the labor market strengthens. It was also noted that because inflation was expected to remain well Minutes of Federal Open Market Committee Meetings | April below the Committee’s 2 percent objective and the unemployment rate was still above participants’ estimates of its longer-run normal level, the Committee did not, at present, face a tradeoff between its employment and inflation objectives, and an expansion of aggregate demand would result in further progress relative to both objectives. Inflation continued to run below the Committee’s 2 percent longer-run objective over the intermeeting period. Many participants saw the recent behavior of the prices of food, energy, shelter, and imports as consistent with a stabilization in inflation and judged that the transitory factors that had reduced inflation, such as declines in administered prices for medical services, were fading. Most participants expected inflation to return to 2 percent within the next few years, supported by highly accommodative monetary policy, stable inflation expectations, and a continued gradual recovery in economic activity. However, a few others expressed the concern that the return to 2 percent inflation could be even more gradual. In their discussion of financial stability, participants generally did not see imbalances that posed significant near-term risks to the financial system and the broader economy, but they nevertheless reviewed some financial developments that pointed to potential future risks. A couple of participants noted that conditions in the leveraged loan market had become stretched, although equity cushions on new deals remained above levels seen prior to the financial crisis. Two others saw declining credit spreads, particularly on speculative-grade corporate bonds, as consistent with an increase in investors’ appetite for risk. In addition, several participants noted that the low level of expected volatility implied by some financial market prices might also signal an increase in risk appetite. Some stated that it would be helpful to continue to explore the appropriate regulatory, supervisory, and monetary policy responses to potential risks to financial stability. It was noted that the changes to the Committee’s forward guidance at the March FOMC meeting had been well understood by investors. However, a number of participants emphasized the importance of communicating still more clearly about the Committee’s policy intentions as the time of the first increase in the federal funds rate moves closer. Some thought it would be helpful to clarify the reasoning underlying the language in the FOMC’s postmeeting statement indicating that even after employment and inflation are near mandate-consistent levels, eco- 181 nomic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run. In addition, a few participants judged that additional clarity about the Committee’s reaction function could be particularly important in the event that future economic conditions necessitate a more rapid rise in the target federal funds rate than the Committee currently anticipates. A number of participants suggested that it would be useful to provide additional information regarding how long the Committee would continue its policy of rolling over maturing Treasury securities at auction and reinvesting principal payments on all agency debt and agency mortgage-backed securities in agency mortgagebacked securities. Committee Policy Action Members viewed the information received over the intermeeting period as indicating that economic growth had picked up recently, following a sharp slowdown during the winter due in part to unusually severe weather conditions. Although labor market indicators were mixed, on balance they showed further improvement. The unemployment rate, however, remained elevated. While household spending appeared to be rising more rapidly, business fixed investment had edged down and the recovery in the housing sector remained slow. Fiscal policy was restraining economic growth, but the extent of that restraint had diminished. The Committee expected that, with appropriate policy accommodation, economic activity would expand at a moderate pace and labor market conditions would continue to improve gradually, moving toward those the Committee judges to be consistent with its dual mandate. Moreover, members continued to see risks to the outlook for the economy and the labor market as nearly balanced. Inflation was running below the Committee’s longer-run objective and was seen as posing possible risks to economic performance, but members anticipated that stable inflation expectations and strengthening economic activity would, over time, return inflation to the Committee’s 2 percent target. However, in light of their concerns about the possible persistence of low inflation, members agreed that inflation developments should be monitored carefully for evidence that inflation was moving back toward the Committee’s longer-run objective. In their discussion of monetary policy in the period ahead, members noted that there had been little change in the economic outlook since the March 182 101st Annual Report | 2014 meeting and decided that it would be appropriate to make a further measured reduction in the pace of asset purchases at this meeting. Accordingly, the Committee agreed that, beginning in May, it would add to its holdings of agency mortgage-backed securities at a pace of $20 billion per month rather than $25 billion per month, and would add to its holdings of longer-term Treasury securities at a pace of $25 billion per month rather than $30 billion per month. Members again judged that, if the economy continued to develop as anticipated, the Committee would likely reduce the pace of asset purchases in further measured steps at future meetings. However, members underscored that the pace of asset purchases was not on a preset course and would remain contingent on the Committee’s outlook for the labor market and inflation as well as its assessment of the likely efficacy and costs of purchases. The Committee agreed that no changes to its target range for the federal funds rate or its forward guidance were warranted at this meeting, aside from removing a short paragraph that was added when the forward guidance was updated at the March meeting and which noted that the change in the Committee’s guidance did not signal a change in the Committee’s policy intentions; members deemed this language no longer necessary. 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 SOMA in accordance with the following domestic policy directive: “Consistent with its statutory mandate, the Federal Open Market Committee seeks monetary and financial conditions that will foster maximum employment and price stability. In particular, 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 undertake open market operations as necessary to maintain such conditions. Beginning in May, the Desk is directed to purchase longer-term Treasury securities at a pace of about $25 billion per month and to purchase agency mortgage-backed securities at a pace of about $20 billion per month. The Committee also directs the Desk to engage in dollar roll and coupon swap transactions as necessary to facilitate settlement of the Federal Reserve’s agency mortgage-backed securities transactions. The Committee directs the Desk to maintain its policy of rolling over maturing Treasury securities into new issues and its policy of reinvesting principal payments on all agency debt and agency mortgage-backed securities in agency mortgage-backed securities. 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 2:00 p.m.: “Information received since the Federal Open Market Committee met in March indicates that growth in economic activity has picked up recently, after having slowed sharply during the winter in part because of adverse weather conditions. Labor market indicators were mixed but on balance showed further improvement. The unemployment rate, however, remains elevated. Household spending appears to be rising more quickly. Business fixed investment edged down, while the recovery in the housing sector remained slow. Fiscal policy is restraining economic growth, although the extent of restraint is diminishing. Inflation has been running below the Committee’s longer-run objective, but 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 that, with appropriate policy accommodation, economic activity will expand at a moderate pace and labor market conditions will continue to improve gradually, moving toward those the Committee judges consistent with its dual mandate. The Committee sees the risks to the outlook for the economy and the labor market as nearly balanced. The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, and it is monitoring inflation developments carefully for evidence that inflation will move back toward its objective over the medium term. The Committee currently judges that there is sufficient underlying strength in the broader economy to support ongoing improvement in labor market conditions. In light of the cumula- Minutes of Federal Open Market Committee Meetings | April tive progress toward maximum employment and the improvement in the outlook for labor market conditions since the inception of the current asset purchase program, the Committee decided to make a further measured reduction in the pace of its asset purchases. Beginning in May, the Committee will add to its holdings of agency mortgage-backed securities at a pace of $20 billion per month rather than $25 billion per month, and will add to its holdings of longerterm Treasury securities at a pace of $25 billion per month rather than $30 billion per month. The Committee is maintaining its existing policy 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’s sizable and still-increasing holdings of longer-term securities should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee’s dual mandate. The Committee will closely monitor incoming information on economic and financial developments in coming months and will continue its purchases of Treasury and agency mortgagebacked securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability. If incoming information broadly supports the Committee’s expectation of ongoing improvement in labor market conditions and inflation moving back toward its longer-run objective, the Committee will likely reduce the pace of asset purchases in further measured steps at future meetings. However, asset purchases are not on a preset course, and the Committee’s decisions about their pace will remain contingent on the Committee’s outlook for the labor market and inflation as well as its assessment of the likely efficacy and costs of such purchases. To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy 183 remains appropriate. In determining how long to maintain the current 0 to ¼ percent target range for the federal funds rate, the Committee will assess progress—both realized and expected— toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the Committee’s 2 percent longerrun goal, and provided that longer-term inflation expectations remain well anchored. When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent. The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.” Voting for this action: Janet L. Yellen, William C. Dudley, Richard W. Fisher, Narayana Kocherlakota, Sandra Pianalto, Charles I. Plosser, Jerome H. Powell, Jeremy C. Stein, and Daniel K. Tarullo. Voting against this action: None. It was agreed that the next meeting of the Committee would be held on Tuesday–Wednesday, June 17–18, 2014. The meeting adjourned at 10:55 a.m. on April 30, 2014. Notation Vote By notation vote completed on April 8, 2014, the Committee unanimously approved the minutes of the Committee meeting held on March 18–19, 2014. William B. English Secretary 184 101st Annual Report | 2014 Meeting Held on June 17–18, 2014 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 17, 2014, at 10:00 a.m. and continued on Wednesday, June 18, 2014, at 9:00 a.m. Present Janet L. Yellen Chair William C. Dudley Vice Chairman Lael Brainard Stanley Fischer Richard W. Fisher Narayana Kocherlakota Loretta J. Mester Charles I. Plosser Jerome H. Powell Daniel K. Tarullo Christine Cumming, Charles L. Evans, Jeffrey M. Lacker, Dennis P. Lockhart, and John C. Williams Alternate Members of the Federal Open Market Committee James Bullard, Esther L. George, and Eric Rosengren Presidents of the Federal Reserve Banks of St. Louis, Kansas City, and Boston, respectively William B. English Secretary and Economist Matthew M. Luecke Deputy Secretary Michelle A. Smith Assistant Secretary Scott G. Alvarez General Counsel Steven B. Kamin Economist James A. Clouse, Thomas A. Connors, Evan F. Koenig, Thomas Laubach, Michael P. Leahy, Samuel Schulhofer-Wohl, Mark E. Schweitzer, and William Wascher Associate Economists Simon Potter Manager, System Open Market Account Lorie K. Logan Deputy Manager, System Open Market Account Robert deV. Frierson1 Secretary of the Board, Office of the Secretary, Board of Governors Nellie Liang Director, Office of Financial Stability Policy and Research, Board of Governors Stephen A. Meyer and William R. Nelson Deputy Directors, Division of Monetary Affairs, Board of Governors Mark E. Van Der Weide Deputy Director, Division of Banking Supervision and Regulation, Board of Governors Jon W. Faust and Stacey Tevlin Special Advisers to the Board, Office of Board Members, Board of Governors Trevor A. Reeve Special Adviser to the Chair, Office of Board Members, Board of Governors Linda Robertson Assistant to the Board, Office of Board Members, Board of Governors Brian M. Doyle Senior Adviser, Division of International Finance, Board of Governors Ellen E. Meade and Joyce K. Zickler Senior Advisers, Division of Monetary Affairs, Board of Governors Daniel M. Covitz, Eric M. Engen, Michael T. Kiley, and David E. Lebow Associate Directors, Division of Research and Statistics, Board of Governors Fabio M. Natalucci1 and Gretchen C. Weinbach1 Associate Directors, Division of Monetary Affairs, Board of Governors David W. Wilcox Economist 1 Attended the joint session of the Federal Open Market Committee and the Board of Governors. Minutes of Federal Open Market Committee Meetings | June Beth Anne Wilson Associate Director, Division of International Finance, Board of Governors William F. Bassett and Jane E. Ihrig1 Deputy Associate Directors, Division of Monetary Affairs, Board of Governors 185 Cletus C. Coughlin, Mary Daly, Troy Davig, Michael Dotsey, Joshua L. Frost, and John A. Weinberg Senior Vice Presidents, Federal Reserve Banks of St. Louis, San Francisco, Kansas City, Philadelphia, New York, and Richmond, respectively Joshua Gallin Deputy Associate Director, Division of Research and Statistics, Board of Governors Deborah L. Leonard,1 Giovanni Olivei, and Douglas Tillett Vice Presidents, Federal Reserve Banks of New York, Boston, and Chicago, respectively Min Wei2 Assistant Director, Division of Monetary Affairs, Board of Governors Marc Giannoni Research Officer, Federal Reserve Bank of New York Jeremy B. Rudd Adviser, Division of Research and Statistics, Board of Governors Penelope A. Beattie1 Assistant to the Secretary, Office of the Secretary, Board of Governors Laura Lipscomb1 Section Chief, Division of Monetary Affairs, Board of Governors David H. Small Project Manager, Division of Monetary Affairs, Board of Governors Katie Ross1 Manager, Office of the Secretary, Board of Governors Wendy Dunn and Patrick McCabe1 Senior Economists, Division of Research and Statistics, Board of Governors Etienne Gagnon Senior Economist, Division of Monetary Affairs, Board of Governors Jonathan Rose Economist, Division of Monetary Affairs, Board of Governors Achilles Sangster II Records Management Analyst, Division of Monetary Affairs, Board of Governors Mark L. Mullinix First Vice President, Federal Reserve Bank of Richmond David Altig and Daniel G. Sullivan Executive Vice Presidents, Federal Reserve Banks of Atlanta and Chicago, respectively 2 Attended Tuesday’s session only. In the agenda for this meeting, it was reported that Loretta J. Mester had been elected a member of the Federal Open Market Committee and that she had executed her oath of office. Developments in Financial Markets and the Federal Reserve’s Balance Sheet In a joint session of the Federal Open Market Committee (FOMC) and the Board of Governors of the Federal Reserve System, the deputy manager of the System Open Market Account (SOMA) reported on developments in domestic and foreign financial markets. The SOMA manager reported on the System open market operations during the period since the Committee met on April 29–30, 2014, outlined the testing of the Term Deposit Facility, described the results from the fixed-rate overnight reverse repurchase agreement (ON RRP) operational exercise, and provided some possible options for adjusting the list of counterparties eligible to participate in ON RRP operations. The manager also noted the effects of recent foreign central bank policy actions on the yields on the international portion of the SOMA portfolio and discussed ongoing staff work on improving data collections regarding bank funding markets. 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. Monetary Policy Normalization Meeting participants continued their discussion of issues associated with the eventual normalization of the stance and conduct of monetary policy. The Committee’s consideration of this topic was undertaken as part of prudent planning and did not imply that normalization would necessarily begin sometime 186 101st Annual Report | 2014 soon. A staff presentation included some possible strategies for implementing and communicating monetary policy during a period when the Federal Reserve will have a very large balance sheet. In addition, the presentation outlined design features of a potential ON RRP facility and discussed options for the Committee’s policy of rolling over maturing Treasury securities at auction and reinvesting principal payments on all agency debt and agency mortgage-backed securities (MBS) in agency MBS. Most participants agreed that adjustments in the rate of interest on excess reserves (IOER) should play a central role during the normalization process. It was generally agreed that an ON RRP facility with an interest rate set below the IOER rate could play a useful supporting role by helping to firm the floor under money market interest rates. One participant thought that the ON RRP rate would be the more effective policy tool during normalization in light of the wider variety of counterparties eligible to participate in ON RRP operations. The appropriate size of the spread between the IOER and ON RRP rates was discussed, with many participants judging that a relatively wide spread—perhaps near or above the current level of 20 basis points—would support trading in the federal funds market and provide adequate control over market interest rates. Several participants noted that the spread might be adjusted during the normalization process. A couple of participants suggested that adequate control of short-term rates might be accomplished with a very wide spread or even without an ON RRP facility. A few participants commented that the Committee should also be prepared to use its other policy tools, including term deposits and term reverse repurchase agreements, if necessary. Most participants thought that the federal funds rate should continue to play a role in the Committee’s operating framework and communications during normalization, with many of them indicating a preference for continuing to announce a target range. However, a few participants thought that, given the degree of uncertainty about the effects of the Committee’s tools on market rates, it might be preferable to focus on an administered rate in communicating the stance of policy during the normalization period. In addition, participants examined possibilities for changing the calculation of the effective federal funds rate in order to obtain a more robust measure of overnight bank funding rates and to apply lessons from international efforts to develop improved standards for benchmark interest rates. While generally agreeing that an ON RRP facility could play an important role in the policy normalization process, participants discussed several potential unintended consequences of using such a facility and design features that could help to mitigate these consequences. Most participants expressed concerns that in times of financial stress, the facility’s counterparties could shift investments toward the facility and away from financial and nonfinancial corporations, possibly causing disruptions in funding that could magnify the stress. In addition, a number of participants noted that a relatively large ON RRP facility had the potential to expand the Federal Reserve’s role in financial intermediation and reshape the financial industry in ways that were difficult to anticipate. Participants discussed design features that could address these concerns, including constraints on usage either in the aggregate or by counterparty and a relatively wide spread between the ON RRP rate and the IOER rate that would help limit the facility’s size. Several participants emphasized that, although the ON RRP rate would be useful in controlling short-term interest rates during normalization, they did not anticipate that such a facility would be a permanent part of the Committee’s longer-run operating framework. Finally, a number of participants expressed concern about conducting monetary policy operations with nontraditional counterparties. Participants also discussed the appropriate time for making a change to the Committee’s policy of rolling over maturing Treasury securities at auction and reinvesting principal payments on all agency debt and agency MBS in agency MBS. It was noted that, in the staff’s models, making a change to the Committee’s reinvestment policy prior to the liftoff of the federal funds rate, at the time of liftoff, or sometime thereafter would be expected to have only limited implications for macroeconomic outcomes, the Committee’s statutory objectives, or remittances to the Treasury. Many participants agreed that ending reinvestments at or after the time of liftoff would be best, with most of these participants preferring to end them after liftoff. These participants thought that an earlier change to the reinvestment policy would involve risks to the economic outlook if it was seen as suggesting that the Committee was likely to tighten policy more rapidly than currently anticipated or if it had unexpectedly large effects in MBS markets; moreover, an early change could add complexity to the Committee’s communications at a time when it would be clearer to signal changes in policy through Minutes of Federal Open Market Committee Meetings | June interest rates alone. However, some participants favored ending reinvestments prior to the first firming in policy interest rates, as stated in the Committee’s exit strategy principles announced in June 2011. Those participants thought that such an approach would avoid weakening the credibility of the Committee’s communications regarding normalization, would act to modestly reduce the size of the Federal Reserve’s balance sheet, or would help prepare the public for the eventual rise in short-term interest rates. Regardless of whether they preferred to introduce a change to the Committee’s reinvestment policy before or after the initial tightening in shortterm interest rates, a number of participants thought that it might be best to follow a graduated approach with respect to winding down reinvestments or to manage reinvestments in a manner that would smooth the decline in the balance sheet. Some stressed that the details should depend on financial and economic conditions. Overall, participants generally expressed a preference for a simple and clear approach to normalization that would facilitate communication to the public and enhance the credibility of monetary policy. It was observed that it would be useful for the Committee to develop and communicate its plans to the public later this year, well before the first steps in normalizing policy become appropriate. Most participants indicated that they expected to learn more about the effects of the Committee’s various policy tools as normalization proceeds, and many favored maintaining flexibility about the evolution of the normalization process as well as the Committee’s longer-run operating framework. Participants requested additional analysis from the staff on issues related to normalization and agreed that it would be helpful to continue to review these issues at upcoming meetings. The Board meeting concluded at the end of the discussion. Staff Review of the Economic Situation The information reviewed for the June 17–18 meeting indicated that real gross domestic product (GDP) had dropped significantly early in the year but that economic growth had bounced back in recent months. The average pace of employment gains stepped up, and the unemployment rate declined markedly in April and held steady in May, although it was still elevated. Consumer price inflation picked up in recent months, while measures of longer-run inflation expectations remained stable. 187 Most measures of labor market conditions improved in recent months. Total nonfarm payroll employment expanded in April and May at a faster rate than the average monthly pace during the previous two quarters. The unemployment rate dropped to 6.3 percent in April and remained at that level in May. However, the labor force participation rate also declined in April and then held steady in May, while the employment-to-population ratio remained flat. Both the share of workers employed part time for economic reasons and the rate of long-duration unemployment edged down in recent months, although both measures were still high. Initial claims for unemployment insurance decreased slightly, on net, over the intermeeting period, and the rate of job openings stepped up in April; nevertheless, the rate of hiring was unchanged and remained at a modest level. Industrial production increased, on balance, in April and May, as manufacturing output and production in the mining sector expanded and more than offset a further decline in the output of utilities from the elevated levels recorded during the unusually cold winter months. As a result, the rate of industrial capacity utilization rose in recent months. Automakers’ schedules indicated that the pace of light motor vehicle assemblies would step up in the coming months, and broader indicators of manufacturing production, such as the readings on new orders from national manufacturing surveys, were consistent with moderate increases in factory output in the near term. Real personal consumption expenditures (PCE) declined a little in April following strong gains in February and March. The component of the nominal retail sales data used by the Bureau of Economic Analysis to construct its estimate of PCE edged down in May, but light motor vehicle sales moved up briskly. Recent information about key factors that influence household spending mostly pointed to gains in PCE in the coming months. Real disposable income continued to rise in April, and households’ net worth likely increased as equity prices and home values advanced further; however, consumer sentiment in the Thomson Reuters/University of Michigan Surveys of Consumers moved down somewhat in May and early June. The pace of activity in the housing sector remained subdued. Starts of new single-family homes declined slightly, on net, in April and May, although starts of multifamily units increased. Permits for single-family 188 101st Annual Report | 2014 homes, which are usually a better indicator of the underlying pace of residential construction, increased only a little on balance. Sales of new homes rose in April but remained near their average monthly level last year. Existing home sales only edged up in April and were still below last year’s average level, while pending home sales were little changed. Real private expenditures for business equipment and intellectual property products were estimated to have increased slowly in the first quarter as a whole. In April, nominal orders and shipments of nondefense capital goods excluding aircraft decreased a little after rising briskly in March. However, the level of new orders for these capital goods remained above the level of shipments in April, pointing to increases in shipments in subsequent months. Other forwardlooking indicators, such as surveys of business conditions, were also generally consistent with modest increases in business equipment spending in the near term. Nominal business spending for nonresidential structures was essentially unchanged in April. Recent data on the book value of inventories, along with readings on inventories from national and regional manufacturing surveys, did not point to significant inventory imbalances in most industries except in the energy sector, where inventories appeared unusually low after having been drawn down during the winter. Federal spending data for April and May pointed toward only a small decline in real federal government purchases in the second quarter, as the pace of decreases in defense expenditures seemed to ease. Real state and local government purchases appeared to edge up going into the second quarter. The payrolls of these governments expanded in April and May, and nominal state and local construction expenditures increased a little in April. PCE inflation—which excludes food and energy prices—was also around 1½ percent. In May, the consumer price index (CPI) increased at a faster pace than in the preceding few months; both food and energy prices rose more briskly, and core CPI inflation also stepped up. Over the 12 months ending in May, both total and core CPI inflation were about 2 percent. Near-term inflation expectations from the Michigan survey declined slightly, on balance, in May and early June, while longer-term inflation expectations from the survey were little changed. Increases in measures of labor compensation remained modest. Compensation per hour in the nonfarm business sector rose about 2¼ percent over the year ending in the first quarter; with small gains in labor productivity, unit labor costs advanced more slowly than compensation per hour. Over the year ending in May, average hourly earnings for all employees increased around 2 percent. Foreign real GDP growth slowed in the first quarter, especially in China and some other emerging market economies. Real GDP also increased more slowly in Canada, in part because of severe winter weather, and the pace of economic activity remained weak in the euro area. Economic growth continued to be strong in the United Kingdom, and economic activity jumped in Japan as household spending surged in advance of April’s consumption tax hike. Indicators for the second quarter generally suggested that foreign economic growth picked up from the first quarter. In some advanced foreign economies, inflation moved up recently from earlier low readings. Inflation continued to be low, however, in the euro area, and the European Central Bank (ECB) announced additional stimulus measures. Staff Review of the Financial Situation The U.S. international trade deficit widened in March and in April. Both imports and exports recovered from weak readings in February, with imports of consumer goods, automotive products, and capital goods rising significantly and exports of capital goods and industrial supplies showing particular strength. U.S. consumer price inflation, as measured by the PCE price index, was about 1½ percent over the 12 months ending in April, below the Committee’s longer-run objective of 2 percent. Over the same 12-month period, consumer energy prices rose faster than total consumer prices, while consumer food prices climbed more slowly than overall prices; core On balance, financial conditions in the United States remained supportive of growth in economic activity and employment: The expected path of the federal funds rate was slightly lower in the long run, yields on longer-term Treasury securities moved down modestly, equity prices rose, corporate bond spreads narrowed, and the foreign exchange value of the dollar was little changed. Federal Reserve communications over the intermeeting period had limited effects in financial markets. The April FOMC statement and minutes appeared to be generally in line with expectations, while the Chair’s congressional testimony before the Joint Eco- Minutes of Federal Open Market Committee Meetings | June nomic Committee in early May and the subsequent question-and-answer session were viewed by market participants as suggesting marginally more accommodative policy than expected. Results from the Desk’s June Survey of Primary Dealers indicated no change in the dealers’ consensus expectation about the most likely timing of the first increase in the federal funds rate target but showed a lower median longer-run level of the federal funds rate relative to the April survey. Expectations for Federal Reserve asset purchases were largely unchanged. In addition, although there was significant dispersion among dealer responses, the median dealer expected the FOMC to end its reinvestment of principal payments on Treasury securities, agency debt, and agency MBS sometime after the first increase in the federal funds rate target; in the April survey, the median dealer had expected reinvestments to end before liftoff. Yields on short- and medium-term nominal Treasury securities increased slightly, on balance, over the intermeeting period. In contrast, yields at the long end of the curve edged lower, continuing a downward trend evident over much of this year. Market participants continued to discuss the decreases in long forward rates since the beginning of the year and pointed to a variety of domestic and global factors possibly contributing to this trend, including lower expectations for potential growth and policy rates in the longer run, a decline in inflation risk premiums, purchases of longer-term securities by priceinsensitive investors, unwinding of short Treasury positions, and falling interest rate uncertainty. Measures of longer-horizon inflation compensation based on Treasury Inflation-Protected Securities remained about steady. Conditions in unsecured short-term dollar funding markets remained stable over the intermeeting period. The Federal Reserve continued its ON RRP exercise. Total take-up in the ON RRP exercise rose in April and May before falling back in June. Much of the transitory increase in take-up occurred in response to a large seasonal reduction in outstanding Treasury debt and an associated drop in the rates on Treasury repurchase agreements during the first half of the second quarter that were reversed during the second half. In May, the Federal Reserve began an eight-week series of test auctions of seven-day term deposits. The number of participants and the total amount awarded increased over the course of the first five operations. 189 Broad stock price indexes rose over the intermeeting period, apparently boosted by a more optimistic assessment of near-term economic prospects and likely supported by continued low interest rates. Despite generally lackluster results for first-quarter earnings, corporate guidance for profits in coming quarters led to upward revisions in analysts’ forecasts of year-ahead earnings per share for S&P 500 firms. The VIX, an index of option-implied volatility for one-month returns on the S&P 500 index, continued to decline and ended the period near its historical lows. Measures of uncertainty in other financial markets also declined; results from the Desk’s primary dealer survey suggested this development might have reflected low realized volatilities, generally favorable economic news, less uncertainty for the path of monetary policy, and complacency on the part of market participants about potential risks. Credit flows to nonfinancial corporations remained strong. Amid low yields and reduced market volatility, gross issuance of investment- and speculativegrade bonds rebounded in May. Commercial and industrial (C&I) loans on banks’ balance sheets increased and issuance of leveraged loans remained strong. Responses to the June Senior Credit Officer Opinion Survey on Dealer Financing Terms indicated that investor demand for financing to fund purchases of collateralized loan obligations rose somewhat since the beginning of the year. Commercial real estate loans continued to increase amid some further easing of underwriting standards for commercial mortgages. While issuance of commercial mortgage-backed securities started the year a bit slow relative to 2013, it has picked up recently. Bank and insurance company originations of commercial mortgages expanded in the first quarter. Mortgage credit conditions generally remained tight, though further incremental signs of easing emerged amid continued gains in house prices. Mortgage interest rates declined somewhat more than longterm Treasury yields over the intermeeting period, while option-adjusted spreads on production-coupon MBS narrowed. Both mortgage applications for home purchases and refinancing applications remained at very low levels. Conditions in consumer credit markets were solid in recent months. Credit card loan balances increased. Growth in student loans moderated further but remained solid, and outstanding auto loans contin- 190 101st Annual Report | 2014 ued to pick up. Issuance of auto and credit card asset-backed securities was again robust. The expected path of ECB policy rates implied by market quotes for short-term interest rates fell over the intermeeting period, as investors anticipated the easing of policy announced by the ECB at its June meeting. By contrast, late in the period, market participants interpreted statements by Bank of England Governor Carney as signaling an earlier tightening of policy than had been anticipated, and near-term policy rate expectations moved higher in response. Benchmark sovereign bond yields declined modestly in most countries, but U.K. gilt yields rose. The foreign exchange value of the dollar was little changed, on balance, over the period, as the dollar appreciated against the euro but declined against the Canadian dollar and many emerging market currencies. Consistent with some improvement in investor sentiment toward risky assets, foreign equity prices generally rose over the intermeeting period, and foreign sovereign and corporate bond spreads narrowed. In addition, both bond and equity emerging market mutual funds saw net inflows over the period. Staff Economic Outlook In the economic forecast prepared by the staff for the June FOMC meeting, real GDP growth in the first half of this year as a whole was lower, on net, than in the projection for the April meeting. In particular, the available readings on exports, inventory investment, outlays for health-care services, and construction pointed to much weaker real GDP in the first quarter than the staff had expected. However, the staff still anticipated that real GDP growth would rebound briskly in the second quarter, consistent with recent indicators for consumer spending and business investment, along with the expectation that exports and inventory investment would return to more normal levels and that economic activity that had been restrained by the severe winter weather would bounce back. Primarily because of the combination of recent downward surprises in the unemployment rate and weaker-than-expected real GDP, the staff slightly lowered its assumed pace of potential output growth this year and next and slightly decreased its assumption for the natural rate of unemployment over this same period. As a result, the staff’s medium-term forecast for real GDP growth was revised down a little on balance. Nevertheless, the staff continued to project that real GDP would expand at a faster pace in the second half of this year and over the next two years than it did last year and that it would rise more quickly than potential output. The faster pace of real GDP growth was expected to be supported by diminishing drag on spending from changes in fiscal policy, increases in consumer and business confidence, further improvements in credit availability, and a pickup in the rate of foreign economic growth. The expansion in economic activity was anticipated to slowly reduce resource slack over the projection period, and the unemployment rate was expected to decline gradually to the staff’s estimate of its longer-run natural rate in the medium term. In the longer-run outlook, the staff slightly lowered its assumptions for real GDP growth and the level of equilibrium real interest rates. The staff’s forecast for inflation in the near term was revised up a little as recent data showed somewhat faster increases in consumer prices than anticipated. However, the medium-term projection for inflation was revised down slightly, reflecting a reassessment by the staff of the underlying trend in inflation. The staff continued to forecast that inflation would remain below the Committee’s longer-run objective of 2 percent over the next few years. With longer-run inflation expectations assumed to remain stable, changes in commodity and import prices expected to be subdued, and slack in labor and product markets anticipated to diminish slowly, inflation was projected to rise gradually toward the Committee’s objective. The staff continued to project that inflation would reach the Committee’s objective in the longer run. The staff’s economic projections for the June meeting were somewhat different from the forecasts presented at the March meeting, when the FOMC last prepared a Summary of Economic Projections (SEP). The staff’s June projections for the unemployment rate, real GDP growth, and inflation over the next few years were all a little lower, on balance, than those in its March forecast. The staff viewed the extent of uncertainty around its June projections for real GDP growth and the unemployment rate as roughly in line with the average over the past 20 years. Nonetheless, the risks to the forecast for real GDP growth were viewed as tilted a little to the downside, as neither monetary policy nor fiscal policy was seen as being well positioned to help the economy withstand adverse shocks. At the same time, the staff viewed the risks around its outlook for the unemployment rate and for inflation as roughly balanced. Minutes of Federal Open Market Committee Meetings | June Participants’ Views on Current Conditions and the Economic Outlook In conjunction with this FOMC meeting, the meeting participants submitted their assessments of real output growth, the unemployment rate, inflation, and the target federal funds rate for each year from 2014 through 2016 and over the longer run, under each participant’s judgment of appropriate monetary policy.3 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 SEP, which is attached as an addendum to these minutes. In their discussion of the economic situation and the outlook, meeting participants viewed the information received over the intermeeting period as suggesting that economic activity was rebounding in the second quarter following a surprisingly large decline in real GDP in the first quarter of the year. Labor market conditions generally improved further. Although participants marked down their expectations for average growth of real GDP over the first half of 2014, their projections beginning in the second half of 2014 changed little. Over the next two and a half years, they continued to expect economic activity to expand at a rate sufficient to lead to a further decline in the unemployment rate to levels close to their current assessments of its longer-run normal value. Among the factors anticipated to support the sustained economic expansion were accommodative monetary policy, diminished drag from fiscal restraint, further gains in household net worth, improving credit conditions for households and businesses, and rising employment and wages. While inflation was still seen as running below the Committee’s longer-run objective, longer-run inflation expectations remained stable and the Committee anticipated that inflation would move back toward its 2 percent objective over the forecast period. Most participants viewed the risks to the outlook for the economy, the labor market, and inflation as broadly balanced. Household spending appeared to have risen moderately, on balance, in recent months, with sales of 3 Four members of the Board of Governors and the presidents of the 12 Federal Reserve Banks submitted projections. Governor Brainard took office on June 16, 2014, and participated in the June 17–18, 2014, meeting; she was not able to submit economic projections. 191 motor vehicles, in particular, rising strongly. However, several participants read the recent soft information on retail sales and health-care spending as raising some concern about the underlying strength in consumer spending. A couple of participants noted that, to date, consumer spending had been supported importantly by gains in household net worth while income gains had been held back by only modest increases in wages. In their view, an important element in the economic outlook was a pickup in income, from higher wages as well as ongoing employment gains, that would be expected to support a sustained rise in consumer spending. The recovery in the housing sector was reported to have remained slow in all but a few areas of the country. Many participants expressed concern about the still-soft indicators of residential construction, and they discussed a range of factors that might be contributing to either a temporary delay in the housing recovery or a persistently lower level of homebuilding than previously anticipated. Despite attractive mortgage rates, housing demand was seen as being damped by such factors as restrictive credit conditions, particularly for households with low credit scores; high down payments; or low demand among younger homebuyers, due in part to the burden of student loan debt. Others noted supply constraints, pointing to shortages of lots, low inventories of desirable homes for sale, an overhang of homes associated with foreclosures or seriously delinquent mortgages, or rising construction costs. Several other participants suggested the possibility that more persistent structural changes in housing demand associated with an aging population and evolving lifestyle preferences were boosting demand for multifamily units at the expense of single-family homes. Information from participants’ business contacts suggested capital spending was likely to increase going forward. Contacts in a number of Districts reported that they were generally optimistic about the business outlook, although in a couple of regions respondents remained cautious about prospects for stronger economic growth or worried about a renewal of federal fiscal restraint after the current congressional budget agreement expires. Among the industries cited as relatively strong in recent months were transportation, energy, telecommunications, and manufacturing, particularly motor vehicles. Some participants commented that their contacts in small and mediumsized businesses reported an improved outlook for sales, and several heard businesses more generally discuss plans to increase capital expenditures. One par- 192 101st Annual Report | 2014 ticipant noted that District businesses were investing largely to meet replacement needs, while another suggested that the backlog of such needs would likely provide some impetus to business investment. Favorable financial conditions appeared be supporting economic activity. While information about mortgage lending was mixed, a number of participants reported increases in C&I lending by banks in their Districts, a pickup in loan demand at banks, or better credit quality for borrowers. In addition, small businesses reported improvements in credit availability. However, participants also discussed whether some recent trends in financial markets might suggest that investors were not appropriately taking account of risks in their investment decisions. In particular, low implied volatility in equity, currency, and fixedincome markets as well as signs of increased risktaking were viewed by some participants as an indication that market participants were not factoring in sufficient uncertainty about the path of the economy and monetary policy. They agreed that the Committee should continue to carefully monitor financial conditions and to emphasize in its communications the dependence of its policy decisions on the evolution of the economic outlook; it was also pointed out that, where appropriate, supervisory measures should be applied to address excessive risk-taking and associated financial imbalances. At the same time, it was noted that monetary policy needed to continue to promote the favorable financial conditions required to support the economic expansion. In discussing economic developments abroad, a couple of participants noted that recent monetary policy actions by the ECB and the Bank of Japan had improved the outlook for economic activity in those areas and could help return inflation to target. Several others, however, remained concerned that persistent low inflation in Europe and Japan could eventually erode inflation expectations more broadly. And a couple of participants expressed uncertainty about the outlook for economic growth in Japan and China. In addition, several saw developments in Iraq and Ukraine as posing possible downside risks to global economic activity or potential upside risks to world oil prices. Labor market conditions generally continued to improve over the intermeeting period. That improvement was evidenced by the decline in the unemployment rate as well as by changes in other indicators, such as solid gains in nonfarm payrolls, a low level of new claims for unemployment insurance, uptrends in quits and job openings, and more positive views of job availability by households. In assessing labor market conditions, participants again offered a range of views on how far conditions in the labor market were from those associated with maximum employment. Many judged that slack remained elevated, and a number of them thought it was greater than measured by the official unemployment rate, citing, in particular, the still-high level of workers employed part time for economic reasons or the depressed labor force participation rate. Even so, several participants pointed out that both long- and short-term unemployment and measures that include marginally attached workers had declined. Most participants projected the improvement in labor market conditions to continue, with the unemployment rate moving down gradually over the medium term. However, a couple of participants anticipated that the decline in unemployment would be damped as part-time workers shift to full-time jobs and as nonparticipants rejoin the labor force, while a few others commented that they expected no lasting reversal of the decline in labor force participation. Aggregate wage measures continued to rise at only a modest rate, and reports on wages from business contacts and surveys in a number of Districts were mixed. Several of those reports pointed to an absence of wage pressures, while some others indicated that tight labor markets or shortages of skilled workers were leading to upward pressure on wages in some areas or occupations and that an increasing proportion of small businesses were planning to raise wages. Participants discussed the prospects for wage increases to pick up as slack in the labor market diminishes. Several noted that a return to growth in real wages in line with productivity growth would provide welcome support for household spending. Readings on a range of price measures—including the PCE price index, the CPI, and a number of the analytical measures developed at the Reserve Banks—appeared to provide evidence that inflation had moved up recently from low levels earlier in the year, consistent with the Committee’s forecast of a gradual increase in inflation over the medium term. Reports from business contacts were mixed, spanning an absence of price pressures in some Districts and rising input costs in others. Some participants expressed concern about the persistence of belowtrend inflation, and a couple of them suggested that the Committee may need to allow the unemployment rate to move below its longer-run normal level for a time in order keep inflation expectations anchored Minutes of Federal Open Market Committee Meetings | June and return inflation to its 2 percent target, though one participant emphasized the risks of doing so. In contrast, some others expected a faster pickup in inflation or saw upside risks to inflation and inflation expectations because they anticipated a more rapid decline in economic slack. During their consideration of issues related to monetary policy over the medium term, participants generally supported the Committee’s current guidance about the likely path of its asset purchases and about its approach to determining the timing of the first increase in the federal funds rate and the path of the policy rate thereafter. Participants offered views on a range of issues related to policy communications. Some participants suggested that the Committee’s communications about its forward guidance should emphasize more strongly that its policy decisions would depend on its ongoing assessment across a range of indicators of economic activity, labor market conditions, inflation and inflation expectations, and financial market developments. In that regard, circumstances that might entail either a slower or a more rapid removal of policy accommodation were cited. For example, a number of participants noted their concern that a more gradual approach might be appropriate if forecasts of above-trend economic growth later this year were not realized. And a couple suggested that the Committee might need to strengthen its commitment to maintain sufficient policy accommodation to return inflation to its target over the medium term in order to prevent an undesirable decline in inflation expectations. Alternatively, some other participants expressed concern that economic growth over the medium run might be faster than currently expected or that the rate of growth of potential output might be lower than currently expected, calling for a more rapid move to begin raising the federal funds rate in order to avoid significantly overshooting the Committee’s unemployment and inflation objectives. While the current asset purchase program is not on a preset course, participants generally agreed that if the economy evolved as they anticipated, the program would likely be completed later this year. Some committee members had been asked by members of the public whether, if tapering in the pace of purchases continues as expected, the final reduction would come in a single $15 billion per month reduction or in a $10 billion reduction followed by a $5 billion reduction. Most participants viewed this as a technical issue with no substantive macroeconomic consequences and no consequences for the eventual deci- 193 sion about the timing of the first increase in the federal funds rate—a decision that will depend on the Committee’s evolving assessments of actual and expected progress toward its objectives. In light of these considerations, participants generally agreed that if incoming information continued to support its expectation of improvement in labor market conditions and a return of inflation toward its longer-run objective, it would be appropriate to complete asset purchases with a $15 billion reduction in the pace of purchases in order to avoid having the small, remaining level of purchases receive undue focus among investors. If the economy progresses about as the Committee expects, warranting reductions in the pace of purchases at each upcoming meeting, this final reduction would occur following the October meeting. Committee Policy Action In their discussion of monetary policy in the period ahead, members judged that information received since the Federal Open Market Committee met in April indicated that economic activity was rebounding from the decline in the first quarter of the year. Labor market indicators generally showed further improvement. The unemployment rate, though lower, remained elevated. Household spending appeared to be rising moderately and business fixed investment resumed its advance, while the recovery in the housing sector remained slow. Fiscal policy was restraining economic growth, although the extent of restraint was diminishing. The Committee expected that, with appropriate policy accommodation, economic activity would expand at a moderate pace and labor market conditions would continue to improve gradually, moving toward those the Committee judges consistent with its dual mandate. Members saw the risks to the outlook for the economy and the labor market as nearly balanced. Inflation was running below the Committee’s longer-run objective, but the Committee anticipated that with stable inflation expectations and strengthening economic activity, inflation would, over time, return to the Committee’s 2 percent objective. However, members continued to recognize that inflation persistently below its longer-run objective could pose risks to economic performance and agreed to monitor inflation developments closely for evidence that inflation was moving back toward its objective over the medium term. Members judged that the economy had sufficient underlying strength to support ongoing improvement in labor market conditions and a return of inflation 194 101st Annual Report | 2014 toward the Committee’s longer-run 2 percent objective, and thus agreed that a further measured reduction in the pace of the Committee’s asset purchases was appropriate at this meeting. Accordingly, the Committee agreed that beginning in July, it would add to its holdings of agency MBS at a pace of $15 billion per month rather than $20 billion per month, and it would add to its holdings of Treasury securities at a pace of $20 billion per month rather than $25 billion per month. Members again judged that, if incoming information broadly supported the Committee’s expectations for ongoing progress toward meeting its dual objectives of maximum employment and inflation of 2 percent, the Committee would likely reduce the pace of asset purchases in further measured steps at future meetings. The Committee reiterated, however, that purchases were not on a preset course, and that its decisions about the pace of purchases would remain contingent on its outlook for the labor market and inflation as well as its assessment of the likely efficacy and costs of such purchases. The Committee agreed to maintain its target range for the federal funds rate and to reiterate its forward guidance about how it would assess the appropriate timing of the first increase in the target rate and the anticipated behavior of the federal funds rate after it is raised. The guidance continued to emphasize that the Committee’s decisions about how long to maintain the current target range for the federal funds rate would depend on its assessment of actual and expected progress toward its objectives of maximum employment and 2 percent inflation. The Committee again stated that it currently anticipated that it likely would be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continued to run below the Committee’s 2 percent longer-run goal, and provided that longer-term inflation expectations remained well anchored. The forward guidance also reiterated the Committee’s expectation that even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer 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 SOMA in accordance with the following domestic policy directive: “Consistent with its statutory mandate, the Federal Open Market Committee seeks monetary and financial conditions that will foster maximum employment and price stability. In particular, 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 undertake open market operations as necessary to maintain such conditions. Beginning in July, the Desk is directed to purchase longer-term Treasury securities at a pace of about $20 billion per month and to purchase agency mortgage-backed securities at a pace of about $15 billion per month. The Committee also directs the Desk to engage in dollar roll and coupon swap transactions as necessary to facilitate settlement of the Federal Reserve’s agency mortgage-backed securities transactions. The Committee directs the Desk to maintain its policy of rolling over maturing Treasury securities into new issues and its policy of reinvesting principal payments on all agency debt and agency mortgage-backed securities in agency mortgage-backed securities. 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 2:00 p.m.: “Information received since the Federal Open Market Committee met in April indicates that growth in economic activity has rebounded in recent months. Labor market indicators generally showed further improvement. The unemployment rate, though lower, remains elevated. Household spending appears to be rising moderately and business fixed investment resumed its advance, while the recovery in the housing sector remained slow. Fiscal policy is restraining economic growth, although the extent of restraint is diminishing. Inflation has been running below the Committee’s longer-run objective, but 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 that, Minutes of Federal Open Market Committee Meetings | June with appropriate policy accommodation, economic activity will expand at a moderate pace and labor market conditions will continue to improve gradually, moving toward those the Committee judges consistent with its dual mandate. The Committee sees the risks to the outlook for the economy and the labor market as nearly balanced. The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, and it is monitoring inflation developments carefully for evidence that inflation will move back toward its objective over the medium term. The Committee currently judges that there is sufficient underlying strength in the broader economy to support ongoing improvement in labor market conditions. In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions since the inception of the current asset purchase program, the Committee decided to make a further measured reduction in the pace of its asset purchases. Beginning in July, the Committee will add to its holdings of agency mortgage-backed securities at a pace of $15 billion per month rather than $20 billion per month, and will add to its holdings of longerterm Treasury securities at a pace of $20 billion per month rather than $25 billion per month. The Committee is maintaining its existing policy 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’s sizable and still-increasing holdings of longer-term securities should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee’s dual mandate. The Committee will closely monitor incoming information on economic and financial developments in coming months and will continue its purchases of Treasury and agency mortgagebacked securities, and employ its other policy tools as appropriate, until the outlook for the 195 labor market has improved substantially in a context of price stability. If incoming information broadly supports the Committee’s expectation of ongoing improvement in labor market conditions and inflation moving back toward its longer-run objective, the Committee will likely reduce the pace of asset purchases in further measured steps at future meetings. However, asset purchases are not on a preset course, and the Committee’s decisions about their pace will remain contingent on the Committee’s outlook for the labor market and inflation as well as its assessment of the likely efficacy and costs of such purchases. To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy remains appropriate. In determining how long to maintain the current 0 to ¼ percent target range for the federal funds rate, the Committee will assess progress—both realized and expected— toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the Committee’s 2 percent longerrun goal, and provided that longer-term inflation expectations remain well anchored. When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent. The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.” Voting for this action: Janet L. Yellen, William C. Dudley, Lael Brainard, Stanley Fischer, Richard W. 196 101st Annual Report | 2014 Fisher, Narayana Kocherlakota, Loretta J. Mester, Charles I. Plosser, Jerome H. Powell, and Daniel K. Tarullo. Voting against this action: None. It was agreed that the next meeting of the Committee would be held on Tuesday–Wednesday, July 29–30. The meeting adjourned at 11:10 a.m. on June 18, 2014. Notation Vote By notation vote completed on May 19, 2014, the Committee unanimously approved the minutes of the Committee meeting held on April 29–30, 2014. William B. English Secretary Minutes of Federal Open Market Committee Meetings | June Addendum: Summary of Economic Projections Overall, FOMC participants expected that, under appropriate monetary policy, economic growth would pick up notably in the second half of 2014 and remain in 2015 and 2016 above their estimates of the longer-run normal rate of economic growth. Consistent with that outlook, the unemployment rate was projected to continue to decline toward its longer-run normal level over the projection period (table 1 and figure 1). The majority of participants projected that inflation, as measured by the annual change in the price index for personal consumption expenditures (PCE), would rise to a level at or slightly below the Committee’s 2 percent objective in 2016. In conjunction with the June 17–18, 2014, Federal Open Market Committee (FOMC) meeting, meeting participants submitted their assessments of real output growth, the unemployment rate, inflation, and the target federal funds rate for each year from 2014 through 2016 and over the longer run.4 Each participant’s assessment was based on information available at the time of the meeting plus his or her judgment of appropriate monetary policy and assumptions about the factors likely to affect economic outcomes. The longer-run projections represent each participant’s judgment of the value 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 each participant deems most likely to foster outcomes for economic activity and inflation that best satisfy his or her individual interpretation of the Federal Reserve’s objectives of maximum employment and stable prices. 4 197 The majority of participants expected that highly accommodative monetary policy would remain appropriate over the next few years to foster progress toward the Federal Reserve’s longer-run objectives. As shown in figure 2, all but one of the participants anticipated that it would be appropriate to wait at least until 2015 before beginning to increase the federal funds rate, and most projected that it would then be appropriate to raise the target federal funds rate fairly gradually. Given their economic outlooks, most participants judged that it would be appropriate to continue gradually slowing the pace of the Committee’s purchases of longer-term securities and complete the asset purchase program later this year. Four members of the Board of Governors and the presidents of the 12 Federal Reserve Banks submitted projections. Governor Brainard took office on June 16, 2014, and participated in the June 17–18, 2014, FOMC meeting; she was not able to submit economic projections. Most participants saw the uncertainty associated with their outlooks for economic growth, the unem- Table 1. Economic projections of Federal Reserve Board members and Federal Reserve Bank presidents, June 2014 Percent Central tendency1 Range2 Variable Change in real GDP March projection Unemployment rate March projection PCE inflation March projection Core PCE inflation3 March projection 2014 2015 2016 Longer run 2014 2015 2016 Longer run 2.1 to 2.3 2.8 to 3.0 6.0 to 6.1 6.1 to 6.3 1.5 to 1.7 1.5 to 1.6 1.5 to 1.6 1.4 to 1.6 3.0 to 3.2 3.0 to 3.2 5.4 to 5.7 5.6 to 5.9 1.5 to 2.0 1.5 to 2.0 1.6 to 2.0 1.7 to 2.0 2.5 to 3.0 2.5 to 3.0 5.1 to 5.5 5.2 to 5.6 1.6 to 2.0 1.7 to 2.0 1.7 to 2.0 1.8 to 2.0 2.1 to 2.3 2.2 to 2.3 5.2 to 5.5 5.2 to 5.6 2.0 2.0 1.9 to 2.4 2.1 to 3.0 5.8 to 6.2 6.0 to 6.5 1.4 to 2.0 1.3 to 1.8 1.4 to 1.8 1.3 to 1.8 2.2 to 3.6 2.2 to 3.5 5.2 to 5.9 5.4 to 5.9 1.4 to 2.4 1.5 to 2.4 1.5 to 2.4 1.5 to 2.4 2.2 to 3.2 2.2 to 3.4 5.0 to 5.6 5.1 to 5.8 1.5 to 2.0 1.6 to 2.0 1.6 to 2.0 1.6 to 2.0 1.8 to 2.5 1.8 to 2.4 5.0 to 6.0 5.2 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 March projections were made in conjunction with the meeting of the Federal Open Market Committee on March 18–19, 2014. 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. 198 101st Annual Report | 2014 Figure 1. Central tendencies and ranges of economic projections, 2014–16 and over the longer run Percent Change in real GDP 4 Central tendency of projections Range of projections 3 2 1 + 0 - Actual 2009 2010 2011 2012 2013 2014 2015 2016 Longer run Percent Unemployment rate 10 9 8 7 6 5 2009 2010 2011 2012 2013 2014 2015 2016 Longer run Percent PCE inflation 3 2 1 2009 2010 2011 2012 2013 2014 2015 2016 Longer run Percent Core PCE inflation 3 2 1 2009 2010 2011 2012 2013 2014 2015 Note: Definitions of variables are in the general note to table 1. The data for the actual values of the variables are annual. 2016 Longer run Minutes of Federal Open Market Committee Meetings | June 199 Figure 2. Overview of FOMC participants’ assessments of appropriate monetary policy Number of participants Appropriate timing of policy firming 13 12 12 11 10 9 8 7 6 5 4 3 3 2 1 1 2014 2015 2016 Appropriate pace of policy firming Percent Target federal funds rate at year-end 6 5 4 3 2 1 0 2014 2015 2016 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 March 2014, the numbers of FOMC participants who judged that the first increase in the target federal funds rate would occur in 2014, 2015, and 2016 were, respectively, 1, 13, and 2. 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. 200 101st Annual Report | 2014 ployment rate, and inflation as similar to that of the past 20 years. In addition, most participants considered the risks to the outlook for real GDP growth and the unemployment rate to be broadly balanced, and a majority saw the risks to inflation as broadly balanced. However, some saw the risks to their forecasts for economic growth or inflation as tilted to the downside, and a couple saw the risks to their forecasts for inflation as tilted to the upside. The Outlook for Economic Activity Participants generally projected that, conditional on their individual assumptions about appropriate monetary policy, real GDP growth would pick up notably in the second half of this year and remain in 2015 and 2016 above their estimates of the longer-run normal rate of output growth. All participants revised down their projections of real GDP growth for the first half of 2014 compared with their projections in March, but most left their forecasts for the remainder of the projection period largely unchanged. Participants generally judged that real GDP growth in the first half of this year was held down by transitory factors depressing output early in the year, and they pointed to a number of factors that they expected would continue to contribute to a pickup in economic growth later this year and next, including rising household net worth, diminished restraint from fiscal policy, improving labor market conditions, and highly accommodative monetary policy. The central tendencies of participants’ projections for real GDP growth were 2.1 to 2.3 percent in 2014, 3.0 to 3.2 percent in 2015, and 2.5 to 3.0 percent in 2016. The central tendency for the longer-run normal rate of growth of real GDP was 2.1 to 2.3 percent, only slightly lower than in March. Participants continued to anticipate a gradual decline in the unemployment rate over the projection period. The central tendencies of participants’ forecasts for the unemployment rate in the fourth quarter of each year were 6.0 to 6.1 percent in 2014, 5.4 to 5.7 percent in 2015, and 5.1 to 5.5 percent in 2016. Nearly all participants revised down their projected paths for the unemployment rate this year and next relative to their March projections, with the majority pointing to the decline in the unemployment rate in recent months as a reason for the downward revision. The central tendency of participants’ estimates of the longer-run normal rate of unemployment that would prevail under appropriate monetary policy and in the absence of further shocks to the economy also edged down, to 5.2 to 5.5 percent. Most participants projected that the unemployment rate would be close to their individual estimates of its longer-run level at the end of 2016. Figures 3.A and 3.B show that participants continued to hold a range of views regarding the likely outcomes for real GDP growth and the unemployment rate over the next two years. The diversity of views reflected their individual assessments of the rate at which the headwinds that have been holding back the pace of the economic recovery would abate and of the anticipated path for foreign economic activity, the trajectory for growth in household net worth, and the appropriate path of monetary policy. Relative to March, the dispersion of participants’ projections for real GDP growth narrowed a bit in 2014 but was largely unchanged over the next two years, and the dispersion of projections for the unemployment rate over the entire projection period was little changed. The Outlook for Inflation Compared with March, the central tendencies of participants’ projections for inflation were largely unchanged for all years in the projection period, although many participants marked up a bit their projections for inflation in 2014. The vast majority of participants anticipated that, on average, both headline and core inflation would rise gradually over the next few years, and the majority of participants expected headline inflation to be at or slightly below the Committee’s 2 percent objective in 2016. Specifically, the central tendencies for PCE inflation were 1.5 to 1.7 percent in 2014, 1.5 to 2.0 percent in 2015, and 1.6 to 2.0 percent in 2016. The central tendencies of the forecasts for core inflation were broadly similar to those for the headline measure. It was noted that some combination of stable inflation expectations and steadily diminishing resource slack was likely to contribute to a gradual rise of inflation back toward the Committee’s longer-run objective of 2 percent. Figures 3.C and 3.D provide information on the diversity of participants’ views about the outlook for inflation. The ranges of participants’ projections for overall inflation were little changed relative to March. The forecasts for PCE inflation in 2016 were at or below the Committee’s longer-run objective. Similar to the projections for headline inflation, the projections for core inflation in 2016 were concentrated at or below 2 percent. Minutes of Federal Open Market Committee Meetings | June 201 Figure 3.A. Distribution of participants’ projections for the change in real GDP, 2014–16 and over the longer run Number of participants 2014 20 18 16 14 12 10 8 6 4 2 June projections March projections 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 Percent range Number of participants 2015 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 Percent range Number of participants 2016 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 Percent range Number of participants Longer run 1.8 1.9 20 18 16 14 12 10 8 6 4 2 2.0 2.1 2.2 2.3 2.4 2.5 2.6 2.7 2.8 2.9 Percent range Note: Definitions of variables are in the general note to table 1. 3.0 3.1 3.2 3.3 3.4 3.5 3.6 3.7 202 101st Annual Report | 2014 Figure 3.B. Distribution of participants’ projections for the unemployment rate, 2014–16 and over the longer run Number of participants 2014 20 18 16 14 12 10 8 6 4 2 June projections March projections 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 Percent range Number of participants 2015 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 Percent range Number of participants 2016 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 Percent range Number of participants Longer run 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 Percent range Note: Definitions of variables are in the general note to table 1. 5.8 5.9 6.0 6.1 6.2 6.3 6.4 6.5 Minutes of Federal Open Market Committee Meetings | June 203 Figure 3.C. Distribution of participants’ projections for PCE inflation, 2014–16 and over the longer run Number of participants 2014 20 18 16 14 12 10 8 6 4 2 June projections March 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 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 2.1 2.2 2.3 2.4 Percent range Number of participants 2016 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 Longer run 1.3 1.4 20 18 16 14 12 10 8 6 4 2 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 2.4 204 101st Annual Report | 2014 Figure 3.D. Distribution of participants’ projections for core PCE inflation, 2014–16 Number of participants 2014 20 June projections March 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 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 2.1 2.2 2.3 2.4 PPercent range Number of participants 2016 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 | June Appropriate Monetary Policy As indicated in figure 2, nearly all participants judged that low levels of the federal funds rate would remain appropriate for the next few years. In particular, 12 participants thought that the first increase in the target federal funds rate would not be warranted until sometime in 2015, and 3 judged that policy firming would likely not be appropriate until 2016. Only 1 participant thought that an increase in the federal funds rate would be warranted in 2014. All participants projected that the unemployment rate would be below 6 percent at the end of the year in which they judged the initial increase in the federal funds rate to be warranted, and all but one anticipated that inflation would be at or below the Committee’s longer-run objective at that time. Most participants projected that the unemployment rate would remain above their estimates of its longer-run normal level at the end of the year in which they saw the federal funds rate increasing from its effective lower bound. Figure 3.E provides the distribution of participants’ judgments regarding the appropriate level of the target federal funds rate at the end of each calendar year from 2014 to 2016 and over the longer run. As noted earlier, nearly all participants judged that economic conditions would warrant maintaining the current exceptionally low level of the federal funds rate at least until 2015. Relative to their projections in March, the median values of the federal funds rate at the end of 2015 and 2016 increased 13 basis points and 25 basis points to 1.13 percent and 2.50 percent, respectively, while the mean values rose 7 basis points and 11 basis points to 1.18 percent and 2.53 percent, respectively. The dispersion of projections for the value of the federal funds rate was little changed in 2015 but widened slightly in 2016. Most participants expected that the federal funds rate at the end of 2016 would still be significantly below their individual assessments of its longer-run level. For about half of these participants, the low level of the federal funds rate at that time was associated with inflation well below the Committee’s 2 percent objective. In contrast, the rest of these participants saw the federal funds rate at the end of 2016 as still significantly low despite their projections that the unemployment rate would be close to or below their individual longerrun projections and inflation would be at or close to 2 percent at that time. These participants cited some combination of a lower equilibrium real interest rate, continuing headwinds from the financial crisis and 205 subsequent recession, and a desire to raise the federal funds rate at a gradual pace after liftoff as explanations for the still-low level of the projected federal funds rate at the end of 2016. A couple of participants also mentioned broader measures of labor market slack that may take longer to return to their normal levels than the unemployment rate. Estimates of the longer-run level of the federal funds rate ranged from 3¼ to about 4¼ percent, reflecting the Committee’s inflation objective of 2 percent and participants’ individual judgments regarding the appropriate longer-run level of the real federal funds rate in the absence of further shocks to the economy. Compared with March, some participants revised down their estimates of the longer-run federal funds rate, with a lower assessment of the longer-run level of potential output growth cited as a contributing factor for the majority of those revisions. As a result, the median estimate of the longer-run federal funds rate shifted down to 3.75 percent from 4 percent in March, while its mean value declined 11 basis points to 3.78 percent. Participants also described their views regarding the appropriate path of the Federal Reserve’s balance sheet. Conditional on their respective economic outlooks, most participants judged that it would be appropriate to continue to reduce the pace of the Committee’s purchases of longer-term securities in measured steps and to conclude the purchases later this year. A couple of participants judged that a more rapid reduction in the pace of purchases and an earlier end to the asset purchase program would be appropriate. Participants’ views of the appropriate path for monetary policy were informed by their judgments about the state of the economy, including the values of the unemployment rate and other labor market indicators that would be consistent with maximum employment, the extent to which the economy was currently falling short of maximum employment, the prospects for inflation to return to the Committee’s longerterm objective of 2 percent, and the balance of risks around the outlook. Many participants also mentioned the prescriptions of various monetary policy rules as factors they considered in judging the appropriate path for the federal funds rate. Uncertainty and Risks The vast majority of participants continued to judge the levels of uncertainty about their projections for real GDP growth and the unemployment rate as 206 101st Annual Report | 2014 Figure 3.E. Distribution of participants’ projections for the target federal funds rate, 2014–16 and over the longer run Number of participants 2014 20 June projections March projections 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 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 Percent range Number of participants 2016 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 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 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. 3.38 3.62 3.63 3.87 3.88 4.12 4.13 4.37 Minutes of Federal Open Market Committee Meetings | June Table 2. Average historical projection error ranges Percentage points Variable Change in real GDP1 Unemployment rate1 Total consumer prices2 2014 2015 2016 ±1.4 ±0.4 ±0.8 ±2.0 ±1.2 ±1.0 ±2.1 ±1.8 ±1.0 Note: Error ranges shown are measured as plus or minus the root mean squared error of projections for 1994 through 2013 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. For more information, see 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), available at http://www.federalreserve .gov/pubs/feds/2007/200760/200760abs.html; and Board of Governors of the Federal Reserve System, Division of Research and Statistics (2014), “Updated Historical Forecast Errors,” memorandum, April 9, http://www.federalreserve.gov/ foia/files/20140409-historical-forecast-errors.pdf. 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. broadly similar to the norms during the previous 20 years (figure 4).5 Most participants continued to judge the risks to real GDP growth and the unem5 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 1994 through 2013. At the end of this summary, the box “Forecast Uncertainty” discusses the sources and interpretation of uncertainty in the 207 ployment rate to be broadly balanced, although a few participants viewed the risks as weighted to the downside, reflecting, for example, their concerns about the limited ability of monetary policy at the zero lower bound to respond to negative shocks to the economy as well as external economic and geopolitical risks. Similar to March, nearly all participants continued to judge the risks to the unemployment rate to be broadly balanced. Almost all participants saw the level of uncertainty and the balance of risks around their forecasts for overall PCE inflation and core inflation as little changed from March. Most participants continued to judge the levels of uncertainty associated with their forecasts for the two inflation measures to be broadly similar to historical norms, and a majority continued to see the risks to those projections as broadly balanced. A few participants, however, viewed the risks to their inflation forecasts as tilted to the downside, reflecting, for example, the possibilities that the recent low levels of inflation could prove more persistent than anticipated, and that the upward pull on prices from inflation expectations might be weaker than assumed. Conversely, two participants saw upside risks to inflation, with one citing uncertainty about the timing and efficacy of the Committee’s withdrawal of accommodation. economic forecasts and explains the approach used to assess the uncertainty and risks attending the participants’ projections. 208 101st Annual Report | 2014 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 March projections Lower Broadly similar Number of participants Risks to GDP growth Weighted to downside Higher 20 18 16 14 12 10 8 6 4 2 June projections March projections 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 Risks to the unemployment rate Weighted to downside Higher Broadly balanced Number of participants Uncertainty about PCE inflation 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 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 209 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 1.6 to 4.4 percent in the current year, 1.0 to 5.0 percent in the second year, and 0.9 to 5.1 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. 210 101st Annual Report | 2014 Meeting Held on July 29–30, 2014 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 29, 2014, at 10:00 a.m. and continued on Wednesday, July 30, 2014, at 9:00 a.m. Present Janet L. Yellen Chair William C. Dudley Vice Chairman Lael Brainard Stanley Fischer Richard W. Fisher Narayana Kocherlakota Loretta J. Mester Charles I. Plosser Jerome H. Powell Daniel K. Tarullo Charles L. Evans, Jeffrey M. Lacker, Dennis P. Lockhart, and John C. Williams Alternate Members of the Federal Open Market Committee James A. Clouse, Thomas A. Connors, Evan F. Koenig, Thomas Laubach, Michael P. Leahy, Paolo A. Pesenti, Mark E. Schweitzer, and William Wascher Associate Economists Simon Potter Manager, System Open Market Account Lorie K. Logan Deputy Manager, System Open Market Account Robert deV. Frierson1 Secretary of the Board, Office of the Secretary, Board of Governors Nellie Liang Director, Office of Financial Stability Policy and Research, Board of Governors Matthew J. Eichner1 Deputy Director, Division of Research and Statistics, Board of Governors Maryann F. Hunter Deputy Director, Division of Banking Supervision and Regulation, Board of Governors Stephen A. Meyer and William R. Nelson Deputy Directors, Division of Monetary Affairs, Board of Governors Jon W. Faust and Stacey Tevlin Special Advisers to the Board, Office of Board Members, Board of Governors James Bullard, Esther L. George, and Eric Rosengren Presidents of the Federal Reserve Banks of St. Louis, Kansas City, and Boston, respectively Trevor A. Reeve Special Adviser to the Chair, Office of Board Members, Board of Governors William B. English Secretary and Economist Linda Robertson Assistant to the Board, Office of Board Members, Board of Governors Matthew M. Luecke Deputy Secretary Michelle A. Smith Assistant Secretary Scott G. Alvarez General Counsel Thomas C. Baxter Deputy General Counsel Steven B. Kamin Economist Ellen E. Meade and Joyce K. Zickler Senior Advisers, Division of Monetary Affairs, Board of Governors David Bowman Associate Director, Division of International Finance, Board of Governors David E. Lebow2 and Michael G. Palumbo Associate Directors, Division of Research and Statistics, Board of Governors 1 David W. Wilcox Economist 2 Attended the joint session of the Federal Open Market Committee and the Board of Governors. Attended the portion of the meeting following the joint session of the Federal Open Market Committee and the Board of Governors. Minutes of Federal Open Market Committee Meetings | July Fabio M. Natalucci1 and Gretchen C. Weinbach1 Associate Directors, Division of Monetary Affairs, Board of Governors Jane E. Ihrig Deputy Associate Director, Division of Monetary Affairs, Board of Governors Eric C. Engstrom, Patrick E. McCabe,1 and Karen M. Pence Advisers, Division of Research and Statistics, Board of Governors Penelope A. Beattie1 Assistant to the Secretary, Office of the Secretary, Board of Governors Francisco Covas and Elizabeth Klee1 Section Chiefs, Division of Monetary Affairs, Board of Governors David H. Small Project Manager, Division of Monetary Affairs, Board of Governors Katie Ross1 Manager, Office of the Secretary, Board of Governors Elmar Mertens Senior Economist, Division of Monetary Affairs, Board of Governors Peter M. Garavuso Records Project Manager, Division of Monetary Affairs, Board of Governors Gregory L. Stefani First Vice President, Federal Reserve Bank of Cleveland David Altig, Ron Feldman, Jeff Fuhrer, and Daniel G. Sullivan Executive Vice Presidents, Federal Reserve Banks of Atlanta, Minneapolis, Boston, and Chicago, respectively Michael Dotsey and Meg McConnell Senior Vice Presidents, Federal Reserve Banks of Philadelphia and New York, respectively Fred Furlong Group Vice President, Federal Reserve Bank of San Francisco Antoine Martin,1 Douglas Tillett, David C. Wheelock, Jonathan L. Willis, and Patricia Zoebel1 Vice Presidents, Federal Reserve Banks of New York, Chicago, St. Louis, Kansas City, and New York, respectively 211 Robert L. Hetzel Senior Economist, Federal Reserve Bank of Richmond During the interval between the June and July meetings, Chair Yellen appointed a subcommittee on communications issues chaired by Governor Fischer and including President Mester, Governor Powell, and President Williams. Governor Fischer indicated that the subcommittee would continue the work of previous subcommittees in helping the Committee frame and organize the discussion of a broad range of communications issues. Developments in Financial Markets and the Federal Reserve’s Balance Sheet In a joint session of the Federal Open Market Committee (FOMC) and the Board of Governors of the Federal Reserve System, the manager of the System Open Market Account (SOMA) reported on developments in domestic and foreign financial markets. The manager also reported on the System open market operations conducted during the period since the Committee met on June 17–18, 2014, summarized the outcomes of recent test operations of the Term Deposit Facility (TDF), described the results from the fixed-rate overnight reverse repurchase agreement (ON RRP) operational exercise, and reviewed the ongoing effects of recent foreign central bank policy actions on yields on the international portion of the SOMA portfolio. In addition, the manager noted plans for a pilot program for increasing the number of the Open Market Desk’s counterparties for agency mortgage-backed securities (MBS) operations to include a few firms that are too small to qualify as primary dealers. 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. Monetary Policy Normalization Meeting participants continued their discussion of issues associated with the eventual normalization of the stance and conduct of monetary policy, consistent with the Committee’s intention to provide additional information to the public later this year, well before most participants anticipate the first steps in reducing policy accommodation to become appropriate. The staff detailed a possible approach for implementing and communicating monetary policy once the Committee begins to tighten the stance of policy. 212 101st Annual Report | 2014 The approach reflected the Committee’s discussion of normalization strategies and policy tools during the previous two meetings. could help determine the appropriate features to temper the risks that might be associated with an ON RRP facility. Participants expressed general support for the normalization approach outlined by the staff, though some noted reservations about one or more of its features. Almost all participants agreed that it would be appropriate to retain the federal funds rate as the key policy rate, and they supported continuing to target a range of 25 basis points for this rate at the time of liftoff and for some time thereafter. However, one participant preferred to use the range for the federal funds rate as a communication tool rather than as a hard target, and another preferred that policy communications during the normalization period focus on the rate of interest on excess reserves (IOER) and the ON RRP rate in addition to the federal funds rate. Participants agreed that adjustments in the IOER rate would be the primary tool used to move the federal funds rate into its target range and influence other money market rates. In addition, most thought that temporary use of a limited-scale ON RRP facility would help set a firmer floor under money market interest rates during normalization. Most participants anticipated that, at least initially, the IOER rate would be set at the top of the target range for the federal funds rate, and the ON RRP rate would be set at the bottom of the federal funds target range. Alternatively, some participants suggested the ON RRP rate could be set below the bottom of the federal funds target range, judging that it might be possible to begin the normalization process with minimal or no reliance on an ON RRP facility and increase its role only if necessary. However, many other participants thought that such a strategy might result in insufficient control of money market rates at liftoff, which could cause confusion about the likely path of monetary policy or raise questions about the Committee’s ability to implement policy effectively. Participants also discussed approaches to normalizing the size and composition of the Federal Reserve’s balance sheet. In general, they agreed that the size of the balance sheet should be reduced gradually and predictably. In addition, they believed that, in the long run, the balance sheet should be reduced to the smallest level consistent with efficient implementation of monetary policy and should consist primarily of Treasury securities in order to minimize the effect of the SOMA portfolio on the allocation of credit across sectors of the economy. A few participants noted that the appropriate size of the balance sheet would depend on the Committee’s future decisions regarding its framework for monetary policy. Most participants supported reducing or ending reinvestment sometime after the first increase in the target range for the federal funds rate. A few, however, believed that ceasing reinvestment before liftoff was a better approach because it would lead to an earlier reduction in the size of the portfolio. Most participants continued to anticipate that the Committee would not sell MBS, except perhaps to eliminate residual holdings. However, a couple of participants preferred to sell MBS in order to unwind the effect of the Federal Reserve’s holdings on mortgage rates relative to other interest rates more rapidly than would occur as a result of repayments of principal alone. Some others noted that, given the uncertainties attending the normalization process and the outlook for the economy and financial markets, it could be helpful to retain the option to sell some assets. Participants generally agreed that the ON RRP facility should be only as large as needed for effective monetary policy implementation and should be phased out when it is no longer needed for that purpose. Participants expressed their desire to include features in the facility’s design that would limit the Federal Reserve’s role in financial intermediation and mitigate the risk that the facility might magnify strains in short-term funding markets during periods of financial stress. They discussed options to address these concerns, including methods for limiting the program’s size. Many participants noted that further testing would provide additional information that Participants agreed that the Committee should provide additional information to the public regarding the details of normalization well before most participants anticipate the first steps in reducing policy accommodation to become appropriate. They stressed the importance of communicating a clear plan while at the same time noting the importance of maintaining flexibility so that adjustments to the normalization approach could be made as the situation changed and in light of experience. Participants requested additional analysis from the staff on issues related to normalization as background for further discussion at their next meeting. A few participants also suggested that the Committee should solicit additional information from the public regarding the possible effects of an ON RRP facility, but some others pointed out that the Committee would continue to receive such feedback informally in response to its Minutes of Federal Open Market Committee Meetings | July ongoing communications regarding normalization. The Board meeting concluded at the end of the discussion of approaches to policy normalization. Staff Review of the Economic Situation The information reviewed for the July 29–30 meeting indicated that real gross domestic product (GDP) rebounded in the second quarter following its firstquarter decline, but it expanded at only a modest pace, on balance, over the first half of the year. Consumer price inflation rose somewhat in the second quarter, but futures prices for energy and agricultural commodities generally were trending down over the next couple of years and longer-run measures of inflation expectations remained stable. The Bureau of Economic Analysis (BEA) released its advance estimate for second-quarter real GDP, along with revised data for earlier periods, on the second day of the FOMC meeting. The staff’s assessment of economic activity and inflation in the first half of 2014, based on information available before the meeting began, was broadly consistent with the new information from the BEA. Measures of labor market conditions generally continued to improve during the intermeeting period. Total nonfarm payroll employment increased strongly in June, and the average monthly gain for the second quarter was the largest since the first quarter of 2012. The unemployment rate declined to 6.1 percent in June, the labor force participation rate was unchanged, and the employment-to-population ratio edged up. The rate of long-duration unemployment moved down, and the share of workers employed part time for economic reasons edged up; both measures remained elevated by historical standards. Initial claims for unemployment insurance declined further in recent weeks. The rate of job openings rose further in May, but the rate of hiring was unchanged and remained at a modest level. Industrial production increased in the second quarter, as higher output from manufacturers and mines more than offset a decline in the output of electric and natural gas utilities. Capacity utilization also moved higher in the second quarter. Automakers’ production schedules indicated that light motor vehicle assemblies would increase in the third quarter, and readings on new orders from national and regional manufacturing surveys were consistent with moderate gains in factory output in the near term. Real personal consumption expenditures (PCE) rose more quickly in the second quarter than in the first, 213 partly reflecting higher purchases of light motor vehicles. Key factors that tend to influence household spending remained positive in recent months. In particular, gains in equity values and home prices boosted household net worth, and real disposable personal income continued to rise in the second quarter. Consumer sentiment in the Thomson Reuters/ University of Michigan Surveys of Consumers edged down in early July but was only slightly below its average over the first half of the year. Real expenditures for residential investment turned up in the second quarter after declining for two consecutive quarters. Starts of new single-family houses declined in June, but they rose for the quarter as a whole, and the level of permit issuance was consistent with increases in starts in subsequent months. In the multifamily sector, starts and permits also increased, on net, in the second quarter. Existing home sales moved up during the second quarter but remained below year-earlier levels, while new home sales declined. Home prices continued to rise through May, though the rate of increase was less rapid than earlier in the year. Real private expenditures for business equipment and intellectual property products increased in the second quarter. Nominal new orders for nondefense capital goods were little changed, on net, in May and June; however, the level of orders was above that for shipments, pointing to increases in shipments in subsequent months. Other forward-looking indicators, such as national and regional surveys of business conditions, also generally suggested moderate increases in business equipment spending in the near term. Real business expenditures for nonresidential construction also increased in the second quarter. Meanwhile, business inventories generally appeared well aligned with sales, apart from the energy sector, where inventories remained below year-earlier levels. Real federal government purchases decreased over the first half of the year, reflecting ongoing fiscal consolidation and continued declines in defense spending. In contrast, real state and local government purchases increased in the second quarter, as payrolls expanded at a faster pace than in the first quarter and outlays for construction moved higher. The U.S. international trade deficit narrowed in May as imports fell and exports rose. The rise in exports was concentrated in petroleum products and automotive parts. The fall in imports was led by declines in oil and consumer goods. For the second quarter 214 101st Annual Report | 2014 overall, net exports exerted a moderate drag on the change in U.S. real GDP, compared with a more substantial negative contribution in the first quarter. U.S. consumer prices, as measured by the PCE price index, increased at a faster pace in the second quarter than in the first and were about 1½ percent higher than a year earlier. Consumer energy price inflation rose in the second quarter, but retail gasoline prices, measured on a seasonally adjusted basis, subsequently moved lower through the fourth week of July. Consumer food price inflation also increased in the second quarter, reflecting the effects of drought and disease on crop and livestock production; however, spot prices for crops moved down in recent weeks, and futures prices pointed to lower prices for livestock in the year ahead. The PCE price index for items excluding food and energy also rose more quickly in the second quarter than in the first and was 1½ percent higher than a year earlier. Near-term inflation expectations from the Michigan survey were little changed, on net, in June and early July, while longer-term expectations declined. Measures of labor compensation indicated that gains in nominal wages and employee benefits remained modest. Recent indicators suggested that foreign economic activity strengthened in the second quarter: Chinese GDP accelerated substantially, and Mexican data suggested a pickup there. Real GDP growth remained strong in the United Kingdom, and data for both Canada and the euro area showed improvement relative to the first quarter. By contrast, household spending in Japan dropped sharply following the country’s April 1 consumption tax increase. In many advanced foreign economies, inflation picked up in the second quarter from very low rates in the first, although second-quarter inflation in the euro area remained well below the European Central Bank’s objective. Staff Review of the Financial Situation Financial conditions eased somewhat, on balance, between the June and July FOMC meetings, although geopolitical risks weighed on investor sentiment at times. On net, yields on longer-term Treasury securities fell, equity prices rose, and the foreign exchange value of the dollar was little changed. Market participants characterized the Federal Reserve’s monetary policy communications over the intermeeting period as suggesting a slightly more accommodative policy stance than had been expected. The anticipated path of the federal funds rate shifted down modestly following the June FOMC statement and the Chair’s press conference. Policy expectations also edged down on the release of the minutes of the June FOMC meeting. Market participants took note of the discussion of monetary policy normalization in the minutes and, particularly, the discussion of the likely spread between the ON RRP rate and the IOER rate. Results from the Desk’s July Survey of Primary Dealers, conducted shortly before the July FOMC meeting, indicated that market participants’ expectations for the timing of the first increase in the federal funds rate and the subsequent policy path were largely unchanged from those reported in the survey taken just before the June meeting. The median dealer continued to see the third quarter of 2015 as the most likely time for the liftoff of the federal funds rate from the effective lower bound, although, relative to the June survey, the distribution of the modal expected time of liftoff became more concentrated around the third quarter of 2015. On balance, 10- and 30-year nominal Treasury yields both declined about 20 basis points over the intermeeting period. Concerns about tensions in Ukraine and the Middle East and the release of the June minutes appeared to contribute to the declines in longerterm Treasury yields. The decline in yields at the long end of the curve likely also reflected a continuation of a pattern that began last year, which some market participants attributed to a reduction in investors’ expectations for longer-run economic growth and declines in term premiums. Measures of longerhorizon inflation compensation based on Treasury Inflation-Protected Securities were about unchanged. Conditions in unsecured short-term dollar funding markets remained stable over the intermeeting period. The Federal Reserve continued its ON RRP exercise and TDF testing. As a result of somewhat higher market rates on repurchase agreements, ON RRP take-up, on average, was a little lower than in the prior intermeeting period, although participation in the ON RRP exercise jumped to a record high at quarter-end on June 30. Moreover, the ON RRP exercise appeared to have continued to help firm the floor under money market interest rates. In TDF testing that ran from mid-May to early July, gradual increases in offer rates and in the maximum individual award amounts generally resulted in higher participation. Minutes of Federal Open Market Committee Meetings | July The S&P 500 index rose about 1½ percent over the intermeeting period, as earnings reports from a range of companies appeared to indicate that profits in the second quarter had increased modestly relative to the first quarter. The VIX, an index of option-implied volatility for one-month returns on the S&P 500 index, remained at low levels over the intermeeting period. Credit flows to nonfinancial corporations remained strong in the second quarter. Gross issuance of investment- and speculative-grade bonds stayed brisk. Commercial and industrial loans on banks’ balance sheets continued to increase at a robust pace, consistent with reports in the July Senior Loan Officer Opinion Survey on Bank Lending Practices (SLOOS) of easier lending standards and terms as well as stronger loan demand from firms of all sizes. Issuance of leveraged loans by institutional investors also remained solid. Credit conditions in markets for commercial real estate (CRE) improved further in the second quarter. According to the July SLOOS, banks continued to ease their standards and report stronger demand for CRE loans during the second quarter on balance. CRE loans on banks’ books continued to expand moderately, and issuance of commercial mortgagebacked securities remained solid. Credit conditions in residential mortgage markets generally remained tight over the intermeeting period. Mortgage interest rates held steady around 4 percent, and origination volumes continued to be low. According to the July SLOOS, underwriting standards on prime home-purchase loans appeared to have eased further at banks during the second quarter but, on net, standards on all types of residential real estate loans reportedly remained tighter than the midpoints of the respondent banks’ longer-term ranges. In contrast to mortgage lending, consumer credit continued to expand robustly in May, largely on the strength of auto and student loans, though credit card debt picked up somewhat as well. Banks responding to the July SLOOS indicated that demand for auto loans strengthened further in the second quarter. In addition, demand for credit card loans increased, and a few large banks reported having eased lending policies for such loans. Benchmark yields on long-term sovereign bonds in the advanced foreign economies continued the downward trend that began at the start of the year, with 215 rising tensions in the Middle East and Ukraine during the intermeeting period likely adding some to the downward pressure. Concerns about one of Portugal’s largest banks and about litigation risks facing European banks weighed on European financial markets, prompting yield spreads on peripheral sovereign bonds in the euro area to widen and equity price indexes for European banks to decline. Intermeeting data releases on euro-area industrial production came in below market expectations, also weighing on headline equity markets in the region. Mixed news from emerging market economies, including better-thanexpected GDP growth in China and concerns about Argentina’s scheduled debt payments, generally had modest market effects. Changes in emerging market equity indexes were mixed over the period, and emerging market bond yields generally declined. The broad trade-weighted dollar was little changed, on net, over the intermeeting period. The staff’s periodic report on potential risks to financial stability concluded that relatively strong capital positions of U.S. banks, subdued use of maturity transformation and leverage within the broader financial sector, and relatively low levels of leverage for the aggregate nonfinancial sector were important factors supporting overall financial stability. However, the staff report also highlighted that low and declining risk premiums, low levels of market volatility, and a loosening of underwriting standards in a number of markets raised somewhat the risk of an eventual correction in asset valuations. Staff Economic Outlook The data received since the staff prepared its forecast for the June FOMC meeting suggested that real GDP growth was even weaker in the first half of the year than had been anticipated.3 However, the staff left its forecast for real GDP growth in the second half of the year essentially unrevised because other indicators of economic activity appeared comparatively strong in relation to real GDP during the first half of the year. In particular, payroll employment continued to advance at a solid pace, the unemployment rate declined further, industrial production posted steady gains, and readings from business surveys were strong. The staff’s medium-term forecast for real GDP growth was also little revised. The staff continued to project that real GDP would expand at a faster pace in the second half of this year and over 3 The staff’s forecast for the July FOMC meeting was prepared prior to the July 30 release of the BEA’s advance estimate of real GDP in the second quarter and revisions for earlier periods. 216 101st Annual Report | 2014 the next two years than in 2013. This forecast was predicated on a further anticipated waning of the restraint on spending growth from changes in fiscal policy, continued improvement in credit availability, increases in consumer and business confidence, and a pickup in foreign economic growth. In response to a further downward surprise in the unemployment rate, the staff again lowered its forecast for the unemployment rate over the projection period. To reconcile the downward revision to real GDP growth for the first half of year with an unemployment rate that was now closer to the staff’s estimate of its longer-run natural rate, the staff lowered its assumed pace of potential output growth this year by more than it marked down GDP growth. As a result, resource slack in this projection was anticipated to be somewhat narrower this year than in the previous forecast and to be taken up slowly over the projection period. The staff’s near-term forecast for inflation was revised up a little, as recent data showed somewhat faster-than-anticipated increases that were judged to be only partly transitory. With a little less resource slack in this projection, the medium-term forecast for inflation was also revised up slightly. Nonetheless, as in the June projection, inflation was projected to step down in the second half of this year and to remain below the Committee’s longer-run objective of 2 percent over the next few years. With longer-run inflation expectations assumed to remain stable, changes in commodity and import prices expected to be subdued, and slack in labor and product markets anticipated to diminish only slowly, inflation was forecast to rise gradually and to reach the Committee’s objective in the longer run. The staff continued to view uncertainty around its projections for real GDP growth, inflation, and the unemployment rate as roughly in line with the average of the past 20 years. Although the risks to GDP growth were still seen as tilted a little to the downside, as neither monetary policy nor fiscal policy was viewed as well positioned to help the economy withstand adverse shocks, these risks were considered to be more nearly balanced than in the previous projection. The staff continued to view the risks around its outlook for the unemployment rate and for inflation as roughly balanced. Participants’ Views on Current Conditions and the Economic Outlook In their discussion of the economic situation and the outlook, meeting participants generally viewed the rebound in real GDP in the second quarter and the ongoing improvement in labor market conditions as supporting their expectations for continued moderate economic expansion with labor market indicators and inflation moving toward levels the Committee judges consistent with its dual mandate. Although most participants continued to view the risks to the outlook for economic activity and the labor market as nearly balanced, some pointed to possible sources of downside risk, including persistent weakness in the housing sector, a continued slow rise in household income, or spillovers from developments in the Middle East and Ukraine. Participants noted that inflation had moved somewhat closer to the Committee’s 2 percent longer-run objective and generally saw the risks of inflation running persistently below their objective as having diminished somewhat. Household spending appeared to be rising moderately and was expected to contribute to stronger economic growth in the second half of the year than in the first half. Business contacts in several Districts reported a pickup in consumer spending after the weakness in the first quarter. However, a few participants raised concerns that households might remain cautious, with the personal saving rate staying elevated, or that the slow rise in wages and income might be insufficient to support stronger consumer spending. The recovery in housing activity remained slow according to most participants. Although mortgage rates were still low and housing appeared to be relatively affordable, various factors were seen as restraining demand, including low expected income and high levels of student debt as well as difficulty in obtaining mortgage credit, particularly for younger, first-time homebuyers. It was also noted that the weakness in homebuilding along with the continued rise in house prices suggested that supply constraints were also weighing on construction activity. A couple of participants indicated that some demand appeared to have shifted to rental properties. The rising demand for rentals was in part being satisfied by investors buying homes for the rental market; it was also providing support for multifamily construction. Some participants noted their concern that a number of the factors restraining residential construction might persist, damping the housing recovery for some time. Many participants reported continued improvement in sentiment among their business contacts and noted positive readings from recent regional and Minutes of Federal Open Market Committee Meetings | July national surveys of manufacturing and service-sector activity. In particular, participants cited strength in airlines, railroads, trucking firms, businesses supplying the motor vehicle and aerospace industries, and those in the high-tech sector. In addition, higher energy prices continued to provide support for activity in the energy sector. In the agriculture sector, favorable growing conditions for crops had lowered prices but increased the profitability of livestock producers. The reports from their business contacts provided support for participants’ expectation of stronger economic growth in the second half of the year. In some cases, the information from businesses suggested increases in spending on capital equipment or a pickup in investment in commercial and industrial construction and transportation. Contacts in a number of areas indicated that credit was readily available, and reports from participants’ business and financial contacts indicated a strengthening in demand for bank credit. However, several participants reported that businesses remained somewhat uncertain about the economic outlook and thus were still cautious about stepping up capital spending and hiring. Federal fiscal restraint reportedly continued to depress business activity in some areas dependent on federal spending. Labor market conditions improved in recent months according to participants’ reports on developments in their Districts as well as a range of national indicators. The improvement was reflected not only in a pickup in payroll employment gains and a noticeable decline in the overall unemployment rate, but also in reductions in broader measures of underutilization such as long-duration joblessness and the number of workers with part-time jobs who would prefer fulltime employment. The labor force participation rate was stable, and a couple of participants pointed out that the transition rate from long-duration unemployment to employment had moved up. Moreover, some participants cited positive signs of increased hiring and turnover in the labor market, including increases in job openings and hiring plans, higher quit rates, and apparent improvements in matching workers and jobs. Participants generally agreed that both the recent improvement in labor market conditions and the cumulative progress over the past year had been greater than anticipated and that labor market conditions had moved noticeably closer to those viewed as normal in the longer run. Participants differed, however, in their assessments of the remaining degree of labor market slack and how to measure it. A few 217 argued that the unemployment rate continues to serve as a reliable summary statistic for the overall state of the labor market and thought that it should be the Committee’s principal focus for evaluating labor market conditions. However, many participants continued to see a larger gap between current labor market conditions and those consistent with their assessments of normal levels of labor utilization than indicated by the difference between the unemployment rate and estimates of its longer-run normal level. These participants cited, for example, the stillelevated levels of long-term unemployment and workers employed part time for economic reasons as well as low labor force participation. Several participants pointed out that the recent drop in the unemployment rate had been associated with progress in reabsorbing the long-term unemployed into jobs and reducing part-time work, suggesting that slack was diminishing and could be reduced further as employment opportunities expanded. Labor compensation was still rising only modestly. Many participants continued to attribute the subdued rise in wages to the remaining slack in the labor market; it was noted that the elevated level of relatively low-paid part-time workers was holding down overall wage increases. Several other participants pointed to reports that wage pressures had increased in some regions and occupations that were experiencing labor shortages or relatively low unemployment. However, a couple of participants indicated that the pass-through of labor costs has been more attenuated since the mid-1980s and that wage pressures might not be a reliable leading indicator of higher inflation. Inflation firmed in recent months, and most participants anticipated that it would continue to move up toward the Committee’s 2 percent objective. Many of them expected that inflation was likely to rise gradually over the medium term, as resource slack diminished and inflation expectations remained stable. In support of their assessments, several reported results from various statistical models of inflation and inflation expectations. Most now judged that the downside risks to inflation had diminished, but a few participants continued to see inflation as likely to persist below the Committee’s objective over the medium term. Several commented that the upside risks had not increased. However, a few others argued that the recent tightening of the labor market had increased the upside risks to inflation and inflation expectations, particularly in an environment in which the economic expansion was expected to strengthen further. 218 101st Annual Report | 2014 In their discussion of financial stability issues, participants noted evidence of valuation pressures in some particular asset markets, but those pressures did not appear to be widespread and other measures of vulnerability in the financial system were at low to moderate levels. As a result, they generally saw the vulnerabilities in the financial system as well contained. Some participants discussed how the Committee might better incorporate financial stability risks in its discussion of macroeconomic risks. They also suggested that the Committee consider how promptly various financial stability concerns could be addressed, if need be, and which tools, including monetary policy and regulatory responses, would be most timely and effective in doing so. With respect to monetary policy over the medium run, participants generally agreed that labor market conditions and inflation had moved closer to the Committee’s longer-run objectives in recent months, and most anticipated that progress toward those goals would continue. Moreover, many participants noted that if convergence toward the Committee’s objectives occurred more quickly than expected, it might become appropriate to begin removing monetary policy accommodation sooner than they currently anticipated. Indeed, some participants viewed the actual and expected progress toward the Committee’s goals as sufficient to call for a relatively prompt move toward reducing policy accommodation to avoid overshooting the Committee’s unemployment and inflation objectives over the medium term. These participants were increasingly uncomfortable with the Committee’s forward guidance. In their view, the guidance suggested a later initial increase in the target federal funds rate as well as lower future levels of the funds rate than they judged likely to be appropriate. They suggested that the guidance should more clearly communicate how policy-setting would respond to the evolution of economic data. However, most participants indicated that any change in their expectations for the appropriate timing of the first increase in the federal funds rate would depend on further information on the trajectories of economic activity, the labor market, and inflation. In particular, although participants generally saw the drop in real GDP in the first quarter as transitory, some noted that it increased uncertainty about the outlook, and they were looking to additional data on production, spending, and labor market developments to shed light on the underlying pace of economic growth. Moreover, despite recent inflation developments, several participants continued to believe that inflation was likely to move back to the Committee’s objective very slowly, thereby warranting a continuation of highly accommodative policy as long as projected inflation remained below 2 percent and longer-term inflation expectations were well anchored. Committee Policy Action In their discussion of monetary policy in the period ahead, members judged that information received since the Federal Open Market Committee met in June indicated that economic activity rebounded in the second quarter. Household spending appeared to be rising moderately, and business fixed investment was advancing, while the recovery in the housing sector remained slow. Fiscal policy was restraining economic growth, although the extent of the restraint was diminishing. The Committee expected that, with appropriate policy accommodation, economic activity would expand at a moderate pace with labor market indicators and inflation moving toward levels that the Committee judges consistent with its dual mandate. With the incoming information broadly supporting the Committee’s expectation of ongoing improvement in labor market conditions and inflation moving back to the Committee’s 2 percent objective, members generally agreed that a further measured reduction in the pace of asset purchases was appropriate at this meeting. Accordingly, the Committee agreed that, beginning in August, it would add to its holdings of agency MBS at a pace of $10 billion per month rather than $15 billion per month, and it would add to its holdings of Treasury securities at a pace of $15 billion per month rather than $20 billion per month. The Committee again judged that, if incoming data broadly supported its expectations that labor market indicators and inflation would continue to move toward mandate-consistent levels, the Committee would likely reduce the pace of asset purchases in further measured steps at future meetings. However, the Committee reiterated that asset purchases were not on a preset course and that its decisions remained contingent on the outlook for the labor market and inflation as well as its assessment of the likely efficacy and costs of such purchases. Members discussed their assessments of progress— both realized and expected—toward the Committee’s objectives of maximum employment and 2 percent inflation and considered enhancements to the statement language that would more clearly communicate the Committee’s view on such progress. Regarding the labor market, many members concluded that a Minutes of Federal Open Market Committee Meetings | July 219 range of indicators of labor market conditions—including the unemployment rate as well as a number of other measures of labor utilization—had improved more in recent months than they anticipated earlier. They judged it appropriate to replace the description of recent labor market conditions that mentioned solely the unemployment rate with a description of their assessment of the remaining underutilization of labor resources based on their evaluation of a range of labor market indicators. In their discussion, some members expressed reservations about describing the extent of underutilization in labor resources more broadly. In particular, they worried that the degree of labor market slack was difficult to characterize succinctly and that the statement language might prove difficult to adjust as labor market conditions continued to improve. Moreover, they were concerned that, despite the improvement in labor market conditions, the new language might be misinterpreted as indicating increased concern about underutilization of labor resources. At the conclusion of the discussion, the Committee agreed to state that labor market conditions had improved, with the unemployment rate declining further, while also stating that a range of labor market indicators suggested that there remained significant underutilization of labor resources. Many members noted, however, that the characterization of labor market underutilization might have to change before long, particularly if progress in the labor market continued to be faster than anticipated. Regarding inflation, members agreed to update the language in the statement to acknowledge that inflation had recently moved somewhat closer to the Committee’s longerrun objective and to convey their judgment that the likelihood of inflation running persistently below 2 percent had diminished somewhat. Bank of New York, until it was instructed otherwise, to execute transactions in the SOMA in accordance with the following domestic policy directive: After the discussion, all members but one voted to maintain the Committee’s target range for the federal funds rate and to reiterate its forward guidance on how it would assess the appropriate timing of the first increase in the target rate and the anticipated behavior of the federal funds rate after it is raised. One member, however, objected to the guidance that it would likely be appropriate to maintain the current range for the federal funds rate for a considerable time after the asset purchase program ends because it was time dependent and did not recognize the implications for monetary policy of the considerable progress that had been made toward the Committee’s goals. “Information received since the Federal Open Market Committee met in June indicates that growth in economic activity rebounded in the second quarter. Labor market conditions improved, with the unemployment rate declining further. However, a range of labor market indicators suggests that there remains significant underutilization of labor resources. Household spending appears to be rising moderately and business fixed investment is advancing, while the recovery in the housing sector remains slow. Fiscal policy is restraining economic growth, although the extent of restraint is diminishing. Inflation has moved somewhat closer to the Committee’s longer-run objective. Longer-term inflation expectations have remained stable. At the conclusion of the discussion, the Committee voted to authorize and direct the Federal Reserve “Consistent with its statutory mandate, the Federal Open Market Committee seeks monetary and financial conditions that will foster maximum employment and price stability. In particular, 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 undertake open market operations as necessary to maintain such conditions. Beginning in August, the Desk is directed to purchase longer-term Treasury securities at a pace of about $15 billion per month and to purchase agency mortgage-backed securities at a pace of about $10 billion per month. The Committee also directs the Desk to engage in dollar roll and coupon swap transactions as necessary to facilitate settlement of the Federal Reserve’s agency mortgage-backed securities transactions. The Committee directs the Desk to maintain its policy of rolling over maturing Treasury securities into new issues and its policy of reinvesting principal payments on all agency debt and agency mortgage-backed securities in agency mortgage-backed securities. 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 2:00 p.m.: 220 101st Annual Report | 2014 Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that, with appropriate policy accommodation, economic activity will expand at a moderate pace, with labor market indicators and inflation moving toward levels the Committee judges consistent with its dual mandate. The Committee sees the risks to the outlook for economic activity and the labor market as nearly balanced and judges that the likelihood of inflation running persistently below 2 percent has diminished somewhat. The Committee currently judges that there is sufficient underlying strength in the broader economy to support ongoing improvement in labor market conditions. In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions since the inception of the current asset purchase program, the Committee decided to make a further measured reduction in the pace of its asset purchases. Beginning in August, the Committee will add to its holdings of agency mortgage-backed securities at a pace of $10 billion per month rather than $15 billion per month, and will add to its holdings of longerterm Treasury securities at a pace of $15 billion per month rather than $20 billion per month. The Committee is maintaining its existing policy 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’s sizable and still-increasing holdings of longer-term securities should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee’s dual mandate. The Committee will closely monitor incoming information on economic and financial developments in coming months and will continue its purchases of Treasury and agency mortgagebacked securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability. If incoming informa- tion broadly supports the Committee’s expectation of ongoing improvement in labor market conditions and inflation moving back toward its longer-run objective, the Committee will likely reduce the pace of asset purchases in further measured steps at future meetings. However, asset purchases are not on a preset course, and the Committee’s decisions about their pace will remain contingent on the Committee’s outlook for the labor market and inflation as well as its assessment of the likely efficacy and costs of such purchases. To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy remains appropriate. In determining how long to maintain the current 0 to ¼ percent target range for the federal funds rate, the Committee will assess progress—both realized and expected— toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the Committee’s 2 percent longerrun goal, and provided that longer-term inflation expectations remain well anchored. When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent. The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.” Voting for this action: Janet L. Yellen, William C. Dudley, Lael Brainard, Stanley Fischer, Richard W. Fisher, Narayana Kocherlakota, Loretta J. Mester, Jerome H. Powell, and Daniel K. Tarullo. Voting against this action: Charles I. Plosser. Minutes of Federal Open Market Committee Meetings | July Mr. Plosser dissented because he objected to the statement’s guidance indicating that it likely will be appropriate to maintain the current target range for the federal funds rate for “a considerable time after the asset purchase program ends.” In his view, the reference to calendar time should be replaced with language that indicates how monetary policy will respond to incoming data. Moreover, he judged that the statement did not acknowledge the substantial progress that had been made toward the Committee’s economic goals and thus risks unnecessary and disruptive volatility in financial markets, and perhaps in the economy, if the Committee reduces accommodation sooner or more quickly than financial markets anticipate. 221 It was agreed that the next meeting of the Committee would be held on Tuesday–Wednesday, September 16–17, 2014. The meeting adjourned at 11:55 a.m. on July 30, 2014. Notation Vote By notation vote completed on July 8, 2014, the Committee unanimously approved the minutes of the Committee meeting held on June 17–18, 2014. William B. English Secretary 222 101st Annual Report | 2014 Meeting Held on September 16–17, 2014 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, September 16, 2014, at 11:00 a.m. and continued on Wednesday, September 17, 2014, at 9:00 a.m. Present Janet L. Yellen Chair William C. Dudley Vice Chairman Lael Brainard Stanley Fischer Richard W. Fisher Narayana Kocherlakota Loretta J. Mester Charles I. Plosser Jerome H. Powell Daniel K. Tarullo Christine Cumming, Charles L. Evans, Jeffrey M. Lacker, Dennis P. Lockhart, and John C. Williams Alternate Members of the Federal Open Market Committee James Bullard, Esther L. George, and Eric Rosengren Presidents of the Federal Reserve Banks of St. Louis, Kansas City, and Boston, respectively William B. English Secretary and Economist Matthew M. Luecke Deputy Secretary Michelle A. Smith Assistant Secretary James A. Clouse, Evan F. Koenig, Thomas Laubach, Michael P. Leahy, Mark E. Schweitzer, and William Wascher Associate Economists Simon Potter Manager, System Open Market Account Lorie K. Logan Deputy Manager, System Open Market Account Robert deV. Frierson1 Secretary of the Board, Office of the Secretary, Board of Governors Michael S. Gibson2 Director, Division of Banking Supervision and Regulation, Board of Governors Matthew J. Eichner1 Deputy Director, Division of Research and Statistics, Board of Governors Stephen A. Meyer and William R. Nelson Deputy Directors, Division of Monetary Affairs, Board of Governors Mark E. Van Der Weide3 Deputy Director, Division of Banking Supervision and Regulation, Board of Governors Andreas Lehnert Deputy Director, Office of Financial Stability Policy and Research, Board of Governors Andrew Figura, David Reifschneider, and Stacey Tevlin Special Advisers to the Board, Office of Board Members, Board of Governors Trevor A. Reeve Special Adviser to the Chair, Office of Board Members, Board of Governors Linda Robertson Assistant to the Board, Office of Board Members, Board of Governors Christopher J. Erceg Senior Associate Director, Division of International Finance, Board of Governors Scott G. Alvarez General Counsel Steven B. Kamin Economist David W. Wilcox Economist 1 2 3 Attended the joint session of the Federal Open Market Committee and the Board of Governors. Attended Wednesday’s session only. Attended Tuesday’s session only. Minutes of Federal Open Market Committee Meetings | September Michael T. Kiley4 and Jeremy B. Rudd4 Senior Advisers, Division of Research and Statistics, Board of Governors Joyce K. Zickler Senior Adviser, Division of Monetary Affairs, Board of Governors Eric M. Engen and Michael G. Palumbo Associate Directors, Division of Research and Statistics, Board of Governors Fabio M. Natalucci Associate Director, Division of Monetary Affairs, Board of Governors Marnie Gillis DeBoer Deputy Associate Director, Division of Monetary Affairs, Board of Governors Joshua Gallin Deputy Associate Director, Division of Research and Statistics, Board of Governors Edward Nelson Assistant Director, Division of Monetary Affairs, Board of Governors Patrick E. McCabe1 Adviser, Division of Research and Statistics, Board of Governors Penelope A. Beattie1 Assistant to the Secretary, Office of the Secretary, Board of Governors David H. Small Project Manager, Division of Monetary Affairs, Board of Governors Katie Ross1 Manager, Office of the Secretary, Board of Governors Valerie Hinojosa Records Project Manager, Division of Monetary Affairs, Board of Governors Marie Gooding First Vice President, Federal Reserve Bank of Atlanta David Altig, Alberto G. Musalem, and Daniel G. Sullivan Executive Vice Presidents, Federal Reserve Banks of Atlanta, New York, and Chicago, respectively 4 Attended the portion of the meeting following the joint session of the Federal Open Market Committee and the Board of Governors. 223 Troy Davig, Michael Dotsey, Geoffrey Tootell, Christopher J. Waller, and John A. Weinberg Senior Vice Presidents, Federal Reserve Banks of Kansas City, Philadelphia, Boston, St. Louis, and Richmond, respectively Sylvain Leduc, Jonathan P. McCarthy, and Douglas Tillett Vice Presidents, Federal Reserve Banks of San Francisco, New York, and Chicago, respectively Kei-Mu Yi Special Policy Advisor to the President, Federal Reserve Bank of Minneapolis Developments in Financial Markets and the Federal Reserve’s Balance Sheet In a joint session of the Federal Open Market Committee (FOMC) and the Board of Governors of the Federal Reserve System, the manager of the System Open Market Account (SOMA) reported on developments in domestic and foreign financial markets and reviewed the effects of recent foreign central bank policy actions on yields on the international portion of the SOMA portfolio. The deputy manager reported on the System open market operations conducted during the period since the Committee met on July 29–30, 2014, summarized plans for additional test operations of the Term Deposit Facility, and described the results from the fixed-rate overnight reverse repurchase agreement (ON RRP) operational exercise. The deputy manager also outlined a proposal for changes to the ongoing ON RRP exercise to test possible design features that could allow an ON RRP facility to serve as an effective supplementary tool during policy normalization while also mitigating the potential for unintended effects in financial markets. Participants discussed the proposed changes in the ON RRP exercise, including raising the counterparty-specific limit from $10 billion to $30 billion, limiting the overall size of each operation to $300 billion, and introducing an auction process that would be used to determine the interest rate on such operations and allocate take-up if the sum of bids exceeded the overall limit. Testing these design features was generally seen as furthering the Committee’s understanding of how an ON RRP facility might be structured to best balance its objectives of supporting monetary control and of limiting the Federal Reserve’s role in financial intermediation as well as reducing potential financial stability risks the facility might pose during periods of stress. Partici- 224 101st Annual Report | 2014 pants also discussed other tests that could be incorporated in the exercise at a later date, including a daily time-varying cap along with the overall limit on the size of ON RRP operations, small variations in the offered rate on ON RRP operations, and moderate increases and decreases in the overall size limit. A number of participants expressed concern that these tests could be misunderstood as providing a signal of the Committee’s intentions regarding the parameters of the ON RRP program that will be implemented when normalization begins; they wanted to emphasize that the tests are intended to provide additional information to guide the Committee’s decisions. Participants agreed to consider potential additional revisions to the ON RRP exercise at future FOMC meetings. Following the discussion, the Committee unanimously approved the following resolution: “The Federal Open Market Committee (FOMC) authorizes the Federal Reserve Bank of New York to conduct a series of overnight reverse repurchase operations involving U.S. government securities for the purpose of further assessing the appropriate structure of such operations in supporting the implementation of monetary policy during normalization. The reverse repurchase operations authorized by this resolution shall be (i) conducted at an offering rate that may vary from zero to five basis points, (ii) for an overnight term, or such longer term as is warranted to accommodate weekend, holiday, and similar trading conventions, (iii) subject to a percounterparty limit of up to $30 billion per day, (iv) subject to an overall size limit of up to $300 billion per day, (v) awarded to all submitters (A) at the specified offering rate if the sum of the bids received is less than or equal to the overall size limit, or (B) at the stopout rate, determined by evaluating bids in ascending order by submitted rate up to the point at which the total quantity of bids equals the overall size limit, with all bids below this rate awarded in full at the stopout rate and all bids at the stopout rate awarded on a pro rata basis, if the sum of the counterparty offers received is greater than the overall size limit, and (vi) offered beginning with the operation conducted on September 22, 2014, with the resolution adopted at the January 28–29, 2014, FOMC meeting remaining in place until the conclusion of the operation conducted on September 19, 2014. The Chair must approve any change in the offering rate within the range specified in (i) and any changes to the per-counterparty and overall size limits subject to the limits specified in (iii) and (iv). The System Open Market Account manager will notify the FOMC in advance about any changes to the offering rate, per-counterparty limit, or overall size limit applied to operations. These operations shall be authorized through January 30, 2015.” 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. Monetary Policy Normalization Meeting participants considered publication of a summary statement of their monetary policy normalization principles and plans based on the discussions at recent Committee meetings. Participants agreed that it was appropriate at this time to provide additional information regarding their approach to normalization. The proposed statement was seen as a concise summary of participants’ views that would help the public understand the steps that the Committee plans to take when the time comes to begin the normalization process and that would convey the Committee’s confidence in its plans. However, it was emphasized that the Committee would need to be flexible and pragmatic during normalization, adjusting the details of its approach, if necessary, in light of changing conditions. Regarding the specific points in the proposed statement, a couple of participants expressed their preference that the principles make greater allowance for sales of agency mortgagebacked securities (MBS) over the next few years in order to normalize the size and composition of the Federal Reserve’s balance sheet more quickly and to limit distortions in the allocation of credit that they believed were associated with the Federal Reserve’s holdings of agency MBS. In addition, a few participants noted that they would have preferred that the principles point to an earlier end to the reinvestment of repayments of principal on securities held in the SOMA portfolio. At the end of the discussion, all but one participant could support the publication of the following statement after the meeting: Policy Normalization Principles and Plans During its recent meetings, the Federal Open Market Committee (FOMC) discussed ways to normalize the stance of monetary policy and the Federal Reserve’s securities holdings. The dis- Minutes of Federal Open Market Committee Meetings | September cussions were part of prudent planning and do not imply that normalization will necessarily begin soon. The Committee continues to judge that many of the normalization principles that it adopted in June 2011 remain applicable. However, in light of the changes in the System Open Market Account (SOMA) portfolio since 2011 and enhancements in the tools the Committee will have available to implement policy during normalization, the Committee has concluded that some aspects of the eventual normalization process will likely differ from those specified earlier. The Committee also has agreed that it is appropriate at this time to provide additional information regarding its normalization plans. All FOMC participants but one agreed on the following key elements of the approach they intend to implement when it becomes appropriate to begin normalizing the stance of monetary policy: • The Committee will determine the timing and pace of policy normalization—meaning steps to raise the federal funds rate and other shortterm interest rates to more normal levels and to reduce the Federal Reserve’s securities holdings—so as to promote its statutory mandate of maximum employment and price stability. —When economic conditions and the economic outlook warrant a less accommodative monetary policy, the Committee will raise its target range for the federal funds rate. —During normalization, the Federal Reserve intends to move the federal funds rate into the target range set by the FOMC primarily by adjusting the interest rate it pays on excess reserve balances. —During normalization, the Federal Reserve intends to use an overnight reverse repurchase agreement facility and other supplementary tools as needed to help control the federal funds rate. The Committee will use an overnight reverse repurchase agreement facility only to the extent necessary and will phase it out when it is no longer needed to help control the federal funds rate. • The Committee intends to reduce the Federal Reserve’s securities holdings in a gradual and predictable manner primarily by ceasing to reinvest repayments of principal on securities held in the SOMA. 225 —The Committee expects to cease or commence phasing out reinvestments after it begins increasing the target range for the federal funds rate; the timing will depend on how economic and financial conditions and the economic outlook evolve. —The Committee currently does not anticipate selling agency mortgage-backed securities as part of the normalization process, although limited sales might be warranted in the longer run to reduce or eliminate residual holdings. The timing and pace of any sales would be communicated to the public in advance. • The Committee intends that the Federal Reserve will, in the longer run, hold no more securities than necessary to implement monetary policy efficiently and effectively, and that it will hold primarily Treasury securities, thereby minimizing the effect of Federal Reserve holdings on the allocation of credit across sectors of the economy. • The Committee is prepared to adjust the details of its approach to policy normalization in light of economic and financial developments. The Board meeting concluded at the end of the discussion of policy normalization principles and plans. Staff Review of the Economic Situation The information reviewed for the September 16–17 meeting suggested that economic activity was expanding at a moderate pace in the third quarter. Labor market conditions improved a little further, although the unemployment rate was essentially unchanged over the intermeeting period. Consumer price inflation was running below the FOMC’s longer-run objective of 2 percent, but measures of longer-run inflation expectations remained stable. Total nonfarm payroll employment increased in July and August but at a slower pace than in the first half of the year. The unemployment rate was 6.1 percent in August, the same as in June, and the labor force participation rate and the employment-to-population ratio also were unchanged since that time. Both the share of workers employed part time for economic reasons and the rate of long-duration unemployment declined a little over the past two months. Other 226 101st Annual Report | 2014 recent indicators generally pointed to ongoing improvement in labor market conditions: Although some measures of household expectations of the labor market situation deteriorated somewhat, the rates of job openings and of gross private-sector hiring moved up, initial claims for unemployment insurance were essentially flat at a relatively low level, and some readings on firms’ hiring plans improved. On balance, industrial production edged up over July and August, and the rate of manufacturing capacity utilization was unchanged. Automakers’ schedules indicated that the pace of motor vehicle assemblies would decline slightly in the fourth quarter, but broader indicators of manufacturing production, such as the readings on new orders from the national and regional manufacturing surveys, were consistent with moderate increases in factory output in the near term. Real personal consumption expenditures (PCE) appeared to be rising at a moderate pace in the third quarter.5 The components of nominal retail sales data used by the Bureau of Economic Analysis (BEA) to construct its estimates of PCE increased at a solid rate in July and August, and sales of light motor vehicles surged in August after edging down in July. Recent information pertaining to key factors that influence consumer spending were positive: Real disposable incomes continued to increase in July, households’ net worth likely edged up as equity prices and home values rose somewhat further, and consumer sentiment as measured by the Thomson Reuters/University of Michigan Surveys of Consumers improved in August and early September. The pace of activity in the housing sector seemed to be picking up. Starts and permits of both new singlefamily homes and multifamily units were higher in July than their average levels in the second quarter. Sales of existing homes increased further in July, although new home sales declined. Real private expenditures for business equipment and intellectual property products appeared to rise further going into the third quarter. Nominal shipments of nondefense capital goods excluding aircraft moved up in July. Moreover, new orders for these capital goods continued to be above the level of shipments, pointing to increases in shipments in subsequent 5 Recently released data for health-services consumption in the second quarter were notably stronger than the Bureau of Economic Analysis estimated when constructing its most recent PCE estimates for the second quarter. months. In addition, other forward-looking indicators, such as surveys of business conditions, were consistent with moderate gains in business equipment spending in the near term. Nominal business expenditures for nonresidential construction also increased in July. Recent book-value data for inventories, along with readings on inventories from national and regional manufacturing surveys, did not point to significant inventory imbalances in most industries; in the energy sector, inventories were drawn down significantly early in the year and, despite substantial stockbuilding since then, remained low. Total real government purchases seemed to be roughly flat in the third quarter. Federal government purchases probably declined a little, as defense spending was lower in July and August than in the second quarter. State and local government purchases appeared to be rising slowly as the payrolls of these governments expanded a bit further in July and August and their nominal construction expenditures increased in July. The U.S. international trade deficit narrowed in both June and July. Exports were little changed in June, but they expanded robustly in July, with particular strength in industrial supplies and automotive products. Imports fell in June but then partly recovered in July, driven by swings in imports of oil and automotive products. Total U.S. consumer price inflation, as measured by the PCE price index, was about 1½ percent over the 12 months ending in July. Over the 12 months ending in August, the consumer price index (CPI) rose about 1¾ percent. Consumer energy prices declined in both July and August, while consumer food prices rose. Core price inflation (which excludes food and energy prices) was essentially the same as total inflation for the PCE price measure and for the CPI over their most recent 12-month periods. Near-term inflation expectations from the Michigan survey moved down a bit in August and early September, while longerterm inflation expectations in the survey were little changed. Measures of labor compensation increased a little faster than consumer prices. Compensation per hour in the business sector rose 2¾ percent over the year ending in the second quarter; with modest gains in labor productivity, unit labor costs advanced more slowly than compensation per hour. Over the same year-long period, the employment cost index rose only about 2 percent, and average hourly earnings Minutes of Federal Open Market Committee Meetings | September increased at a similar rate over the 12 months ending in August. Foreign economies continued to expand in the second quarter, but with significant differences across countries. Economic growth rebounded strongly from a weak first-quarter pace in Canada, China, and Mexico, supported by improvement in exports. In contrast, the Japanese economy contracted sharply following the consumption tax increase in April, economic activity stagnated in the euro area, and the Brazilian economy fell into recession. In the third quarter, household spending appeared to be normalizing in Japan, and production continued to rise in Mexico. However, indicators of economic activity in the euro area remained weak, and Chinese economic data for July and August suggested some slowing in the third quarter. With inflation very low in the euro area, the European Central Bank reduced its policy interest rates at its September 4 meeting and announced plans to purchase private assets. Staff Review of the Financial Situation Data releases on domestic economic activity were reportedly interpreted by financial market participants as somewhat better than expected, on balance, notwithstanding the disappointing employment report for August. Federal Reserve communications, particularly the July FOMC minutes and the Chair’s speech at the Jackson Hole economic policy symposium, were viewed as signaling slightly less policy accommodation than anticipated. Reflecting these and other developments, yields on nominal Treasury securities rose somewhat and equity prices edged up over the intermeeting period. On net, the conflicts in the Middle East and Ukraine and other geopolitical tensions had limited effects on domestic financial markets. The federal funds rate path implied by financial market quotes was essentially unchanged over the intermeeting period. But the results from the Desk’s September Survey of Primary Dealers indicated that the distribution of the likely date of liftoff across dealers shifted to somewhat earlier dates, and showed the second quarter of 2015 as the most likely date for liftoff. However, the dealers’ expected levels of various employment and inflation indicators at the time of liftoff did not change materially from the previous survey. The yield on 10-year nominal Treasury securities moved up about 15 basis points, on net, since the 227 FOMC met in July, likely boosted in part by Federal Reserve communications. Measures of inflation compensation based on Treasury Inflation-Protected Securities edged down, reportedly reflecting the lower-than-expected CPI data in July and recent declines in oil prices. Broad measures of domestic equity prices were up modestly over the intermeeting period, with some reports suggesting that investors were interpreting incoming economic data as implying that the economic recovery was strengthening. Yields on corporate bonds and agency MBS rose about in line with those on comparable-maturity Treasury securities. High-yield bond mutual funds experienced sharp outflows early in the intermeeting period, and spreads on such bonds widened noticeably; however, these spreads returned to their initial levels over subsequent weeks, and high-yield bond funds attracted modest inflows. Measures of liquidity in the corporate bond market remained stable in the face of these substantial flows. Conditions in short-term dollar funding markets were little changed. The Federal Reserve continued its testing of ON RRP operations over the intermeeting period. Take-up in ON RRP operations increased a little, on average, over the period relative to the previous intermeeting period. Credit conditions for domestic businesses remained favorable. Corporate bond issuance slowed in July and August, reflecting a fairly typical summer lull as well as the elevated volatility in the high-yield bond market early in the intermeeting period, but issuance rebounded strongly in the first week of September. Commercial paper outstanding and commercial and industrial loans at banks expanded briskly. Credit conditions in the commercial real estate (CRE) sector continued to ease, and growth in CRE loans at banks stayed solid. The issuance of commercial mortgagebacked securities remained robust in July and August. Issuance of institutional leveraged loans continued apace in July and August, traditionally a slow period in this market. The issuance of “new money” loans, which are typically earmarked for corporate leveraged-buyouts and mergers and acquisitions, was strong, and the pipeline of such loans was reported to be quite large heading into the fall. The issuance of collateralized loan obligations was still a major source of demand for leveraged loans. 228 101st Annual Report | 2014 Financing conditions for households remained mixed. Auto loans were widely available; standards and terms for credit card loans eased somewhat, though they were still tight; and access to residential mortgages continued to be limited for all but those with excellent credit histories. Responding in part to disappointing economic data abroad, the U.S. dollar appreciated against most currencies over the intermeeting period, including large appreciations against the euro, the yen, and the pound sterling. Greater monetary accommodation in the euro area and expectations of a lower policy rate in the near term added to the downward pressure on the euro while uncertainty about the outcome of the forthcoming referendum on Scottish independence weighed on the value of the pound. In addition, nearterm policy rate expectations moved down in the United Kingdom, reacting to both the release of the August Inflation Report and uncertainty induced by the referendum. Sovereign yields in the European economies generally declined, and yield spreads of sovereign bonds from the euro-area periphery over German bunds narrowed considerably. Most foreign equity indexes ended the period modestly higher. Staff Economic Outlook In the economic forecast prepared by the staff for the September FOMC meeting, the projection for growth in real gross domestic product (GDP) in the second half of this year was revised down slightly from the one prepared for the previous meeting, primarily because of a somewhat weaker near-term outlook for consumer spending. The staff’s medium-term forecast for real GDP was also revised down a little, reflecting a higher projected path for the foreign exchange value of the dollar along with slightly smaller projected gains for home prices. The staff still anticipated that the pace of real GDP growth in 2015 and 2016 would exceed the growth rate of potential output, supported by continued increases in consumer and business confidence, the further easing of the restraint on spending from changes in fiscal policy, additional improvements in credit availability, and a pickup in foreign economic growth. In 2017, real GDP growth was projected to begin slowing toward, but to remain above, the rate of potential output growth. The expansion in economic activity over the projection period was anticipated to steadily reduce resource slack, and the unemployment rate was expected to decline gradually and temporarily move slightly below the staff’s estimate of its longerrun natural rate toward the end of the period. The staff’s near-term forecast for inflation was a little lower than the projection prepared for the previous FOMC meeting, reflecting recent readings on core consumer price inflation that were lower than anticipated and declines in oil prices that were faster than expected, but the forecast for inflation over the medium term was little changed. The staff continued to project inflation to be lower in the second half of this year than in the first half and to remain below the Committee’s longer-run objective of 2 percent over the next few years. With longer-term inflation expectations assumed to remain stable, resource slack projected to diminish slowly, and changes in commodity and import prices expected to be subdued, inflation was projected to rise gradually and to reach the Committee’s objective in the longer run. Overall, the staff’s economic projection for the September meeting was quite similar to the forecast presented at the June meeting, when the FOMC last prepared a Summary of Economic Projections (SEP). The staff’s September projection showed a slightly higher path for the unemployment rate, a bit lower real GDP growth, and essentially no change to inflation compared with its June forecast. The staff continued to view the uncertainty around its projections for real GDP growth, the unemployment rate, and inflation as similar to the average over the past 20 years. The risks to the forecast for real GDP growth were still seen as tilted a little to the downside, as neither monetary policy nor fiscal policy was viewed as well positioned to help the economy withstand adverse shocks. At the same time, the staff viewed the risks around its outlook for the unemployment rate and for inflation as roughly balanced. Participants’ Views on Current Conditions and the Economic Outlook In conjunction with this FOMC meeting, members of the Board of Governors and the Federal Reserve Bank presidents submitted their projections of real output growth, the unemployment rate, inflation, and the federal funds rate for each year from 2014 through 2017 and over the longer run, conditional on each participant’s assessment of appropriate monetary policy. The longer-run projections represent each participant’s assessment of the value 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 | September described in the SEP, which is attached as an addendum to these minutes. In their discussion of the economic situation and the outlook, meeting participants viewed the information received over the intermeeting period as suggesting that economic activity was expanding at a moderate rate. On balance, labor market conditions improved somewhat further; however, the unemployment rate was little changed, and most participants judged that there remained significant underutilization of labor resources. Participants generally expected that, over the medium term, real economic activity would increase at a pace sufficient to lead to a further gradual decline in the unemployment rate toward levels consistent with the Committee’s objective of maximum employment. Inflation was running below the Committee’s longer-run objective, but longerterm inflation expectations were stable. Participants anticipated that inflation would move toward the Committee’s 2 percent goal in coming years, with several expressing concern that inflation might persist below the Committee’s objective for quite some time. Most viewed the risks to the outlook for economic activity and the labor market as broadly balanced. However, a number of participants noted that economic growth over the medium term might be slower than they expected if foreign economic growth came in weaker than anticipated, structural productivity continued to increase only slowly, or the recovery in residential construction continued to lag. Household spending appeared to be rising moderately, with several participants noting that the recent positive reports on retail sales, motor vehicle purchases, and health-care spending had reduced their concern about weakness in the underlying pace of household spending. Among the favorable factors attending the outlook for consumer spending, participants cited continued gains in household wealth, improved household balance sheets, low delinquency rates, a high saving rate, or rising confidence in employment and income prospects. However, other participants said they heard mixed reports from business contacts regarding consumer spending or were uncertain about the prospects for stronger gains in real income necessary to sustain moderate growth in household spending. The recovery in housing activity remained slow in all but a few areas of the country despite relatively low mortgage rates, rising house prices, and improvements in household wealth. Contacts in a couple of Districts reported that new construction was being 229 held back by shortages of materials, of lots available for development, and of skilled workers or by the overhang of vacant homes not on the market. Households with relatively low credit scores continued to have difficulty obtaining mortgage loans. It was noted that this difficulty could be a factor restraining the demand for housing, particularly among younger households who have high levels of student loan debt or weak job prospects. A few participants pointed out the relative strength in construction of and demand for multifamily units, which possibly was due to a shift in demand among younger homebuyers away from single-family homes. Information from business contacts in most parts of the country indicated improvements in business conditions, rising confidence about the economic outlook, and increasing willingness to undertake new investment projects. According to national and regional surveys, manufacturing activity was strong, and several participants had received reports of hiring and increased capital spending in that sector. Among the other industries cited as relatively strong in recent months were transportation, energy, and services. Several participants noted positive signs of further increases in investment spending going forward, including elevated levels of new orders and shipments of capital goods, strong interest in the technology sector, and the need to replace aging capital. A couple of participants added that nonresidential construction activity was rising in their Districts. The improvement in business conditions was reflected in reports of increased demand for loans at banks in several Districts. Demand rose for loans to both households and businesses, and a couple of participants indicated that borrowers were expanding their use of existing credit lines as well as obtaining new commitments. Bankers in one District stated that, while they had eased the terms and conditions on loans in response to competition from other lenders, they had not taken on riskier loans. Some financial developments that could undermine financial stability over time were noted, including a deterioration in leveraged lending standards, stretched stock market valuations, and compressed risk spreads. However, one participant suggested that the leveraged loan market seemed to be moving into better balance, and that market participants appeared to be taking appropriate account of the changes in interest rates that might be associated with the eventual normalization of the stance of monetary policy. Moreover, a couple of participants, while stressing the importance of remaining vigilant about potential risks to finan- 230 101st Annual Report | 2014 cial stability, observed that conditions in financial markets at present did not suggest the types of financial stability considerations that would impede the achievement of the Committee’s macroeconomic objectives. Some participants noted that expectations for the path of the federal funds rate implied by market quotes appeared to remain below most of the projections of the federal funds rate provided by Committee participants in the SEP, which represent each individual participant’s assessment of the appropriate path for the federal funds rate consistent with his or her economic outlook. However, it was pointed out that measures of financial market participants’ expectations incorporate their judgments regarding not only the most likely outcomes, but also the possible downside tail risks that might be associated with especially low paths for the federal funds rate. For example, respondents to the recent Survey of Primary Dealers placed considerable odds on the federal funds rate returning to the zero lower bound during the two years following the initial increase in that rate. The probability that investors attach to such low interest rate scenarios could pull the expected path of the federal funds rate computed from market quotes below most Committee participants’ assessments of appropriate policy as reported in the SEP. The restraint on economic activity from fiscal policy was seen as diminishing, and a couple of participants pointed out that, over the second half of the year, the remaining drag was likely to be small. Nonetheless, the cutbacks in both defense and nondefense federal outlays, as well as state governments’ budget restraint, continued to weigh on jobs and income in some parts of the country. Fiscal policy overall was anticipated to be a neutral factor for economic growth over the next several years. During participants’ discussion of prospects for economic activity abroad, they commented on a number of uncertainties and risks attending the outlook. Over the intermeeting period, the foreign exchange value of the dollar had appreciated, particularly against the euro, the yen, and the pound sterling. Some participants expressed concern that the persistent shortfall of economic growth and inflation in the euro area could lead to a further appreciation of the dollar and have adverse effects on the U.S. external sector. Several participants added that slower economic growth in China or Japan or unanticipated events in the Middle East or Ukraine might pose a similar risk. At the same time, a couple of partici- pants pointed out that the appreciation of the dollar might also tend to slow the gradual increase in inflation toward the FOMC’s 2 percent goal. Labor market conditions continued to improve over the intermeeting period. Although the unemployment rate was little changed, participants variously cited positive readings from other indicators, including a decline in longer-term unemployment, the low level of new claims for unemployment insurance, the rise in job openings, and survey reports of increased hiring plans and job availability. While the most recent estimate of nonfarm payroll employment showed a smaller monthly gain than earlier in the year, it followed six months in which increases had averaged more than 200,000. Some participants were reluctant to place much weight on one monthly report or noted that the first estimate for August has frequently been revised up in recent years. Participants generally agreed that the accumulated progress in labor market conditions since the Committee’s current asset purchase program began in September 2012 had been substantial and expected that progress would be sustained. Nonetheless, they continued to express differing views on the extent of remaining slack in labor markets. Most agreed that underutilization of labor resources remained significant; these participants noted variously that the level of nonfarm payroll jobs had only recently returned to its pre-recession level, that the number of individuals working part time for economic reasons was still elevated relative to the level of unemployment, and that the labor force participation rate was still below assessments of its structural trend. In this regard, a couple of participants pointed out that the stability of the participation rate, on balance, over the past year suggested that some of the cyclical shortfall had diminished. Most agreed that the Committee’s assessment of labor market slack should be grounded in its review of a range of labor market indicators, although a few saw the gap between the unemployment rate and their estimate of its longerrun normal level as a reliable indicator of slack. Most measures of labor compensation showed no broad-based increase in wage inflation. However, businesses in several Districts continued to report upward pressure on wages in specific industries and occupations associated with labor shortages or difficult-to-fill jobs, while a couple of participants noted a more general rise in current or planned wage increases in their regions. Several participants commented that the relatively subdued rise in nominal labor compensation was still below longer-run trend Minutes of Federal Open Market Committee Meetings | September rates of productivity growth and inflation and was a signal of slack remaining in the labor market. However, a couple of others suggested some caution in reading subdued wage inflation as an indicator of labor market underutilization. They pointed out that if nominal wages did not adjust downward when unemployment was high, pent-up wage deflation could help explain the modest increases in wages so far during the recovery, and wages could rise more rapidly going forward as the unemployment rate continues to decline. Inflation had been running below the Committee’s longer-run objective, and the readings on consumer prices over the intermeeting period were somewhat softer than during the preceding four months, in part because of declining energy prices. Most participants anticipated that inflation would move gradually back toward its objective over the medium term. However, participants differed somewhat in their assessments of how quickly inflation would move up. Some cited the stability of longer-run inflation expectations at a level consistent with the Committee’s objective as an important factor in their forecasts that inflation would reach 2 percent in coming years. Participants’ views on the responsiveness of inflation to the level and change in resource utilization varied, with a few seeing labor markets as sufficiently tight that wages and prices would soon begin to move up noticeably but with some others indicating that inflation was unlikely to approach 2 percent until the unemployment rate falls below its longer-run normal level. While most viewed the risk that inflation would run persistently below 2 percent as having diminished somewhat since earlier in the year, a couple noted the possibility that longer-term inflation expectations might be slightly lower than the Committee’s 2 percent objective or that domestic inflation might be held down by persistent disinflation among U.S. trading partners and further appreciation of the dollar. In their discussion of the appropriate path for monetary policy over the medium term, meeting participants agreed that the timing of the first increase in the federal funds rate and the appropriate path of the policy rate thereafter would depend on incoming economic data and their implications for the outlook. That said, several participants thought that the current forward guidance regarding the federal funds rate suggested a longer period before liftoff, and perhaps also a more gradual increase in the federal funds rate thereafter, than they believed was likely to be appropriate given economic and financial conditions. In addition, the concern was raised that the reference 231 to “considerable time” in the current forward guidance could be misunderstood as a commitment rather than as data dependent. However, it was noted that the current formulation of the Committee’s forward guidance clearly indicated that the Committee’s policy decisions were conditional on its ongoing assessment of realized and expected progress toward its objectives of maximum employment and 2 percent inflation, and that its assessment reflected its review of a broad array of economic indicators. It was emphasized that the current forward guidance for the federal funds rate was data dependent and did not indicate that the first increase in the target range for the federal funds rate would occur mechanically after some fixed calendar interval following the completion of the current asset purchase program. If employment and inflation converged more rapidly toward the Committee’s goals than currently expected, the date of liftoff could be earlier, and subsequent increases in the federal funds rate target more rapid, than participants currently anticipated. Conversely, if employment and inflation returned toward the Committee’s objectives more slowly than currently anticipated, the date of liftoff for the federal funds rate could be later, and future federal funds rate target increases could be more gradual. In addition, some participants saw the current forward guidance as appropriate in light of risk-management considerations, which suggested that it would be prudent to err on the side of patience while awaiting further evidence of sustained progress toward the Committee’s goals. In their view, the costs of downside shocks to the economy would be larger than those of upside shocks because, in current circumstances, it would be less problematic to remove accommodation quickly, if doing so becomes necessary, than to add accommodation. A number of participants also noted that changes to the forward guidance might be misinterpreted as a signal of a fundamental shift in the stance of policy that could result in an unintended tightening of financial conditions. Participants also discussed how the forward-guidance language might evolve once the Committee decides that the current formulation no longer appropriately conveys its intentions about the future stance of policy. Most participants indicated a preference for clarifying the dependence of the current forward guidance on economic data and the Committee’s assessment of progress toward its objectives of maximum employment and 2 percent inflation. A clarification along these lines was seen as likely to improve the public’s understanding of the Committee’s reaction function while allowing the Committee to retain 232 101st Annual Report | 2014 flexibility to respond appropriately to changes in the economic outlook. One participant favored using a numerical threshold based on the inflation outlook as a form of forward guidance. A few participants, however, noted the difficulties associated with expressing forward guidance in terms of numerical thresholds for some set of economic variables. Another participant indicated a preference for reducing reliance on explicit forward guidance in the statement and conveying instead guidance regarding the future stance of monetary policy through other mechanisms, including the SEP. It was noted that providing explicit forward guidance regarding the future path of the federal funds rate might become less important once a highly accommodative stance of policy is no longer appropriate and the process of policy normalization is well under way. It was generally agreed that when changes to the forward guidance become appropriate, they will likely present communication challenges, and that caution will be needed to avoid sending unintended signals about the Committee’s policy outlook. Committee Policy Action In their discussion of monetary policy for the period ahead, members judged that information received since the FOMC met in July indicated that economic activity was expanding at a moderate pace. Household spending appeared to be rising moderately, and business fixed investment was advancing, while the recovery in the housing sector remained slow. Fiscal policy was restraining economic growth, although the extent of restraint was diminishing and would soon be quite small. Inflation was running below the Committee’s longer-run objective, but longer-term inflation expectations were stable. The Committee expected that, with appropriate policy accommodation, economic activity would expand at a moderate pace, with labor market indicators and inflation moving toward levels that the Committee judges consistent with its dual mandate. With incoming information continuing to broadly support the Committee’s expectation of ongoing improvement in labor market conditions and inflation moving back toward the Committee’s 2 percent objective, members agreed that a further measured reduction in the pace of asset purchases was appropriate at this meeting. Accordingly, the Committee agreed that, beginning in October, it would add to its holdings of agency MBS at a pace of $5 billion per month rather than $10 billion per month, and it would add to its holdings of longer-term Treasury securities at a pace of $10 billion per month rather than $15 billion per month. The Committee judged that, if incoming information broadly supported its expectations that labor market indicator and inflation would continue to move toward mandateconsistent levels, it would end its current program of asset purchases at its October meeting. Members discussed their assessments of progress toward the Committee’s objectives of maximum employment and 2 percent inflation and considered possible enhancements to the statement that would more clearly communicate the Committee’s view on such progress. Regarding the labor market, many members indicated that, although labor market conditions had generally continued to improve, there was still significant slack in labor markets. A few members, however, expressed reservations about continuing to characterize the extent of underutilization of labor resources as significant. In the end, members agreed to indicate that labor market conditions had improved somewhat further, but that the unemployment rate was little changed and a range of labor market indicators continued to suggest that there remained significant underutilization of labor resources. It was noted, however, that the characterization of labor market underutilization might have to be changed if progress in the labor market continued. Regarding inflation, members agreed that inflation had moved closer to the Committee’s 2 percent objective during the first half of the year but, more recently, had fallen back somewhat. As a consequence, they updated the language in the statement to indicate that inflation had been running below the Committee’s longer-run objective. However, with stable longer-term inflation expectations, the Committee continued to judge that the likelihood of inflation running persistently below 2 percent had diminished somewhat since early in the year. After the discussion, all members but two voted to maintain the Committee’s target range for the federal funds rate and to reiterate its forward guidance about the federal funds rate. The guidance continued to state that the Committee’s decisions about how long to maintain the current target range for the federal funds rate would depend on its assessment of actual and expected progress toward its objectives of maximum employment and 2 percent inflation. The Committee again anticipated that it likely would be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continued to run below the Committee’s Minutes of Federal Open Market Committee Meetings | September 2 percent longer-run goal, and provided that longerterm inflation expectations remained well anchored. The forward guidance also reiterated the Committee’s expectation that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run. Two members, however, dissented because, in their view, the statement language did not accurately reflect the progress made to date toward the Committee’s goals of maximum employment and inflation of 2 percent, and they believed that ongoing progress will likely warrant an earlier increase in the federal funds rate than suggested by the forward guidance in the Committee’s postmeeting statement. 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 SOMA in accordance with the following domestic policy directive: “Consistent with its statutory mandate, the Federal Open Market Committee seeks monetary and financial conditions that will foster maximum employment and price stability. In particular, 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 undertake open market operations as necessary to maintain such conditions. Beginning in October, the Desk is directed to purchase longer-term Treasury securities at a pace of about $10 billion per month and to purchase agency mortgage-backed securities at a pace of about $5 billion per month. The Committee also directs the Desk to engage in dollar roll and coupon swap transactions as necessary to facilitate settlement of the Federal Reserve’s agency mortgage-backed securities transactions. The Committee directs the Desk to maintain its policy of rolling over maturing Treasury securities into new issues and its policy of reinvesting principal payments on all agency debt and agency mortgage-backed securities in agency mortgage-backed securities. 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.” 233 The vote encompassed approval of the statement below to be released at 2:00 p.m.: “Information received since the Federal Open Market Committee met in July suggests that economic activity is expanding at a moderate pace. On balance, labor market conditions improved somewhat further; however, the unemployment rate is little changed and a range of labor market indicators suggests that there remains significant underutilization of labor resources. Household spending appears to be rising moderately and business fixed investment is advancing, while the recovery in the housing sector remains slow. Fiscal policy is restraining economic growth, although the extent of restraint is diminishing. Inflation has been running below the Committee’s longer-run objective. 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 that, with appropriate policy accommodation, economic activity will expand at a moderate pace, with labor market indicators and inflation moving toward levels the Committee judges consistent with its dual mandate. The Committee sees the risks to the outlook for economic activity and the labor market as nearly balanced and judges that the likelihood of inflation running persistently below 2 percent has diminished somewhat since early this year. The Committee currently judges that there is sufficient underlying strength in the broader economy to support ongoing improvement in labor market conditions. In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions since the inception of the current asset purchase program, the Committee decided to make a further measured reduction in the pace of its asset purchases. Beginning in October, the Committee will add to its holdings of agency mortgage-backed securities at a pace of $5 billion per month rather than $10 billion per month, and will add to its holdings of longerterm Treasury securities at a pace of $10 billion per month rather than $15 billion per month. The Committee is maintaining its existing policy of reinvesting principal payments from its hold- 234 101st Annual Report | 2014 ings of agency debt and agency mortgagebacked securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. The Committee’s sizable and still-increasing holdings of longer-term securities should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee’s dual mandate. The Committee will closely monitor incoming information on economic and financial developments in coming months and will continue its purchases of Treasury and agency mortgagebacked securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability. If incoming information broadly supports the Committee’s expectation of ongoing improvement in labor market conditions and inflation moving back toward its longer-run objective, the Committee will end its current program of asset purchases at its next meeting. However, asset purchases are not on a preset course, and the Committee’s decisions about their pace will remain contingent on the Committee’s outlook for the labor market and inflation as well as its assessment of the likely efficacy and costs of such purchases. To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy remains appropriate. In determining how long to maintain the current 0 to ¼ percent target range for the federal funds rate, the Committee will assess progress—both realized and expected— toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the Committee’s 2 percent longerrun goal, and provided that longer-term inflation expectations remain well anchored. When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent. The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.” Voting for this action: Janet L. Yellen, William C. Dudley, Lael Brainard, Stanley Fischer, Narayana Kocherlakota, Loretta J. Mester, Jerome H. Powell, and Daniel K. Tarullo. Voting against this action: Richard W. Fisher and Charles I. Plosser. President Fisher dissented because he believed that the continued strengthening of the real economy, the improved outlook for labor utilization and for general price stability, and continued signs of financial market excess will likely warrant an earlier reduction in monetary accommodation than is suggested by the Committee’s stated forward guidance. Mr. Plosser dissented because he objected to the statement’s guidance indicating that it likely will be appropriate to maintain the current target range for the federal funds rate for “a considerable time after the asset purchase program ends.” In his view, the reference to calendar time should be replaced with language that indicates how monetary policy will respond to incoming data. Moreover, he judged that the statement did not acknowledge the substantial progress that had been made toward the Committee’s economic goals and thus risks unnecessary and disruptive volatility in financial markets, and perhaps in the economy, if the Committee reduces accommodation sooner or more quickly than financial markets anticipate. It was agreed that the next meeting of the Committee would be held on Tuesday–Wednesday, October 28– 29, 2014. The meeting adjourned at 10:35 a.m. on September 17, 2014. Minutes of Federal Open Market Committee Meetings | September Notation Vote pant’s assessment of the value 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 each participant deems most likely to foster outcomes for economic activity and inflation that best satisfy his or her individual interpretation of the Federal Reserve’s objectives of maximum employment and stable prices. By notation vote completed on August 19, 2014, the Committee unanimously approved the minutes of the Committee meeting held on July 29–30, 2014. William B. English Secretary Addendum: Summary of Economic Projections Overall, FOMC participants expected that, under appropriate monetary policy, economic growth would be faster in the second half of 2014 and in 2015 than their estimates of the U.S. economy’s longer-run normal growth rate. Participants then saw real growth moving back slowly toward its longer-run rate in 2016 and 2017. The unemployment rate was projected to continue to decline gradually over the forecast period, and to be at or below participants’ individual judgments of its longer-run normal level by the end of 2017 (table 1 and figure 1). Almost all participants projected that inflation, as measured by the four-quarter change in the price index for personal consumption expenditures (PCE), would rise gradually over the next few years, reaching a level at or near the Committee’s 2 percent objective in 2016 or 2017. In conjunction with the September 16–17, 2014, Federal Open Market Committee (FOMC) meeting, meeting participants submitted their projections of real output growth, the unemployment rate, inflation, and the federal funds rate for each year from 2014 through 2017 and in the longer run.5 Each participant’s projection was based on information available at the time of the meeting plus his or her assessment of appropriate monetary policy and assumptions about the factors likely to affect economic outcomes. The longer-run projections represent each partici5 235 As discussed in its Policy Normalization Principles and Plans, released on September 17, 2014, the Committee intends to target a range for the federal funds rate during normalization. Participants were asked to provide, in their contributions to the Summary of Economic Projections, either the midpoint of the target range for the federal funds rate for any period when a range was anticipated or the target level for the federal funds rate, as appropriate. In the lower panel of figure 2, these values have been rounded to the nearest ⅛ percentage point. Participants judged that it would be appropriate to begin adjusting the current highly accommodative stance of policy over the projection period as labor Table 1. Economic projections of Federal Reserve Board members and Federal Reserve Bank presidents, September 2014 Percent Central tendency1 Range2 Variable Change in real GDP June projection Unemployment rate June projection PCE inflation June projection Core PCE inflation3 June projection 2014 2015 2016 2017 Longer run 2014 2015 2016 2017 Longer run 2.0 to 2.2 2.1 to 2.3 5.9 to 6.0 6.0 to 6.1 1.5 to 1.7 1.5 to 1.7 1.5 to 1.6 1.5 to 1.6 2.6 to 3.0 3.0 to 3.2 5.4 to 5.6 5.4 to 5.7 1.6 to 1.9 1.5 to 2.0 1.6 to 1.9 1.6 to 2.0 2.6 to 2.9 2.5 to 3.0 5.1 to 5.4 5.1 to 5.5 1.7 to 2.0 1.6 to 2.0 1.8 to 2.0 1.7 to 2.0 2.3 to 2.5 n.a. 4.9 to 5.3 n.a. 1.9 to 2.0 n.a. 1.9 to 2.0 n.a. 2.0 to 2.3 2.1 to 2.3 5.2 to 5.5 5.2 to 5.5 2.0 2.0 1.8 to 2.3 1.9 to 2.4 5.7 to 6.1 5.8 to 6.2 1.5 to 1.8 1.4 to 2.0 1.5 to 1.8 1.4 to 1.8 2.1 to 3.2 2.2 to 3.6 5.2 to 5.7 5.2 to 5.9 1.5 to 2.4 1.4 to 2.4 1.6 to 2.4 1.5 to 2.4 2.1 to 3.0 2.2 to 3.2 4.9 to 5.6 5.0 to 5.6 1.6 to 2.1 1.5 to 2.0 1.7 to 2.2 1.6 to 2.0 2.0 to 2.6 n.a. 4.7 to 5.8 n.a. 1.7 to 2.2 n.a. 1.8 to 2.2 n.a. 1.8 to 2.6 1.8 to 2.5 5.0 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 June projections were made in conjunction with the meeting of the Federal Open Market Committee on June 17–18, 2014. 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. 236 101st Annual Report | 2014 Figure 1. Central tendencies and ranges of economic projections, 2014–17 and over the longer run Percent Change in real GDP 4 Central tendency of projections Range of projections 3 2 1 + 0 - Actual 2009 2010 2011 2012 2013 2014 2015 2016 2017 Longer run Percent Unemployment rate 10 9 8 7 6 5 2009 2010 2011 2012 2013 2014 2015 2016 2017 Longer run Percent PCE inflation 3 2 1 2009 2010 2011 2012 2013 2014 2015 2016 2017 Longer run Percent Core PCE inflation 3 2 1 2009 2010 2011 2012 2013 2014 2015 Note: Definitions of variables are in the general note to table 1. The data for the actual values of the variables are annual. 2016 2017 Longer run Minutes of Federal Open Market Committee Meetings | September market indicators and inflation move back toward values the Committee judges consistent with the attainment of its mandated objectives of maximum employment and stable prices. As shown in figure 2, all but a few participants anticipated that it would be appropriate to begin raising the target range for the federal funds rate in 2015, with most projecting that it will be appropriate to raise the target federal funds rate fairly gradually. Consistent with the improvement in the outlook for the labor market since the Committee began its current asset purchase program in September 2012, as well as participants’ expectation of ongoing improvement in labor market conditions and inflation moving back toward their longerrun objective, all participants judged that it would be appropriate to complete the asset purchase program in October of this year. Most participants saw the uncertainty associated with their outlooks for economic growth, the unemployment rate, and inflation as similar to that of the past 20 years, although a few judged it as somewhat higher. In addition, most participants considered the risks to the outlook for real gross domestic product (GDP) growth and the unemployment rate to be broadly balanced, and a substantial majority saw the risks to inflation as broadly balanced. However, a few participants, on net, saw the risks to their forecasts for economic growth or inflation as tilted to the downside. The Outlook for Economic Activity Participants generally projected that, conditional on their individual assumptions about appropriate monetary policy, economic growth would pick up from its low level in the first half of the year and run above their estimates of the longer-run normal rate of economic growth in the second half of 2014 and in 2015. Participants pointed to a number of factors that they expected would contribute to a pickup in economic growth in the second half of this year and next year, including rising household net worth, diminished restraint from fiscal policy, improving labor market conditions, and highly accommodative monetary policy. In general, participants then saw real growth moving gradually back toward, but remaining at or somewhat above, its longer-run rate in 2016 and 2017. Many participants revised down their projections of real GDP growth somewhat in one or more years and particularly for 2015, compared with their projections in June. Participants pointed to a couple of fac- 237 tors leading them to mark down their projected paths for real GDP growth including the incorporation of weaker-than-expected data on consumer spending and perceptions of slower growth in potential GDP. The central tendencies of participants’ projections for real GDP growth in their most recent projections were 2.0 to 2.2 percent in 2014, 2.6 to 3.0 percent in 2015, 2.6 to 2.9 percent in 2016, and 2.3 to 2.5 percent in 2017. The central tendency of the projections of real GDP growth over the longer run was 2.0 to 2.3 percent, essentially the same as in June. Participants anticipated that the unemployment rate would continue to decline gradually over the forecast period and, by the fourth quarter of 2017, would be close to or below their individual assessments of its longer-run normal level. The central tendencies of participants’ forecasts for the unemployment rate in the fourth quarter of each year were 5.9 to 6.0 percent in 2014, 5.4 to 5.6 percent in 2015, 5.1 to 5.4 percent in 2016, and 4.9 to 5.3 percent in 2017. Participants’ projected paths for the unemployment rate were slightly lower than in June, with many participants citing lower-than-expected incoming unemployment data. The central tendency of participants’ estimates of the longer-run normal rate of unemployment that would prevail under appropriate monetary policy and in the absence of further shocks to the economy was unchanged at 5.2 to 5.5 percent. Figures 3.A and 3.B show that participants held a range of views regarding the likely outcomes for real GDP growth and the unemployment rate through 2017. The diversity of views reflected their individual assessments of the rate at which the forces that have been restraining the pace of the economic recovery would abate, of the anticipated path for foreign economic activity, of the trajectory for growth in consumption as labor market slack diminishes, and of the appropriate path of monetary policy. Relative to June, the dispersions of participants’ projections for real GDP growth and for the unemployment rate over the entire projection period were little changed. The Outlook for Inflation Compared with June, the central tendencies of participants’ projections for inflation under the assumption of appropriate policy were largely unchanged for 2014 to 2016, and the trends anticipated over that period were generally expected to continue in 2017. Almost all participants projected that PCE inflation would rise gradually over the next few years to a level at or near the Committee’s 2 percent objective. A few 238 101st Annual Report | 2014 Figure 2. Overview of FOMC participants’ assessments of appropriate monetary policy Number of participants Appropriate timing of policy firming 15 14 14 13 12 11 10 9 8 7 6 5 4 3 2 2 1 1 2014 2015 2016 Percent Appropriate pace of policy firming: Midpoint of target range or target level for the federal funds rate 5 4.5 4 3.5 3 2.5 2 1.5 1 0.5 0 2014 2015 2016 2017 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 range for the federal funds rate from its current range of 0 to ¼ percent will occur in the specified calendar year. In June 2014, the numbers of FOMC participants who judged that the first increase in the target federal funds rate would occur in 2014, 2015, and 2016 were, respectively, 1, 12, and 3. In the lower panel, each shaded circle indicates the value (rounded to the nearest ⅛ percentage point) of an individual participant’s judgment of the midpoint of the appropriate target range for the federal funds rate or the appropriate target level for the federal funds rate at the end of the specified calendar year or over the longer run. Minutes of Federal Open Market Committee Meetings | September 239 Figure 3.A. Distribution of participants’ projections for the change in real GDP, 2014–17 and over the longer run Number of participants 2014 18 16 14 12 10 8 6 4 2 September projections June projections 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 Percent range Number of participants 2015 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 Percent range Number of participants 2016 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 Percent range Number of participants 2017 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 Percent range Number of participants Longer run 1.8 1.9 18 16 14 12 10 8 6 4 2 2.0 2.1 2.2 2.3 2.4 2.5 2.6 2.7 2.8 2.9 Percent range Note: Definitions of variables are in the general note to table 1. 3.0 3.1 3.2 3.3 3.4 3.5 3.6 3.7 240 101st Annual Report | 2014 Figure 3.B. Distribution of participants’ projections for the unemployment rate, 2014–17 and over the longer run Number of participants 2014 18 16 14 12 10 8 6 4 2 September projections June projections 4.6 4.7 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 Percent range Number of participants 2015 18 16 14 12 10 8 6 4 2 4.6 4.7 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 Percent range Number of participants 2016 18 16 14 12 10 8 6 4 2 4.6 4.7 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 Percent range Number of participants 2017 18 16 14 12 10 8 6 4 2 4.6 4.7 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 Percent range Number of participants Longer run 4.6 4.7 18 16 14 12 10 8 6 4 2 4.8 4.9 5.0 5.1 5.2 5.3 5.4 5.5 Percent range Note: Definitions of variables are in the general note to table 1. 5.6 5.7 5.8 5.9 6.0 6.1 6.2 6.3 Minutes of Federal Open Market Committee Meetings | September participants expected PCE inflation to rise somewhat above 2 percent at some point during the forecast period, while several others expected inflation to remain below 2 percent even at the end of 2017. The central tendencies for PCE inflation were 1.5 to 1.7 percent in 2014, 1.6 to 1.9 percent in 2015, 1.7 to 2.0 percent in 2016, and 1.9 to 2.0 percent in 2017. The central tendencies of the forecasts for core inflation were broadly similar to those for the headline measure. It was noted that a combination of factors—including stable inflation expectations, steadily diminishing resource slack, a pickup in wage growth, a gradual decline in the foreign exchange value for the dollar, and still-accommodative monetary policy—was likely to contribute to a gradual rise of inflation back toward the Committee’s longer-run objective of 2 percent. Figures 3.C and 3.D provide information on the diversity of participants’ views about the outlook for inflation. The ranges of participants’ projections for inflation in 2014, 2015, and 2016 were little changed relative to June. The range in 2017 shows a very substantial concentration near the Committee’s 2 percent longer-run objective by that time. Appropriate Monetary Policy Participants judged that it would be appropriate to begin reducing policy accommodation over the projection period as labor market indicators and inflation move back toward values the Committee judges consistent with the attainment of its mandated objectives of maximum employment and price stability. As shown in figure 2, all but a few participants anticipated that it would be appropriate to begin raising the target range for the federal funds rate in 2015, and most projected that the appropriate level of the federal funds rate would remain below its longer-run normal level through 2016. Most participants expected the appropriate level of the federal funds rate would be approaching, or would already have reached, their individual view of its longer-run normal level by the end of 2017. All participants projected that the unemployment rate would be below 5.75 percent at the end of the year in which they judged the initial increase in the target range for the federal funds rate would be warranted, and all but one anticipated that inflation would be at or below the Committee’s 2 percent goal at that time. Most participants projected that the unemployment rate would be above their estimates of its longer-run normal level at the end of the year in 241 which they saw the target range for the federal funds rate increasing from its effective lower bound, although all but one thought that, by the end of 2016, the unemployment rate would be at or below their individual judgments of its longer-run normal rate. Figure 3.E provides the distribution of participants’ judgments regarding the appropriate level of the target federal funds rate at the end of each calendar year from 2014 to 2017 and over the longer run. As noted earlier, nearly all participants judged that economic conditions would warrant maintaining the current exceptionally low level of the federal funds rate into 2015. Relative to their projections in June, the median values of the federal funds rate at the end of 2015 and 2016 increased 26 basis points and 38 basis points to 1.38 percent and 2.88 percent, respectively, while the mean values rose 10 basis points and 16 basis points to 1.28 percent and 2.69 percent, respectively. The dispersion of projections for the appropriate level of the federal funds rate was little changed in 2015 and 2016. Most participants judged that it would be appropriate to set the federal funds rate at or near its longer-run normal level in 2017, though some projected that the federal funds rate would still need to be set appreciably below its longer-run normal level, and one anticipated that it would be appropriate to target a level noticeably above its longer-run normal level. Participants provided a number of reasons why they thought it would be appropriate for the federal funds rate to remain below its longer-run normal level for some time after inflation and unemployment were near mandateconsistent levels. These reasons included an assessment that headwinds holding back the recovery will continue to exert restraint on economic activity at that time and that the risks to the economic outlook are asymmetric as a result of the constraints on monetary policy caused by the effective lower bound on the federal funds rate. As in June, estimates of the longer-run level of the federal funds rate ranged from 3.25 to about 4.25 percent. All participants judged that inflation in the longer run would be equal to the Committee’s inflation objective of 2 percent, implying that their individual judgments regarding the appropriate longer-run level of the real federal funds rate in the absence of further shocks to the economy ranged from 1.25 to about 2.25 percent. Participants also described their views regarding the appropriate path of the Federal Reserve’s balance 242 101st Annual Report | 2014 Figure 3.C. Distribution of participants’ projections for PCE inflation, 2014–17 and over the longer run Number of participants 2014 September projections June projections 1.3 1.4 1.5 1.6 1.7 1.8 1.9 2.0 2.1 2.2 18 16 14 12 10 8 6 4 2 2.3 2.4 Percent range Number of participants 2015 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 2016 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 2017 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 Longer run 1.3 1.4 18 16 14 12 10 8 6 4 2 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 243 Figure 3.D. Distribution of participants’ projections for core PCE inflation, 2014–17 Number of participants 2014 September projections June 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 2.3 2.4 Percent range Number of participants 2015 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 2016 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 2017 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 2.4 244 101st Annual Report | 2014 Figure 3.E. Distribution of participants’ judgments of the midpoint of the appropriate target range for the federal funds rate or the appropriate target level for the federal funds rate, 2014–17 and over the longer run Number of participants 2014 18 16 14 12 10 8 6 4 2 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 4.38 4.62 Percent range Number of participants 2015 0.00 0.37 18 16 14 12 10 8 6 4 2 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 2016 0.00 0.37 18 16 14 12 10 8 6 4 2 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 2017 0.00 0.37 18 16 14 12 10 8 6 4 2 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 0.00 0.37 0.38 0.62 18 16 14 12 10 8 6 4 2 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 Note: The midpoints of the target ranges for the federal funds rate and the target levels for the federal funds rate are measured at the end of the specified calendar year or over the longer run. Minutes of Federal Open Market Committee Meetings | September sheet. Conditional on their respective economic outlooks, all participants judged that it likely would be appropriate to conclude asset purchases in October of this year. A few participants thought that it would be appropriate to begin reducing the size of the balance sheet relatively soon, with a couple of them judging that the Committee should reduce or cease the reinvestment of principal payments on securities held in the Federal Reserve’s portfolio. Participants’ views of the appropriate path for monetary policy were informed by their judgments about the state of the economy, including the values of the unemployment rate and other labor market indicators that would be consistent with maximum employment, the extent to which the economy was currently falling short of maximum employment, the prospects for inflation to return to the Committee’s longerterm objective of 2 percent, the desire to minimize potential disruption in financial markets, and the balance of risks around the outlook. Many participants also mentioned the prescriptions of various monetary policy rules as factors they considered in judging the appropriate path for the federal funds rate. 245 Table 2. Average historical projection error ranges Percentage points Variable Change in real GDP1 Unemployment rate1 Total consumer prices2 2014 2015 2016 2017 ±1.3 ±0.3 ±0.8 ±1.9 ±1.0 ±1.0 ±2.1 ±1.6 ±1.1 ±2.2 ±1.9 ±1.0 Note: Error ranges shown are measured as plus or minus the root mean squared error of projections for 1994 through 2013 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. For more information, see 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), available at www.federalreserve.gov/ pubs/feds/2007/200760/200760abs.html; and Board of Governors of the Federal Reserve System, Division of Research and Statistics (2014), “Updated Historical Forecast Errors,” memorandum, April 9, www.federalreserve.gov/foia/files/ 20140409-historical-forecast-errors.pdf. 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. the outlook for the unemployment rate to be broadly balanced. Uncertainty and Risks A significant majority of participants continued to judge the levels of uncertainty about their projections for real GDP growth and the unemployment rate as broadly similar to the norms during the previous 20 years (figure 4).6 Most participants continued to judge the risks to their outlooks for real GDP growth and the unemployment rate to be broadly balanced. A few participants viewed the risks to real GDP growth as weighted to the downside; one viewed the risks as weighted to the upside. Those participants who viewed risks as weighted to the downside cited, for example, concern about the limited ability of monetary policy at the effective lower bound to respond to further negative shocks to the economy. As in June, nearly all participants judged the risks to 6 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 1994 through 2013. 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. Participants generally saw the level of uncertainty and the balance of risks around their forecasts for overall PCE inflation and core inflation as little changed from June. Most participants continued to judge the levels of uncertainty associated with their forecasts for the two inflation measures to be broadly similar to historical norms, and most continued to see the risks to those projections as broadly balanced. Several participants, however, viewed the risks to their inflation forecasts as tilted to the downside, reflecting, for example, the possibility that the recent low levels of inflation could prove more persistent than anticipated; the possibility that the upward pull on prices from inflation expectations might be weaker than assumed; the current lack of inflationary pressures domestically or from abroad; and the judgment that, in current circumstances, it would be difficult for the Committee to respond effectively to low-inflation outcomes. Conversely, one participant saw upside risks to inflation, citing uncertainty about the timing and efficacy of the Committee’s withdrawal of monetary policy accommodation. 246 101st Annual Report | 2014 Figure 4. Uncertainty and risks in economic projections Number of participants Number of participants Risks to GDP growth Uncertainty about GDP growth September projections June projections Lower 18 16 14 12 10 8 6 4 2 Broadly similar September projections June projections Weighted to downside Higher Broadly balanced Number of participants 18 16 14 12 10 8 6 4 2 Weighted to upside Number of participants Risks to the unemployment rate Uncertainty about the unemployment rate 18 16 14 12 10 8 6 4 2 18 16 14 12 10 8 6 4 2 Lower Broadly similar Weighted to downside Higher Broadly balanced Number of participants Weighted to upside Number of participants Uncertainty about PCE inflation Risks to PCE inflation 18 16 14 12 10 8 6 4 2 Lower Broadly similar 18 16 14 12 10 8 6 4 2 Weighted to downside Higher Broadly balanced Number of participants Weighted to upside Number of participants Uncertainty about core PCE inflation Risks to core PCE inflation 18 16 14 12 10 8 6 4 2 Lower Broadly similar Higher 18 16 14 12 10 8 6 4 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. Minutes of Federal Open Market Committee Meetings | September 247 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, 1.1 to 4.9 percent in the second year, 0.9 to 5.1 percent in the third year, and 0.8 to 5.2 percent in the fourth 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, 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. 248 101st Annual Report | 2014 Meeting Held on October 28–29, 2014 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 28, 2014, at 1:00 p.m. and continued on Wednesday, October 29, 2014, at 9:00 a.m. Present Janet L. Yellen Chair William C. Dudley Vice Chairman Lael Brainard Stanley Fischer Richard W. Fisher Narayana Kocherlakota Loretta J. Mester Charles I. Plosser Jerome H. Powell Daniel K. Tarullo Christine Cumming, Charles L. Evans, Jeffrey M. Lacker, Dennis P. Lockhart, and John C. Williams Alternate Members of the Federal Open Market Committee James Bullard, Esther L. George, and Eric Rosengren Presidents of the Federal Reserve Banks of St. Louis, Kansas City, and Boston, respectively William B. English Secretary and Economist Matthew M. Luecke Deputy 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 James A. Clouse, Thomas A. Connors, Evan F. Koenig, Thomas Laubach, Samuel Schulhofer-Wohl, and William Wascher Associate Economists Simon Potter Manager, System Open Market Account Lorie K. Logan Deputy Manager, System Open Market Account Robert deV. Frierson1 Secretary of the Board, Office of the Secretary, Board of Governors 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 Stephen A. Meyer and William R. Nelson Deputy Directors, Division of Monetary Affairs, Board of Governors Andrew Figura, David Reifschneider, and Stacey Tevlin Special Advisers to the Board, Office of Board Members, Board of Governors Trevor A. Reeve Special Adviser to the Chair, Office of Board Members, Board of Governors Linda Robertson Assistant to the Board, Office of Board Members, Board of Governors Christopher J. Erceg Senior Associate Director, Division of International Finance, Board of Governors Ellen E. Meade and Joyce K. Zickler Senior Advisers, Division of Monetary Affairs, Board of Governors Eric M. Engen and David E. Lebow Associate Directors, Division of Research and Statistics, Board of Governors Fabio M. Natalucci1 Associate Director, Division of Monetary Affairs, Board of Governors 1 Attended the joint session of the Federal Open Market Committee and the Board of Governors. Minutes of Federal Open Market Committee Meetings | October Joseph W. Gruber Deputy Associate Director, Division of International Finance, Board of Governors John J. Stevens2 Deputy Associate Director, Division of Research and Statistics, Board of Governors Steven A. Sharpe Assistant Director, Division of Research and Statistics, Board of Governors Patrick E. McCabe1 Adviser, Division of Research and Statistics, Board of Governors Robert J. Tetlow3 Adviser, Division of Monetary Affairs, Board of Governors Penelope A. Beattie1 Assistant to the Secretary, Office of the Secretary, Board of Governors Christopher J. Gust Section Chief, Division of Monetary Affairs, Board of Governors David H. Small Project Manager, Division of Monetary Affairs, Board of Governors Katie Ross1 Manager, Office of the Secretary, Board of Governors Canlin Li Senior Economist, Division of Monetary Affairs, Board of Governors Randall A. Williams Records Project Manager, Division of Monetary Affairs, Board of Governors Helen E. Holcomb First Vice President, Federal Reserve Bank of Dallas David Altig, Jeff Fuhrer, James J. McAndrews, and Glenn D. Rudebusch Executive Vice Presidents, Federal Reserve Banks of Atlanta, Boston, New York, and San Francisco, respectively 2 3 Attended the portion of the meeting following the joint session of the Federal Open Market Committee and the Board of Governors. Attended the discussion of longer-run goals and monetary policy strategy. 249 Troy Davig, Michael Dotsey, Joshua L. Frost,1 Spencer Krane, and Christopher J. Waller Senior Vice Presidents, Federal Reserve Banks of Kansas City, Philadelphia, New York, Chicago, and St. Louis, respectively Todd E. Clark and Douglas Tillett Vice Presidents, Federal Reserve Banks of Cleveland and Chicago, respectively Andreas L. Hornstein Senior Advisor, Federal Reserve Bank of Richmond Developments in Financial Markets and the Federal Reserve’s Balance Sheet In a joint session of the Federal Open Market Committee (FOMC) and the Board of Governors of the Federal Reserve System, the deputy manager of the System Open Market Account (SOMA) reported on developments in domestic and foreign financial markets as well as System open market operations conducted during the period since the Committee met on September 16–17, 2014. In addition, the deputy manager summarized the outcomes of recent test operations of the Term Deposit Facility, described the results from the overnight reverse repurchase agreement (ON RRP) operational exercise, and reviewed the implications of recent foreign central bank policy actions for the international portion of the SOMA portfolio. The SOMA manager then discussed the Open Market Desk’s plans for modestly expanding the list of counterparties eligible to participate in ON RRP operations based on substantially the same criteria established in the past for such counterparties. The manager also described ongoing staff work on improving data collections regarding bank funding markets and possibly using those data to provide more robust measures of bank funding rates. Finally, the manager reported on potential arrangements that would allow depository institutions to pledge funds held in a segregated account at the Federal Reserve as collateral in borrowing transactions with private creditors and would provide an additional supplementary tool during policy normalization; the manager noted possible next steps that the staff could potentially undertake to investigate the issues related to such arrangements. Next, the staff outlined two proposals that the Committee could consider for further testing of RRP operations. In the first proposal, the Desk would vary by modest amounts the interest rate on ON RRP operations according to a preannounced schedule. Varying the spread between the ON RRP rate and 250 101st Annual Report | 2014 the interest on excess reserves rate could provide the Committee with information about the effect of that spread on money markets and the demand for ON RRP. In addition, changes in the ON RRP rate would provide further information about the effectiveness of an ON RRP facility in providing a floor for money market rates during policy normalization. In the second proposal, the Desk would conduct a series of preannounced term RRP operations that would extend across the end of the year. In their discussion of term RRP testing, participants noted that the testing could provide information about the potential effectiveness of another of the Committee’s supplementary policy tools and would help address expected downward pressures on short-term rates at year-end. But it was also noted that by conducting the term RRPs, the Committee would be losing information on how market participants might adjust and make investment arrangements prior to year-end with only the $300 billion in ON RRP available. One participant commented that the downward pressure on rates at year-end might be more directly addressed by raising the overall size limit on the ON RRP exercise. However, it was emphasized that increasing the cap on ON RRP operations at year-end could raise the risks for financial markets that had led the FOMC to impose the cap; these concerns were seen as less pronounced with a temporary program of term RRP operations. It was also noted that the proposed term RRP operations were only a test and that the Committee had not yet decided the conditions under which such operations would be used in the future.4 Following the discussion of the testing of RRP operations, the Committee unanimously approved the following resolution on the ON RRP exercise: “The Federal Open Market Committee (FOMC) modifies the authorization concerning overnight reverse repurchase operations adopted at the September 17, 2014, FOMC meeting as follows: (i) The offering rate of the operations may vary from zero to ten basis points. This modification shall be effective beginning with the operation conducted on November 3, 2014, and conclude with the operation conducted on December 12, 2014.” 4 Following the conclusion of the meeting, the Desk released a statement outlining the planned ON RRP and term RRP exercises. By unanimous vote, the Committee approved the following resolution on term RRP operations: “During the period of December 1, 2014, to December 30, 2014, the Federal Open Market Committee (FOMC) authorizes the Federal Reserve Bank of New York to conduct a series of term reverse repurchase operations involving U.S. Government securities. Such operations shall: (i) mature no later than January 5, 2015; (ii) be subject to an overall size limit of $300 billion outstanding at any one time; (iii) be subject to a maximum bid rate of ten basis points; (iv) be awarded to all submitters: (A) at the highest submitted rate if the sum of the bids received is less than or equal to the preannounced size of the operation, or (B) at the stopout rate, determined by evaluating bids in ascending order by submitted rate up to the point at which the total quantity of bids equals the preannounced size of the operation, with all bids below this rate awarded in full at the stopout rate and all bids at the stopout rate awarded on a pro rata basis, if the sum of the counterparty offers received is greater than the preannounced size of the operation. Such operations may be for forward settlement. The System Open Market Account manager will inform the FOMC in advance of the terms of the planned operations. The Chair must approve the terms of, timing of the announcement of, and timing of the operations. These operations shall be conducted in addition to the authorized overnight reverse repurchase agreements, which remain subject to a separate overall size limit of $300 billion per day.” 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. The Board meeting concluded at the end of the discussion of developments in financial markets and the Federal Reserve’s balance sheet. Staff Review of the Economic Situation The information reviewed for the October 28–29 meeting indicated that economic activity expanded at a moderate pace in the third quarter and that labor market conditions improved over the intermeeting period. Consumer price inflation continued to run below the FOMC’s longer-run objective of 2 percent. Minutes of Federal Open Market Committee Meetings | October 251 Market-based measures of inflation compensation declined somewhat, while survey-based measures of longer-term inflation expectations remained stable. up in August, and sales of existing single-family homes moved essentially sideways over the past several months. Total nonfarm payroll employment rose in September and the gains for July and August were revised up, leaving the average increase in the third quarter similar to that for the first half of the year. In September, the unemployment rate declined to 5.9 percent, and the share of workers employed part time for economic reasons decreased a little. The labor force participation rate edged down, and the employment-to-population ratio remained essentially unchanged. Other indicators generally suggested a continued improvement in labor market conditions. Although the rate of gross private-sector hiring declined, the rate of job openings moved up, measures of firms’ hiring plans increased, initial claims for unemployment insurance remained low, and some measures of household expectations for labor market conditions improved. Real spending on business equipment and intellectual property products appeared to have risen at a moderate pace in the third quarter. Nominal shipments of nondefense capital goods excluding aircraft were little changed, on net, in August and September after a solid increase in July. New orders for these capital goods declined in September but remained above the level of shipments, indicating that shipments may increase further in subsequent months. Other forward-looking indicators, such as national and regional surveys of business conditions, were generally consistent with moderate gains in business equipment spending in the near term. Nominal business spending for new nonresidential construction decreased in August, and vacancy rates for nonresidential buildings remained elevated. Meanwhile, inventories in most industries were about in line with sales; in the energy sector, inventories appeared somewhat lean despite substantial stockbuilding since earlier in the year. Industrial production increased briskly in September after having been little changed, on net, over the first two months of the quarter, and the rate of capacity utilization in the manufacturing sector moved up. Readings on new orders from the national and regional manufacturing surveys were generally consistent with moderate near-term increases in factory output, but automakers’ production schedules for the fourth quarter pointed to some slowing in the pace of motor vehicle assemblies. Real personal consumption expenditures (PCE) appeared to have increased at a modest pace in the third quarter. The components of the nominal retail sales data used by the Bureau of Economic Analysis to construct its estimates of PCE were, in total, little changed in September following solid gains in July and August. In addition, sales of light motor vehicles fell back in September following a steep increase in August. Recent data on factors that tend to support household spending were mixed. Real disposable income continued to increase in August, and consumer sentiment as measured by the Thomson Reuters/University of Michigan Surveys of Consumers improved in September and early October. In contrast, household net worth likely decreased because of a decline in equity prices. Housing market conditions seemed to be improving only slowly. Starts and permits of single-family homes were little changed, on net, in recent months. New home sales were flat in September after moving Total real government purchases appeared to have risen modestly in the third quarter. Federal government purchases likely increased, as nominal defense spending was higher in the third quarter than in the second quarter. In addition, real state and local government purchases probably rose somewhat, as the payrolls of these governments expanded and their nominal construction expenditures increased during the third quarter. The U.S. international trade deficit narrowed slightly in August. Following large increases in July, both exports and imports grew only modestly, with gains concentrated in capital goods excluding automotive products. Total U.S. consumer price inflation, as measured by the PCE price index, was about 1½ percent over the 12 months ending in August. Over the 12 months ending in September, both the consumer price index (CPI) and the CPI excluding food and energy prices rose about 1¾ percent. Consumer energy prices declined further in September, largely reflecting continued declines in retail gasoline prices, and survey data suggested gasoline prices fell further over the first few weeks of October. Consumer food prices rose solidly in recent months. Near-term inflation expectations from the Michigan survey declined in September and early October, while longer-term 252 101st Annual Report | 2014 inflation expectations in the survey were little changed. Foreign economies appeared to have continued to expand at a moderate rate in the third quarter, although with considerable divergence across countries. In Japan, consumption staged a mild rebound after contracting in the previous quarter in response to a tax increase, while indicators for the euro area pointed to only continued sluggish growth. Thirdquarter growth in real gross domestic product (GDP) remained healthy in the United Kingdom, and indicators for Canada also were positive. Among emerging market economies, GDP growth remained strong in the third quarter in China and Korea and indicators for Mexico were favorable as well. The Brazilian economy appeared to be stabilizing. Foreign inflation remained generally subdued and in some regions quite low, especially in the euro area, where headline inflation was well below 1 percent. Staff Review of the Financial Situation Concerns about the global economic outlook apparently helped to prompt a sharp pullback from risky assets in the United States, but prices of those assets subsequently reversed much of their declines by the end of the intermeeting period. In addition, a number of technical factors reportedly contributed to volatile interest rate moves in mid-October. Worries about a possible spread of Ebola also appeared to weigh on market sentiment somewhat at times. On net, yields on longer-term Treasury securities fell notably, U.S. equity prices edged down, corporate bond spreads widened modestly, and the dollar appreciated moderately against most other currencies. Federal Reserve communications were reportedly viewed as slightly more accommodative than anticipated, on balance. The expected path of the federal funds rate implied by market quotes shifted down notably, on net, over the period. Market-based measures suggested that the expected date of the first increase in the federal funds rate was pushed out from the third quarter of 2015 to late 2015. However, the results from the Desk’s October Survey of Primary Dealers indicated that the dealers’ projected path of the federal funds rate was little changed from the September survey, with dealers continuing to see the middle of next year as the most likely time of liftoff. The Treasury market experienced significant volatility on October 15, with 5- and 10-year Treasury yields dropping as much as 30 basis points in about an hour before retracing much of those moves by the end of the day. Amid very high trading volumes, Treasury market liquidity, as measured by bid–asked spreads, worsened significantly, and measures of the implied volatility of longer-term rates jumped on the day but subsequently fell back. While the release of the somewhat weaker-than-expected data for September U.S. retail sales was seen as the trigger for these sharp movements, market participants indicated that a number of technical factors related to investor positioning and trading strategies likely amplified the swing in interest rates. Over the intermeeting period as a whole, longer-term nominal Treasury yields declined about 30 basis points. Market-based measures of inflation compensation moved lower as well, extending the declines seen since the summer. The decline in inflation compensation reportedly reflected in part concerns about global growth and the risk of building disinflationary pressures, the lower-than-expected August CPI report, the decline in oil prices, and the appreciation of the U.S. dollar. Yields on agency mortgage-backed securities (MBS) declined roughly in line with comparable Treasury yields, while spreads on both investment- and speculative-grade corporate bonds widened modestly relative to Treasury securities. The S&P 500 index decreased about 1 percent, on net, over the intermeeting period. Option-implied volatility for the S&P 500 index over the next month increased moderately, on balance, ending the period below its long-run historical average, though during the mid-October volatility spike, it briefly touched high levels last seen in 2011. About half of the firms in the S&P 500 index reported earnings for the third quarter, with the reports generally viewed as positive. Overall, third-quarter earnings estimates continued to imply modest growth in earnings per share compared with the previous quarter. Despite some volatility related to quarter-end, conditions in unsecured funding markets were little changed, on net, over the intermeeting period. In secured funding markets, some money market rates fell in the days leading up to quarter-end, reportedly reflecting in part the announcement of the $300 billion overall size limit on the ON RRP exercise following the September FOMC meeting. After quarter- Minutes of Federal Open Market Committee Meetings | October end, however, short-term rates generally moved back toward their preannouncement levels. Credit flows to nonfinancial business picked up in September and early October. Gross issuance of investment- and speculative-grade bonds rebounded from seasonal lows over the summer, notwithstanding the slowdown during the mid-October market volatility spike. Commercial and industrial loans on banks’ books continued to expand at a robust pace in the third quarter, consistent with the strong demand from large and middle-market firms reported in the October Senior Loan Officer Opinion Survey on Bank Lending Practices (SLOOS). In the leveraged loan market, institutional issuance slowed some in September, though investors’ interest in the asset class remained strong. Financing conditions in the commercial real estate (CRE) market continued to ease. According to the October SLOOS, banks eased CRE lending standards, on net, and reported stronger demand for such loans. Growth of CRE loans on the balance sheets of large banks slowed in the third quarter, while growth at small banks remained moderate. Issuance of commercial mortgage-backed securities stayed robust in September. Over the intermeeting period, mortgage rates to qualified borrowers declined about 25 basis points. The decline in rates coincided with an appreciable increase in the volume of refinancing activity. Mortgage lending conditions were little changed on net. Conditions in most consumer credit markets remained accommodative during the third quarter. Auto loans continued to be widely available, and respondents to the October SLOOS indicated that demand for auto loans had strengthened further in the third quarter. In addition, demand for credit card loans increased, and a few large banks reported having eased lending policies on such loans. As in the United States, participants in foreign financial markets became more concerned, on balance, about prospects for global economic growth. On net over the period, equity indexes were down in most advanced and emerging market economies, and measures of implied volatility rose. Benchmark sovereign yields fell sharply, with German yields reaching record lows. Expected policy rate paths moved down in most advanced economies, and marketbased measures of inflation compensation continued to decline. The Riksbank unexpectedly cut its main 253 policy rate to zero in response to the low level of Swedish inflation. Spreads on peripheral European sovereign bonds increased, modestly for most countries but more substantially for Greek bonds, reflecting, in part, market concerns that Greece might exit its International Monetary Fund program prematurely. Spreads on emerging market bonds generally edged higher. In addition, the broad nominal dollar index ended the period moderately higher. The European Central Bank released the results of the 2014 comprehensive assessment, which included both an asset quality review and a forward-looking stress test. Under the stress test, which recognizes capital raising and balance sheet adjustments through September 2014, 13 banks were identified as needing to strengthen their capital positions and 8 will be required to raise net new capital. The results were broadly in line with expectations, and the market reaction to the release was limited. The staff’s periodic report on potential risks to financial stability noted that recent developments in financial markets highlighted the potential for shocks to trigger increases in market volatility and declines in asset prices that could undermine financial stability. Nevertheless, the U.S. financial system appeared resilient to shocks of the magnitude seen recently due to the relatively strong capital and liquidity profiles of large domestic banking firms, subdued aggregate leverage in the nonfinancial sector, and relatively restrained use of short-term wholesale funding across the financial sector. However, the staff report also pointed to asset valuation pressures that were broadening, as well as a loosening of underwriting standards in the speculative corporate debt and CRE markets; it noted the need to closely monitor these developments going forward. Staff Economic Outlook The information on economic activity received since the staff prepared its forecast for the September FOMC meeting was close to expectations, and therefore, the staff’s projection for real GDP growth over the remainder of the year was little revised. However, in response to a further rise in the foreign exchange value of the dollar, a deterioration in global growth prospects, and a decline in equity prices, the staff revised down its projection for real GDP growth a little over the medium term. Even with the slower expansion of economic activity in this projection, real GDP was still expected to rise faster than potential output in 2015 and 2016, supported by accom- 254 101st Annual Report | 2014 modative monetary policy and a further easing of the restraint on spending from changes in fiscal policy; in 2017, real GDP growth was projected to step down toward the rate of potential output growth. As a result, resource slack was anticipated to decline steadily, albeit at a slightly slower rate than in the previous projection, and the unemployment rate was expected to gradually improve and to be at the staff’s estimate of its longer-run natural rate in 2017. The staff’s forecast for inflation this quarter and early next year was reduced in response to further declines in crude oil prices, but the forecast for inflation over the medium term was only a touch lower. Consumer price inflation was projected to be lower in the second half of this year than in the first half and to remain below the Committee’s longer-run objective of 2 percent over the next few years. With resource slack projected to diminish slowly and changes in commodity and import prices anticipated to be subdued, inflation was projected to rise gradually and to reach the Committee’s objective in the longer run. The staff continued to view the uncertainty around its projections for real GDP growth, the unemployment rate, and inflation as similar to the average over the past 20 years. The risks to the forecast for real GDP growth and inflation were seen as tilted to the downside, reflecting recent financial developments and concerns about the foreign economic outlook, as well as the staff’s assessment that neither monetary policy nor fiscal policy appeared well positioned to help the economy withstand adverse shocks. At the same time, the staff continued to view the risks around its outlook for the unemployment rate as roughly balanced. Participants’ Views on Current Conditions and the Economic Outlook In their discussion of the economic situation and the outlook, most meeting participants viewed the information received over the intermeeting period as suggesting that economic activity continued to expand at a moderate pace. Labor market conditions improved somewhat further, with solid job gains and a lower unemployment rate; on balance, participants judged that the underutilization of labor resources was gradually diminishing. Participants generally expected that, over the medium term, real economic activity would increase at a pace sufficient to lead to a further gradual decline in the unemployment rate toward levels consistent with the Committee’s objec- tive of maximum employment. Inflation was continuing to run below the Committee’s longer-run objective. Market-based measures of inflation compensation declined somewhat, while survey-based measures of longer-term inflation expectations remained stable. Participants anticipated that inflation would be held down over the near term by the decline in energy prices and other factors, but would move toward the Committee’s 2 percent goal in coming years, although a few expressed concern that inflation might persist below the Committee’s objective for quite some time. Most viewed the risks to the outlook for economic activity and the labor market as nearly balanced. However, a number of participants noted that economic growth over the medium term might be slower than they currently expected if the foreign economic or financial situation deteriorated significantly. Household spending advanced at a moderate pace over the intermeeting period, and reports from contacts in several parts of the country indicated that recent retail or auto sales had been robust. However, one participant pointed to mixed retail sales reports that likely reflected a continuation of restrained discretionary spending on the part of low- and middleincome households. Many participants judged that the recent significant decline in energy prices would provide a boost to consumer spending over the near term, with several of them noting that the drop in gasoline prices would benefit lower-income households in particular. Among the other favorable factors that were expected to support continued growth in consumer spending, participants cited solid gains in payroll employment, low interest rates, rising consumer confidence, and the decline in levels of household debt relative to income. The recovery in the housing sector remained slow despite low interest rates and some recent improvement in the availability of mortgage credit. Contacts in some parts of the country reported continued weakness in single-family construction, while in other regions activity reportedly was picking up gradually following a sluggish summer. A few participants pointed to continued strong growth in multifamily construction, although the limited pipeline of new projects in one District suggested that activity could slow in 2015. Reports from business contacts in many parts of the country pointed to an improvement in business conditions, with indexes of the manufacturing sector posting broad-based gains in recent months in a Minutes of Federal Open Market Committee Meetings | October number of Districts. A couple of participants reported expectations of a robust holiday sales season based on accumulating inventories of consumer goods or an increase in e-commerce traffic and related transportation activity. Contacts in several regions reported ready availability of credit, strong loan growth, or a steady increase in commercial construction activity. While the fall in energy prices was generally regarded as a positive development for many businesses, it was noted that a sustained drop in prices would have effects on oil drilling and related investment activity. In the agricultural sector, the robust fall harvest had driven down crop prices; food processing and farm equipment businesses were slowing as a result of lower farm income and a drop in exports. In discussing economic developments abroad, participants pointed to a somewhat weaker economic outlook and increased downside risks in Europe, China, and Japan, as well as to the strengthening of the dollar over the period. It was observed that if foreign economic or financial conditions deteriorated further, U.S. economic growth over the medium term might be slower than currently expected. However, many participants saw the effects of recent developments on the domestic economy as likely to be quite limited. These participants suggested variously that the share of external trade in the U.S. economy is relatively small, that the effects of changes in the value of the dollar on net exports are modest, that shifts in the structure of U.S. trade and production over time may have reduced the effects on U.S. trade of developments like those seen of late, or that the slowdown in external demand would likely prove to be less severe than initially feared. Several participants judged that the decline in the prices of energy and other commodities as well as lower long-term interest rates would likely provide an offset to the higher dollar and weaker foreign growth, or that the domestic recovery remained on a firm footing. Indicators of labor market conditions continued to improve over the intermeeting period, with a further reduction in the unemployment rate, declines in longer-duration unemployment, strong growth in payroll employment, and a low level of initial claims for unemployment insurance. Business contacts reported employment gains in several parts of the country, with relatively few pointing to emerging wage pressures, although one participant indicated that larger wage gains had been accruing to some individuals who switched jobs. Labor market conditions indexes constructed from a broad set of indica- 255 tors suggested that the underutilization of labor had continued to diminish, although a number of participants noted that underutilization of labor market resources remained. A couple of participants judged that the large number of individuals working part time for economic reasons and the continued drift down in the labor force participation rate suggested that the unemployment rate was understating the degree of labor market underutilization. Most participants anticipated that inflation was likely to edge lower in the near term, reflecting the decline in oil and other commodity prices and lower import prices. These participants continued to expect inflation to move back to the Committee’s 2 percent target over the medium term as resource slack diminished in an environment of well-anchored inflation expectations, although a few of them thought the return to 2 percent might be quite gradual. Surveybased measures of inflation expectations remained well anchored, but market-based measures of inflation compensation over the next five years as well as over the five-year period beginning five years ahead had declined over the intermeeting period. Various explanations were offered for the decline in the market-based measures, and participants expressed different views about how to interpret these recent movements. The explanations included a decline in inflation risk premiums, possibly reflecting a lower perceived probability of higher inflation outcomes; and special factors, including liquidity risk premiums, that might be influencing the pricing of Treasury Inflation-Protected Securities and inflation derivatives. One participant noted that even if the declines reflected lower inflation risk premiums and not a reduction in expected inflation, policymakers might still want to take them into account because such a change could reflect increased concerns on the part of investors about adverse outcomes in which low inflation was accompanied by weak economic activity. A couple of participants noted that it was likely too early to draw conclusions regarding these developments, especially in light of the recent market volatility. However, many participants observed that the Committee should remain attentive to evidence of a possible downward shift in longer-term inflation expectations; some of them noted that if such an outcome occurred, it would be even more worrisome if growth faltered. In their discussion of financial market developments and financial stability issues, participants judged that the movements in the prices of stocks, bonds, commodities, and the U.S. dollar over the intermeeting 256 101st Annual Report | 2014 period appeared to have been driven primarily by concerns about prospects for foreign economic growth. Many participants commented on the turbulence in financial markets that occurred in midOctober. Some participants pointed out that, despite the market volatility, financial conditions remained highly accommodative and that further pockets of turbulence were likely to arise as the start of policy normalization approached. That said, more work to better understand the recent market dynamics was seen as desirable. In addition, a couple of participants noted the potential usefulness of collecting additional data on wholesale funding markets in order to better understand how changes in interest rates could influence those markets. In their discussion of communications regarding the path of the federal funds rate over the medium term, meeting participants agreed that the timing of the first increase in the federal funds rate and the appropriate path of the policy rate thereafter would depend on incoming economic data and their implications for the outlook. Most participants judged that it would be helpful to include new language in the Committee’s forward guidance to clarify how the Committee’s decision about when to begin the policy normalization process will depend on incoming information about the economy. Some participants preferred to eliminate language in the statement indicating that the current target range for the federal funds rate would likely be maintained for a “considerable time” after the end of the asset purchase program. These participants were concerned that such a characterization could be misinterpreted as suggesting that the Committee’s decisions would not depend on the incoming data. However, other participants thought that the “considerable time” phrase was useful in communicating the Committee’s policy intentions or that additional wording could be used to emphasize the data-dependence of the Committee’s decision process. A couple of them noted that the removal of the “considerable time” phrase might be seen as signaling a significant shift in the stance of policy, potentially resulting in an unintended tightening of financial conditions. A couple of others thought that the current forward guidance might be read as suggesting an earlier date of liftoff than was likely to prove appropriate, given the outlook for inflation and the downside risks to the economy associated with the effective lower bound on interest rates. With regard to the pace of interest rate increases after the start of policy normalization, a number of participants thought that it could soon be helpful to clarify the Committee’s likely approach. It was noted that communication about post-liftoff policy would pose challenges given the inherent uncertainty of the economic and financial outlook and the Committee’s desire to retain flexibility to adjust policy in response to the incoming data. Most participants supported retaining the language in the statement indicating that the Committee anticipates that economic conditions may warrant keeping the target range for the federal funds rate below longerrun normal levels even after employment and inflation are near mandate-consistent levels. However, a couple of participants thought that the language should be amended in light of the prescriptions suggested by many monetary policy rules and the risks associated with keeping interest rates below their longer-run values for an extended period of time. Committee Policy Action In their discussion of monetary policy for the period ahead, members judged that information received since the FOMC met in September indicated that economic activity was expanding at a moderate pace. Labor market conditions had improved somewhat further, with solid job gains and a lower unemployment rate; on balance, a range of indicators suggested that underutilization of labor resources was gradually diminishing. Household spending was rising moderately and business fixed investment was advancing, while the recovery in the housing sector remained slow. Inflation had continued to run below the Committee’s longer-run objective. Market-based measures of inflation compensation had declined somewhat, but survey-based measures of longer-term inflation expectations had remained stable. The Committee expected that, with appropriate policy accommodation, economic activity would expand at a moderate pace, with labor market indicators and inflation moving toward levels the Committee judges consistent with its dual mandate. In their discussion of language for the post-meeting statement, a number of members judged that, while some underutilization in the labor market remained, it appeared to be gradually diminishing. In addition, members considered the advantages and disadvantages of adding language to the statement to acknowledge recent developments in financial markets. On the one hand, including a reference would show that the Committee was monitoring financial developments while also providing an opportunity to note that financial conditions remained highly supportive of growth. On the other hand, including a reference risked the possibility of suggesting greater Minutes of Federal Open Market Committee Meetings | October concern on the part of the Committee than was actually the case, perhaps leading to the misimpression that monetary policy was likely to respond to increases in volatility. In the end, the Committee decided not to include such a reference. Finally, a couple of members suggested including language in the statement indicating that recent foreign economic developments had increased uncertainty or had boosted downside risks to the U.S. economic outlook, but participants generally judged that such wording would suggest greater pessimism about the economic outlook than they thought appropriate. In their discussion of the asset purchase program, members generally agreed that the condition articulated by the Committee when it began the program in September 2012 had been achieved—that is, there had been a substantial improvement in the outlook for the labor market—and that there was sufficient underlying strength in the broader economy to support ongoing progress toward maximum employment in a context of price stability. Accordingly, all members but one supported concluding the Committee’s asset purchase program at the end of October and maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency MBS in agency MBS and of rolling over maturing Treasury securities at auction. By keeping the Committee’s holdings of longer-term securities at sizable levels, this policy was expected to help maintain accommodative financial conditions. In addition, the Committee agreed to maintain the target range for the federal funds rate at 0 to ¼ percent and to reaffirm the indication in the statement that the Committee’s decision about how long to maintain the current target range for the federal funds rate would depend on its assessment of actual and expected progress toward its objectives of maximum employment and 2 percent inflation. All but one member agreed that the Committee should reiterate the expectation that it likely would be appropriate to maintain the current target range for the federal funds rate for a considerable time following the end of the asset purchase program in October, especially if projected inflation continued to run below the Committee’s 2 percent longer-run goal, and provided that longer-term inflation expectations remained well anchored. The one member thought that the Committee should instead strengthen the forward guidance in order to underscore the Committee’s commitment to its 2 percent inflation objec- 257 tive. The Committee agreed to include additional wording in the statement in order to emphasize that the Committee’s decision on the timing of the first increase in the federal funds rate would be data dependent. In particular, the statement would say that, if incoming information indicated faster progress toward the Committee’s employment and inflation objectives than the Committee now expects, then increases in the target range for the federal funds rate would likely occur sooner than currently anticipated. It would also note that, if progress proves slower than expected, then increases in the target range would likely occur later than currently anticipated. The Committee also agreed to reiterate its expectation that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer 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 SOMA in accordance with the following domestic policy directive: “Consistent with its statutory mandate, the Federal Open Market Committee seeks monetary and financial conditions that will foster maximum employment and price stability. In particular, 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 undertake open market operations as necessary to maintain such conditions. The Desk is directed to conclude the current program of purchases of longer-term Treasury securities and agency mortgage-backed securities by the end of October. The Committee directs the Desk to maintain its policy of rolling over maturing Treasury securities into new issues and its policy of reinvesting principal payments on all agency debt and agency mortgagebacked securities in agency mortgage-backed securities. The Committee also directs the Desk to engage in dollar roll and coupon swap transactions as necessary to facilitate settlement of the Federal Reserve’s agency mortgage-backed securities 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 258 101st Annual Report | 2014 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 2:00 p.m.: “Information received since the Federal Open Market Committee met in September suggests that economic activity is expanding at a moderate pace. Labor market conditions improved somewhat further, with solid job gains and a lower unemployment rate. On balance, a range of labor market indicators suggests that underutilization of labor resources is gradually diminishing. Household spending is rising moderately and business fixed investment is advancing, while the recovery in the housing sector remains slow. Inflation has continued to run below the Committee’s longer-run objective. Market-based measures of inflation compensation have declined somewhat; survey-based measures of 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 that, with appropriate policy accommodation, economic activity will expand at a moderate pace, with labor market indicators and inflation moving toward levels the Committee judges consistent with its dual mandate. The Committee sees the risks to the outlook for economic activity and the labor market as nearly balanced. Although inflation in the near term will likely be held down by lower energy prices and other factors, the Committee judges that the likelihood of inflation running persistently below 2 percent has diminished somewhat since early this year. The Committee judges that there has been a substantial improvement in the outlook for the labor market since the inception of its current asset purchase program. Moreover, the Committee continues to see sufficient underlying strength in the broader economy to support ongoing progress toward maximum employment in a context of price stability. Accordingly, the Committee decided to conclude its asset purchase program this month. 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 and of rolling over maturing Treasury securities at auction. This policy, by keeping the Committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions. To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that the current 0 to ¼ percent target range for the federal funds rate remains appropriate. In determining how long to maintain this target range, the Committee will assess progress—both realized and expected—toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. The Committee anticipates, based on its current assessment, that it likely will be appropriate to maintain the 0 to ¼ percent target range for the federal funds rate for a considerable time following the end of its asset purchase program this month, especially if projected inflation continues to run below the Committee’s 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored. However, if incoming information indicates faster progress toward the Committee’s employment and inflation objectives than the Committee now expects, then increases in the target range for the federal funds rate are likely to occur sooner than currently anticipated. Conversely, if progress proves slower than expected, then increases in the target range are likely to occur later than currently anticipated. When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent. The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.” Minutes of Federal Open Market Committee Meetings | October Voting for this action: Janet L. Yellen, William C. Dudley, Lael Brainard, Stanley Fischer, Richard W. Fisher, Loretta J. Mester, Charles I. Plosser, Jerome H. Powell, and Daniel K. Tarullo. Voting against this action: Narayana Kocherlakota. Mr. Kocherlakota dissented because he believed that, in light of continued sluggishness in the inflation outlook and the recent slide in market-based measures of longer-term inflation expectations, the Committee should commit to maintaining the current target range for the federal funds rate at least until projected inflation one to two years ahead has returned to 2 percent and should continue the asset purchase program at its current pace. Mr. Kocherlakota noted that when the Committee first reduced its asset purchases in December 2013, it said in the post-meeting statement that it would be monitoring inflation developments carefully for evidence that inflation was moving back toward its objective over the medium term; Mr. Kocherlakota indicated he saw no such evidence. Longer-Run Goals and Monetary Policy Strategy In the discussion at the January 2014 FOMC meeting regarding the annual reaffirmation of the Statement on Longer-Run Goals and Monetary Policy Strategy, participants noted that, while they were generally satisfied with the statement, it would be appropriate to consider whether any changes might be warranted before the statement was reaffirmed in 2015. The Committee subsequently referred the matter to the subcommittee on communications, which identified possible issues for consideration by the full Committee. The subcommittee then asked the staff to prepare a memorandum to the Committee exploring those issues. At this meeting, a staff presentation discussed three issues related to the existing statement that might warrant elaboration or clarification: whether inflation persistently below the Committee’s 2 percent longer-run objective and inflation similarly persistently above that objective would be regarded as equally undesirable, whether additional information should be provided about the “balanced approach” that the Committee takes in promoting its 259 two objectives under circumstances in which these objectives are judged not to be complementary, and how financial stability is linked to the Committee’s mandated goals of maximum employment and price stability. Following the staff presentation, participants discussed a range of topics related to these three issues and to monetary policy communications more broadly. Participants generally thought that it was worthwhile to periodically consider possible changes to the statement, regardless of whether any were ultimately implemented. Most participants agreed that the existing consensus statement was working well as a communications tool and judged that the threshold for making changes to the document should be a high one. On the specific issues, there was widespread agreement that inflation moderately above the Committee’s 2 percent goal and inflation the same amount below that level were equally costly—and many participants thought that that view was largely shared by the public. One participant suggested that the Committee should clarify the time horizon within which it seeks to achieve its inflation objective. Participants believed that the language referring to the Committee’s balanced approach in promoting its objectives was appropriately broad and encompassed the views of participants. A number of participants noted that financial stability is a necessary condition for the achievement of the Committee’s longer-run goals. A few of them offered suggestions for communicating more specifically how financial stability, and perhaps other asymmetric risks to the outlook, are taken into account in the setting of monetary policy. However, several other participants noted that reaching an agreement in the near term on clarifying the linkages between monetary policy and financial stability could prove challenging, in part because the issues involved are complex and need further study. Regarding broader communications issues, a number of participants suggested that the subcommittee could again investigate the feasibility and desirability of constructing a consensus forecast, building on the lessons of the experiments carried out in 2012, and several thought that further enhancements to the Summary of Economic Projections might also be worth considering. No decisions were made at this meeting, and participants generally agreed that it would be useful to discuss these issues further at upcoming meetings. 260 101st Annual Report | 2014 It was agreed that the next meeting of the Committee would be held on Tuesday–Wednesday, December 16–17, 2014. The meeting adjourned at 12:45 p.m. on October 29, 2014. Notation Vote By notation vote completed on October 7, 2014, the Committee unanimously approved the minutes of the Committee meeting held on September 16–17, 2014. William B. English Secretary Minutes of Federal Open Market Committee Meetings | December Meeting Held on December 16–17, 2014 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 16, 2014, at 1:00 p.m. and continued on Wednesday, December 17, 2014, at 9:00 a.m. Present Janet L. Yellen Chair William C. Dudley Vice Chairman Lael Brainard Stanley Fischer Richard W. Fisher Narayana Kocherlakota Loretta J. Mester Charles I. Plosser Jerome H. Powell Daniel K. Tarullo Christine Cumming, Charles L. Evans, Jeffrey M. Lacker, Dennis P. Lockhart, and John C. Williams Alternate Members of the Federal Open Market Committee James Bullard, Esther L. George, and Eric Rosengren Presidents of the Federal Reserve Banks of St. Louis, Kansas City, and Boston, respectively William B. English Secretary and Economist Matthew M. Luecke Deputy Secretary Michelle A. Smith Assistant Secretary Scott G. Alvarez General Counsel Steven B. Kamin Economist David W. Wilcox Economist 261 James A. Clouse, Thomas A. Connors, Evan F. Koenig, Thomas Laubach, Michael P. Leahy, Paolo A. Pesenti, Samuel Schulhofer-Wohl, Mark E. Schweitzer, and William Wascher Associate Economists Simon Potter Manager, System Open Market Account Lorie K. Logan Deputy Manager, System Open Market Account Robert deV. Frierson1 Secretary of the Board, Office of the Secretary, Board of Governors Michael S. Gibson Director, Division of Banking Supervision and Regulation, Board of Governors Stephen A. Meyer and William R. Nelson Deputy Directors, Division of Monetary Affairs, Board of Governors Andreas Lehnert Deputy Director, Office of Financial Stability Policy and Research, Board of Governors Andrew Figura, David Reifschneider, and Stacey Tevlin Special Advisers to the Board, Office of Board Members, Board of Governors Trevor A. Reeve Special Adviser to the Chair, Office of Board Members, Board of Governors Linda Robertson Assistant to the Board, Office of Board Members, Board of Governors Christopher J. Erceg Senior Associate Director, Division of International Finance, Board of Governors Michael T. Kiley Senior Adviser, Division of Research and Statistics, and Senior Associate Director, Office of Financial Stability Policy and Research, Board of Governors Ellen E. Meade and Joyce K. Zickler Senior Advisers, Division of Monetary Affairs, Board of Governors 1 Attended the joint session of the Federal Open Market Committee and the Board of Governors. 262 101st Annual Report | 2014 Daniel M. Covitz, Eric M. Engen, and Diana Hancock Associate Directors, Division of Research and Statistics, Board of Governors David Lopez-Salido Deputy Associate Director, Division of Monetary Affairs, Board of Governors John J. Stevens Deputy Associate Director, Division of Research and Statistics, Board of Governors Stephanie R. Aaronson Assistant Director, Division of Research and Statistics, Board of Governors Robert J. Tetlow Adviser, Division of Monetary Affairs, Board of Governors Elizabeth Klee Section Chief, Division of Monetary Affairs, Board of Governors Katie Ross1 Manager, Office of the Secretary, Board of Governors Achilles Sangster II Information Management Analyst, Division of Monetary Affairs, Board of Governors Kelly J. Dubbert First Vice President, Federal Reserve Bank of Kansas City David Altig and Alberto G. Musalem Executive Vice Presidents, Federal Reserve Banks of Atlanta and New York, respectively Michael Dotsey, Geoffrey Tootell, and Christopher J. Waller Senior Vice Presidents, Federal Reserve Banks of Philadelphia, Boston, and St. Louis, respectively Hesna Genay, Douglas Tillett, Robert G. Valletta, and Alexander L. Wolman Vice Presidents, Federal Reserve Banks of Chicago, Chicago, San Francisco, and Richmond, respectively Willem Van Zandweghe Assistant Vice President, Federal Reserve Bank of Kansas City Developments in Financial Markets and the Federal Reserve’s Balance Sheet In a joint session of the Federal Open Market Committee (FOMC) and the Board of Governors of the Federal Reserve System, the manager of the System Open Market Account (SOMA) reported on developments in domestic and foreign financial markets as well as System open market operations conducted during the period since the Committee met on October 28–29, 2014. In addition, the manager reviewed the implications of recent foreign central bank policy actions for the international portion of the SOMA portfolio. The manager also provided an update on staff work related to potential arrangements that would allow depository institutions to pledge funds held in a segregated account at the Federal Reserve as collateral in borrowing transactions with private creditors and which could potentially provide an additional supplementary tool during policy normalization. After further review, staff analysis suggested that such accounts involved a number of operational, regulatory, and policy issues. These issues raised questions about these accounts’ possible effectiveness that would be difficult to resolve in a timely fashion. It was therefore decided that further work to implement such accounts would be shelved for now. The deputy manager followed with a discussion of the outcomes of recent tests of supplementary normalization tools, namely the Term Deposit Facility (TDF) and term and overnight reverse repurchase agreements (term RRPs and ON RRPs, respectively). Regarding the TDF testing, the introduction of an early withdrawal option led to significant increases in the number of participating depository institutions and in take-up relative to earlier operations without this feature. As expected, both participation and take-up in the operations continued to be sensitive to the offering rate and maximum individual award amount. The Open Market Desk successfully conducted the first two of four preannounced term RRP operations extending across the end of the year to help address expected downward pressures on shortterm rates. Commentary from market participants suggested that these operations may help alleviate some of the volatility in short-term rates that would otherwise be expected around the year-end. Regarding the ON RRP testing—during which the offered Minutes of Federal Open Market Committee Meetings | December rate was varied between 3 and 10 basis points—increases in offered rates appeared to put some upward pressure on unsecured money market rates, as anticipated, and the offered rate continued to provide a soft floor for secured rates. Changes in the spread between the rate paid on reserves and the ON RRP offered rate did not appear to affect the volume of activity in the federal funds market. While the tests of ON RRPs had been informative, the staff suggested that additional testing could further improve understanding of how this supplementary tool could be used to achieve greater control of the federal funds rate during policy normalization. Accordingly, participants discussed a draft resolution to extend the Desk’s authority to conduct the ON RRP exercise for 12 months beyond the expiration of the current authorization on January 30, 2015. It was noted that a one-year extension to what had been a one-year testing program was a practical step and signaled nothing about either the timing of the start of policy normalization or how long an ON RRP facility might be needed. Following the discussion of the extension of ON RRP test operations, the Committee unanimously approved the following resolution: “The Federal Open Market Committee (FOMC) authorizes the Federal Reserve Bank of New York to conduct a series of overnight reverse repurchase operations involving U.S. government securities for the purpose of further assessing the appropriate structure of such operations in supporting the implementation of monetary policy during normalization. The reverse repurchase operations authorized by this resolution shall be (i) conducted at an offering rate that may vary from zero to five basis points; (ii) for an overnight term or such longer term as is warranted to accommodate weekend, holiday, and similar trading conventions; (iii) subject to a percounterparty limit of up to $30 billion per day; (iv) subject to an overall size limit of up to $300 billion per day; and (v) awarded to all submitters (A) at the specified offering rate if the sum of the bids received is less than or equal to the overall size limit, or (B) at the stop-out rate, determined by evaluating bids in ascending order by submitted rate up to the point at which the total quantity of bids equals the overall size limit, with all bids below this rate awarded in full at the stop-out rate and all bids at the stop-out rate awarded on a pro rata basis, if the sum of the counterparty offers received is greater than 263 the overall size limit. The Chair must approve any change in the offering rate within the range specified in (i) and any changes to the percounterparty and overall size limits subject to the limits specified in (iii) and (iv). The System Open Market Account manager will notify the FOMC in advance about any changes to the offering rate, per-counterparty limit, or overall size limit applied to operations. These operations shall be authorized for one additional year beyond the previously authorized end date— that is, through January 29, 2016.” 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. The Board meeting concluded at the end of the discussion of developments in financial markets and the Federal Reserve’s balance sheet. Staff Review of the Economic Situation The information reviewed for the December 16–17 meeting suggested that economic activity was increasing at a moderate pace in the fourth quarter and that labor market conditions had improved further. Consumer price inflation continued to run below the FOMC’s longer-run objective of 2 percent, partly restrained by declining energy prices. Marketbased measures of inflation compensation moved lower, but survey measures of longer-run inflation expectations remained stable. Total nonfarm payroll employment expanded in October and November at a faster pace than in the third quarter. The unemployment rate edged down to 5.8 percent in October and remained at that level in November. Both the labor force participation rate and the employment-to-population ratio rose slightly, and the share of workers employed part time for economic reasons declined. The rate of private-sector job openings stayed, on balance, at its recent elevated level in September and October, and the rates of hiring and of quits stepped up on net. Industrial production rose in October and November, led by strong increases in manufacturing output. Automakers’ schedules indicated that the pace of light motor vehicle assemblies would move up somewhat in the first quarter, and broader indicators of manufacturing production, such as the readings on 264 101st Annual Report | 2014 new orders from the national and regional manufacturing surveys, were generally consistent with solid gains in factory output over the near term. remaining wider than the monthly average in the third quarter, real net exports looked to be declining in the fourth quarter. Real personal consumption expenditures (PCE) appeared to be rising robustly in the fourth quarter. The components of the nominal retail sales data used to construct estimates of PCE rose strongly in October and November, and light motor vehicle sales increased noticeably. Key factors that influence household spending pointed toward further solid PCE growth. Real disposable income rose further in October, energy prices continued to decline, households’ net worth likely increased as home values advanced, and consumer sentiment in early December from the Thomson Reuters/University of Michigan Surveys of Consumers was at its highest level since before the most recent recession. Both total U.S. consumer price inflation, as measured by the PCE price index, and core inflation, as measured by PCE prices excluding food and energy, were about 1½ percent over the 12 months ending in October; consumer energy prices declined, while consumer food prices rose more than overall prices. Over the 12 months ending in November, total inflation as measured by the consumer price index (CPI) was 1¼ percent, partly reflecting the further decline in energy prices, while core CPI inflation was 1¾ percent. Measures of expected long-run inflation from a variety of surveys, including the Michigan survey, the Blue Chip Economic Indicators, the Survey of Professional Forecasters, and the Desk’s Survey of Primary Dealers, remained stable. In contrast, market-based measures of inflation compensation moved lower. The pace of activity in the housing sector generally remained slow. Both starts and permits of new single-family homes increased only a little, on balance, in October and November. Starts of multifamily units declined, on net, over the past two months. Sales of new and existing homes rose modestly in October. Real private expenditures for business equipment and intellectual property appeared to be decelerating in the fourth quarter. Nominal orders and shipments of nondefense capital goods excluding aircraft declined in October. However, new orders for these capital goods remained above the level of shipments, and other forward-looking indicators, such as national and regional surveys of business conditions, were generally consistent with modest near-term gains in business equipment spending. Firms’ nominal spending for nonresidential structures edged down in October after rising slightly in the third quarter. Data for October and November pointed toward a decline in real federal government purchases in the fourth quarter after a surprisingly large third-quarter increase. Real state and local government purchases appeared to be rising modestly in the fourth quarter as their payrolls and construction expenditures increased a little in recent months. The U.S. international trade deficit was little changed in October, as exports and imports both rose. The gains in exports were concentrated in aircraft and other capital goods, and the increase in imports reflected a pickup in purchases of automotive products and computers. But with the October deficit Labor compensation continued to increase only a little faster than consumer prices. Compensation per hour in the nonfarm business sector rose about 2 percent over the year ending in the third quarter. Similar rates of increase were observed for the employment cost index over the same year-long period and for average hourly earnings for all employees over the 12 months ending in November. Overall growth in foreign real gross domestic product (GDP) remained subdued in the third quarter. In the advanced foreign economies, real GDP contracted for a second consecutive quarter in Japan, rose only slightly in the euro area, but continued to expand moderately in Canada and the United Kingdom. In the emerging market economies, economic growth slowed in Mexico in the third quarter and remained sluggish in Brazil; economic growth in China likely slowed moderately in the fourth quarter. Oil prices continued to decline, likely reflecting favorable supply developments as well as some weakening in global demand. Inflation in the advanced foreign economies remained quite low during the intermeeting period, partly because of the fall in oil prices. Declining oil prices had a smaller effect on inflation in the emerging market economies, reflecting the greater prevalence of administered energy prices. Staff Review of the Financial Situation Over the intermeeting period, market participants became a bit more optimistic about U.S. economic prospects while also responding to economic and Minutes of Federal Open Market Committee Meetings | December policy developments abroad. The sharp decline in oil prices weighed on inflation compensation and left a mixed imprint on other asset markets. On net, yields on longer-term Treasury securities fell, corporate bond spreads widened, equity prices were little changed, and the foreign exchange value of the dollar appreciated. Economic data releases reinforced the views of market participants that the U.S. economic recovery continued to gain momentum. In addition, investors appeared to read the October FOMC statement as suggesting a slightly less accommodative path for future monetary policy than they had previously expected. Results from the December Survey of Primary Dealers indicated that the dealers’ expectations for the timing of the first increase in the federal funds target range and the subsequent policy path were little changed from the October survey. The average probability distribution of the expected date of liftoff continued to imply that the most likely date would be around the middle of 2015, with the distribution having narrowed slightly compared with the previous survey. Longer-term nominal Treasury yields declined significantly, on balance, over the intermeeting period. Measures of inflation compensation based on Treasury Inflation-Protected Securities and on inflation swaps decreased, reportedly reflecting, in part, the decline in oil prices and increased concerns about global economic growth. Broad U.S. equity price indexes were about unchanged over the intermeeting period. Optionimplied volatility for one-month returns on the S&P 500 index—the VIX—rose sharply late in the period to levels close to those in mid-October. Investmentand speculative-grade corporate bond spreads widened over the period. Spreads on speculative-grade bonds for energy-related firms rose substantially because of the pronounced decline in oil prices. Business financing flows were robust over the intermeeting period. Gross bond issuance by nonfinancial corporations was the strongest in more than a year. Nonfinancial commercial paper outstanding expanded noticeably in November, more than compensating for a slowdown in October. Commercial and industrial loans on banks’ books continued to 265 expand briskly. In addition, issuance of both leveraged loans and collateralized loan obligations were strong in October and November. Financing for commercial real estate (CRE) remained broadly available. CRE loans on banks’ books expanded at a moderate pace in October and November, and issuance of commercial mortgage-backed securities (CMBS) was strong. According to the December Senior Credit Officer Opinion Survey on Dealer Financing Terms, broker-dealers had eased somewhat all of the terms on which they finance CMBS for most-favored clients. Measures of residential mortgage lending conditions were little changed over the intermeeting period. Credit conditions for mortgages remained tight for borrowers with less-than-pristine credit. Interest rates on 30-year fixed-rate mortgages declined, consistent with the moves in longer-term Treasury yields. Refinancing activity was subdued. Financing conditions in consumer credit markets generally stayed accommodative. Auto and student loan balances expanded robustly in October, and revolving credit balances increased at a moderate pace. Issuance of consumer asset-backed securities was strong in the fourth quarter. Reflecting divergent economic and monetary policy prospects in the United States and abroad, the dollar appreciated substantially against most currencies over the intermeeting period. The dollar moved up significantly against the yen as the Bank of Japan expanded its asset purchase program as well as against the currencies of oil exporters as oil prices declined. Over the period, market participants seemed to conclude that monetary policy in Europe was likely to be put on a more accommodative path, and 10-year yields in Germany and the United Kingdom declined further. As German yields fell to new record lows, spreads of most euro-area peripheral bonds over those yields narrowed. Changes in stock prices abroad were mixed, on net, over the intermeeting period: There were large increases in Japan and China along with large decreases in oil-exporting countries, such as Canada, Mexico, and Russia. Late in the intermeeting period, following the sharp fall in oil prices, the Russian ruble depreciated rapidly and substantially, prompting the Russian central bank, which had already raised its policy rate in early 266 101st Annual Report | 2014 November, to raise the rate twice more in five days, with the most recent increase following an unscheduled policy meeting on December 15. Staff Economic Outlook In the staff forecast prepared for the December FOMC meeting, real GDP growth in the second half of 2014 was higher than in the projection for the October meeting, largely reflecting stronger-thanexpected data for PCE. Nevertheless, real GDP growth was anticipated to slow in the fourth quarter as both net exports and federal government purchases—important positive contributors to real GDP growth in the third quarter—were anticipated to drop back. The staff’s medium-term forecast for real GDP growth was revised up a little on net. The projected path for oil prices was lower, and the trajectory for equity prices was a bit higher. And although the projected path of the dollar was revised up, the staff revised down its estimate of how much the appreciation of the dollar since last summer would restrain projected growth in real GDP. The staff continued to forecast that real GDP would expand at a faster pace in 2015 and 2016 than it had this year and that it would rise more quickly than potential output, supported by increases in consumer and business confidence and a pickup in foreign economic growth, along with monetary policy that was assumed to remain highly accommodative for some time. In 2017, real GDP growth was projected to begin slowing toward, but to remain above, the rate of potential output growth as the normalization of monetary policy was assumed to proceed. The expansion in economic activity over the medium term was anticipated to slowly reduce resource slack, and the unemployment rate was expected to decline gradually and to temporarily move slightly below the staff’s estimate of its longer-run natural rate. The staff’s forecast for inflation in the near term was revised down to reflect the further large energy price declines since the October FOMC meeting, which were anticipated to lead to a temporary decrease in the total PCE price index late this year and early next year. The staff’s inflation projection for the next few years was essentially unchanged; the staff continued to project that inflation would move up gradually toward, but run somewhat below, the Committee’s longer-run objective of 2 percent. Nevertheless, inflation was projected to reach the Committee’s objective over time, with longer-run inflation expectations assumed to remain stable, prices of energy and nonoil imports forecast to begin rising next year, and slack in labor and product markets anticipated to diminish slowly. The staff viewed the uncertainty around its projections for real GDP growth, the unemployment rate, and inflation as similar to the average over the past 20 years. The risks to the forecast for real GDP growth and inflation were viewed as tilted a little to the downside, reflecting the staff’s assessment that neither monetary policy nor fiscal policy was well positioned to help the economy withstand adverse shocks. At the same time, the staff viewed the risks around its outlook for the unemployment rate as roughly balanced. Participants’ Views on Current Conditions and the Economic Outlook In conjunction with this FOMC meeting, members of the Board of Governors and the Federal Reserve Bank presidents submitted their projections of the most likely outcomes for real GDP growth, the unemployment rate, inflation, and the federal funds rate for each year from 2014 through 2017 and over the longer run, conditional on 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 the Summary of Economic Projections (SEP), which is attached as an addendum to these minutes. In their discussion of the economic situation and the outlook, meeting participants regarded the information received over the intermeeting period as supporting their view that economic activity was expanding at a moderate pace. Labor market conditions improved further, with solid job gains and a lower unemployment rate; participants judged that the underutilization of labor resources was continuing to diminish. Participants expected that, over the medium term, real economic activity would increase at a pace sufficient to lead to further improvements in labor market indicators toward levels consistent with the Committee’s objective of maximum employment. Inflation was continuing to run below the Committee’s longer-run objective, reflecting in part continued reductions in oil prices and falling import prices. Market-based measures of inflation compensation declined further, while survey-based measures of longer-term inflation expectations remained Minutes of Federal Open Market Committee Meetings | December stable. Participants generally anticipated that inflation would rise gradually toward the Committee’s 2 percent objective as the labor market improved further and the transitory effects of lower energy prices and other factors dissipated. The risks to the outlook for economic activity and the labor market were seen as nearly balanced. Some participants suggested that the recent domestic economic data had increased their confidence in the outlook for growth going forward. Participants generally regarded the net effect of the recent decline in energy prices as likely to be positive for economic activity and employment. However, many of them thought that a further deterioration in the foreign economic situation could result in slower domestic economic growth than they currently expected. Household spending continued to advance over the intermeeting period, and reports from contacts in several parts of the country indicated that recent retail or auto sales had been robust. Many participants pointed to relatively high levels of consumer confidence as signaling near-term strength in discretionary consumer spending, and most participants judged that the recent significant decline in energy prices would provide a boost to consumer spending. Participants also cited solid gains in payroll employment, low interest rates, and the decline in levels of household debt relative to income as factors that were expected to support continued growth in consumer spending. In contrast, residential construction continued to be slow, and recent readings on singlefamily building permits suggested that this sluggishness was likely to continue in the short run. Industry contacts pointed to generally solid business conditions, with businesses in many parts of the country expressing some optimism about prospects for further improvement in 2015. Manufacturing activity was strong, as indicated by the index of industrial production and a variety of regional reports. Information from some regions pointed to a pickup in capital investment, although the continued decline in oil prices led business contacts to expect a slowdown in drilling activity and, if prices remain low, reduced capital investment in the oil and gas industries. In the agricultural sector, the robust fall harvest reportedly lowered crop prices; operating margins fo
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