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S. HRG. 110-854
FEDERAL RESERVE'S FIRST MONETARY POLICY
REPORT FOR 2008
HEARING
BEFORE THE
COMMITTEE ON
BANKING, HOUSING, AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED TENTH CONGRESS
SECOND SESSION
ON
OVERSIGHT ON THE MONETARY POLICY REPORT TO CONGRESS PURSUANT TO THE FULL EMPLOYMENT AND BALANCED GROWTH ACT OF 1978
FEBRUARY 28, 2008
Printed for the use of the Committee on Banking, Housing, and Urban Affairs
Available at: http://www.access.gpo.gov/congress/senate/senate05sh.html
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
CHRISTOPHER J. DODD, Connecticut, Chairman
RICHARD C. SHELBY, Alabama
TIM JOHNSON, South Dakota
ROBERT F. BENNETT, Utah
JACK REED, Rhode Island
WAYNE ALLARD, Colorado
CHARLES E. SCHUMER, New York
MICHAEL B. ENZI, Wyoming
EVAN BAYH, Indiana
CHUCK HAGEL, Nebraska
THOMAS R. CARPER, Delaware
JIM BUNNING, Kentucky
ROBERT MENENDEZ, New Jersey
MIKE CRAPO, Idaho
DANIEL K. AKAKA, Hawaii
ELIZABETH DOLE, North Carolina
SHERROD BROWN, Ohio
MEL MARTINEZ, Florida
ROBERT P. CASEY, Pennsylvania
BOB CORKER, Tennessee
JON TESTER, Montana
SHAWN MAHER, Staff Director
WILLIAM D. DUHNKE, Republican Staff Director and
Counsel
ROGER HOLLINGSWORTH, Deputy Staff Director
AARON KLEIN, Chief Economist
DEAN V. SHAHINIAN, Senior Counsel
JULIE CHON, International Economic Adviser
MARK OESTERLE, Republican Chief Counsel
PEGGY KUHN, Republican Senior Financial Economist
MlKE NIELSEN, Republican Professional Staff Member
DAWN RATLIFF, Chief Clerk
DEVIN HARTLEY, Hearing Clerk
SHELVIN SIMMONS, IT Director
JIM CROWELL, Editor
(ID
C O N T E N T S
THURSDAY, FEBRUARY 28, 2008
Page
Opening statement of Chairman Dodd
Opening statements, comments, or prepared statements of:
Senator Shelby
Senator Bunning
Prepared statement
Senator Dole
Prepared statement
1
4
45
45
WITNESS
Ben S. Bernanke, Chairman, Board of Governors of the Federal Reserve
System
Prepared statement
Response to written questions of:
Senator Shelby
6
46
50
ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD
Monetary Policy Report to the Congress dated February 27, 2008
(III)
62
FEDERAL RESERVE'S FIRST MONETARY
POLICY REPORT FOR 2008
THURSDAY, FEBRUARY 28, 2008
U.S. SENATE,
COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS,
Washington, DC.
The Committee met at 10:11 a.m., in room SD—538, Dirksen Senate Office Building, Senator Christopher J. Dodd (Chairman of the
Committee) presiding.
OPENING STATEMENT OF CHAIRMAN CHRISTOPHER J. DODD
Chairman DODD. The Committee will come to order.
I am pleased to call the Committee to order this morning. Today,
the Committee will hear the testimony of Federal Reserve Chairman Ben Bernanke on the outlook of the Nation's economy, the
Fed's conduct of monetary policy, and the status of important consumer protection regulations that are under the Fed's jurisdiction.
This is Chairman Bernanke's second appearance before the Committee this year. Mr. Chairman, it is good to have you with us,
and, again, it is 2 weeks ago and now again today here. You are
becoming a regular here, and so we appreciate your appearance before the Committee.
When Chairman Bernanke was first before the Committee 2
weeks ago, I laid out the facts of what I consider to be our Nation's
very serious, if not perilous, economic condition. Growth is slowing,
inflation is rising, consumer confidence is plummeting, while indebtedness is deepening. And just as ominously, the credit markets
have experienced significant disruptions. Consumers are unable or
unwilling to borrow. Lenders are unable or unwilling to lend. There
is a palpable sense of uncertainty and even fear in the markets
with a crisis of confidence that has spread beyond the mortgage
markets to markets in student loans. And I noted this morning—
by the way, 2 weeks ago I pointed out that Michigan was indicating
some serious problems with student lending, and this morning I
am reading where Pennsylvania today—you may have seen the article—may decide to also curtail student loans as a result of this
growing economic situation. We have also seen the problem with
credit cards, government bonds, and corporate finance.
Unfortunately, the crisis of confidence does not just exist by
American consumers and lenders. It increasingly appears that
there is a crisis of confidence among the rest of the world in the
United States economy. Yesterday, the dollar reached its lowest
level since 1973, when the dollar was first allowed to float freely.
And the Fed's own monetary report details an alarming fact. For(l)
eign entities have not only stopped purchasing U.S. securities; they
have actually been selling them because they have lost, it appears,
confidence in their value. Now, I am going to be raising some questions, Mr. Chairman, about that, and I will be interested in your
observations about these reports in the Monetary Policy Report.
As I have said previously, the catalyst of the current economic
crisis I believe very strongly is the housing crisis. Overall, 2007
was the first year since data has been kept that the United States
had an annual decline in nationwide housing prices. A recent
Moody's report forecast that home values will drop in 2008 by 10
percent to 15 percent, and others are predicting similar declines in
2009 as well. This would be the first time since the Great Depression that national home prices have dropped in consecutive years.
We have all witnessed in the past where regionally there have been
declines in home prices, but to have national numbers like this is
almost unprecedented, certainly in recent history.
If the catalyst of the current economic crisis is the housing crisis,
then the catalyst of the housing crisis is the foreclosure crisis. This
week, it was reported that foreclosures in January were up 57 percent compared to a year ago and continue to hit record levels.
When all is said and done, over 2 million Americans could lose
their homes as a result of what Secretary Paulson has properly and
accurately described as "bad lending practices." These are lending
practices that no sensible banker, I think, would ever engage in.
Reckless, careless, and sometimes unscrupulous actors in the mortgage lending industry essentially allowed banks—rather, essentially allowed loans to be made that they knew hard-working, lawabiding borrowers would never be able to repay.
Let me add here very quickly, because I think it is important to
make the point here, that we are not talking about everyone here
at all. We are talking about some who engaged in practices that
I think were unscrupulous or bad lending practices. But many institutions acted very responsibly, and I would not want the world
to suggest here that this Committee believed that this was an indictment on all lending institutions. And engaged—those who did
act improperly engaged in practices that the Federal Reserve under
its prior leadership, in my view, and this administration did absolutely nothing to effectively stop.
The crisis affects more than families who lose their homes. Property values for each home within a one-eighth square mile of a
foreclosed home could drop on an average as much as $5,000. This
will affect somewhere between 44 to 50 million homes in our country. So the ripple effect beyond the foreclosed property goes far beyond that and has a contagion effect, in my view, in our communities all across this country beyond the very stark reality of those
who actually lose their homes, the effect of others watching the
value of their properties decline, not to mention what that means
to local tax bases, supporting local police and fire, and a variety of
other concerns raised by this issue.
I certainly want to commend the Fed Chairman—I said so yesterday publicly, Mr. Chairman; I do so again this morning—for
candidly acknowledging the weakness in the economy and for actively addressing those weaknesses by injecting liquidity and cutting interest rates. I also am pleased that the administration and
the Congress were able to reach agreement on a stimulus package,
and our hope is—while some have argued this is not big enough
or strong enough, our collective hope is this will work, will have
some very positive impact on the economy. Certainly this will have
some support, we hope, for working families who are bearing the
brunt of these very difficult times.
However, I think more needs to be done to address the root cause
of our economic problems. Any serious effort to address our economic woes should include, I think, an effort to take on the foreclosure crisis. And, again, there are various ideas out there on how
we might do this more effectively, and certainly the Chairman and
others have offered some ideas and suggestions. Senator Shelby
and I have been working and talking—and Mel Martinez and others who are involved in these issues—about ways in which we can
in the coming days do constructive things in a positive way to indicate and show not only our concern about the issue but some very
strong ideas on how we can right this and restore that confidence
I talked about earlier.
We on this Committee have already taken some steps to address
these problems. We have passed the FHA modernization legislation
through the Committee and the Senate and continue to work to
make it law. We had a very good meeting yesterday, I would point
out, Senator Shelby and I and the leadership of the House Financial Services Committee, I say to you, Mr. Chairman, in hopes that
we can come to some very quick conclusion on that piece of legislation and move it along here.
We appropriated close to $200 million to facilitate foreclosure
prevention efforts by borrowers and lenders, and I want to commend Senator Schumer and others who have been involved in this
idea of counseling and ideas to minimize the impact of this problem
as well.
In addition, the recently enacted stimulus package that I mentioned already includes a temporary increase in the conforming
loan limits for GSEs to try to address the problems that have
spread throughout the credit market and the jumbo mortgage market. And while this temporary increase is helpful, we still need to
implement broad GSE reform. And as I have said previously, I am
committed to doing that, and we will get that done.
I have spoken about my belief in the need for additional steps
to mitigate the foreclosure crisis in a reasonable and thoughtful
manner. These steps include targeting some community development block grant assistance to communities in a targeted way to
help them to counter the impact of foreclosed and abandoned properties in their communities. And they include establishing a temporary homeownership loan initiative, which I have raised and others have commented on, either using existing platforms or a new
entity that can facilitate mortgage refinancing.
But it is not just the Congress that needs to do more, and, again,
the Fed needs, in my view, to be as vigilant a financial regulator
as it has been a monetary policymaker. That includes breaking
with its past and becoming more vigilant about policing indefensible lending practices. And, again, I commend the Chairman of the
Federal Reserve—we have talked about this here—on the proposed
regulations that you have articulated that would follow on the
HOEPA legislation. And while I have expressed some disappointment about how far they go in certain areas here, the Chairman
and I have talked about this a bit. We will be involved in the comment period here and are looking forward to finalizing those regulations, and hopefully at least shutting the door on this kind of a
problem re-emerging in the coming months and years.
So I want to thank you, Mr. Chairman, and your colleagues and
urge them to consider some of the stronger measures, and we will
offer some additional comments on them.
Despite these unprecedented challenges, I think all of us here on
this Committee, Republicans and Democrats, remain confident in
the future of the American economy, and our concerns that will be
raised here this morning should not reflect anything but that confidence in the future. We may need to change some of our policies,
regulations, and priorities, but we strongly believe that the ingenuity, productivity, and capability of the American worker and the
entrepreneur ought never to be underestimated in this country.
And we remain firm and committed to doing everything we can to
strengthen those very points.
So I look forward to working with my good friend, Senator
Shelby, and other Members of the Committee to do what we can
here to play our role in all of this in a constructive way, to work
with you, Mr. Chairman, and the Federal Reserve, the Secretary of
the Treasury, and others of the financial institution regulators to
see what we can do in the short term to get this moving in a better
direction.
So, with that, let me turn to Senator Shelby for his opening comments, and then we will try to get to some questions. And I will
leave opening comments for the go-around and question period so
we can get to a question-and-answer period here to make this as
productive a session as possible. But we thank you again for being
with us.
STATEMENT OF SENATOR RICHARD C. SHELBY
Senator SHELBY. Thank you, Chairman Dodd.
Chairman Bernanke, we are pleased to have you again before the
Committee to deliver the Federal Reserve's Semiannual Monetary
Policy Report. I will keep my remarks brief this morning as we are
all here to hear your views on the U.S. economy and other related
issues. We also have the benefit of having read about your remarks
before the House yesterday.
Chairman Bernanke, the Federal Reserve has taken a number of
steps over the past 6 months to address the tightening of credit
markets and the slowdown in economic growth. In a bid to improve
interbank liquidity, the Federal Reserve established the term auction facility in December of last year and has conducted, as I understand it, six auctions to date.
Since last August, the Federal Open Market Committee has reduced the Federal funds target a total of 225 basis points, taking
the target from 5.25 percent to 3 percent.
Mr. Chairman, since monetary policy works with a lag, the full
impact of this boost to the economy is not yet clear to you or to us.
I know that we will spend time this morning discussing the length
and the depth of the housing correction that Senator Dodd alluded
to, and I think we should. I also want to make sure, however, that
this Committee focuses on the risks associated with increasing inflation.
The Labor Department, Mr. Chairman, reported this week, as
you know, that wholesale price inflation hit a 26-year high in January. The January rise in the Consumer Price Index meant a 12month change in the overall CPI of 4.3 percent, twice the pace of
a year ago. In addition, gold and oil are at all-time highs. These
numbers certainly raise questions, Mr. Chairman, as to how much
more room the Federal Reserve will have to provide further monetary accommodation without threatening long-term price stability,
which is very important to all of us. While it is difficult to see our
Nation's economy experience minimal growth, the consequences of
failing to restrain inflation will be far more painful and more difficult to unwind.
Chairman Bernanke, we are pleased to have you with us this
morning, and we look forward to your thoughts on this and other
issues.
Chairman DODD. Thank you very much.
Let me correct myself. The tradition has been, Mr. Chairman, if
Members do want to make some opening comments at a moment
like this, and I do not want to break that tradition. So I am going
to ask if any Members would like to make any opening comments
at this point, I would be happy to entertain them. I realize that has
been the tradition of the Committee, and I do not want to violate
the traditions of the Committee. Does any Member want to be
heard, some opening comments to make at this point? If they
would like to, I would be happy to entertain
Senator BUNNING. Let me ask a question. If we do not make
them now and we make them during our timeframe, does that limit
how many questions we can ask?
Chairman DODD. Well, that is the idea. I mean, I do not want
to limit your time, but
[Laughter.]
Chairman DODD. So if you would like to
Senator SHELBY. Make your opening statement.
Senator BAYH. That would make Chairman Bernanke happy.
Chairman DODD. I understand that, and that is why you get the
gavel after 27 years. But if you would like to make an opening comment
Senator BUNNING. OK.
Chairman DODD. All right. Anyone else who would like to be
heard?
Senator SHELBY. Why don't you add a minute and do both?
Chairman DODD. We will add a minute. Why don't I add a
minute to the time here? Instead of having 5 or 6 minutes, we will
make it 7 or 8 minutes. And I have never tried to be too rigid about
that, and so we will do it that way if that is all right. That will
move things along. Is that OK with everyone? Thank you very
much.
Mr. Chairman, we welcome you to the Committee.
STATEMENT OF BEN S. BERNANKE, CHAIRMAN,
BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
Mr. BERNANKE. Thank you. Chairman Dodd, Ranking Member
Shelby, and other Members of the Committee, I am pleased to
present the Federal Reserve's Monetary Policy Report to the Congress. In my testimony this morning, I will briefly review the economic situation and outlook, beginning with developments in real
activity and inflation, and then turn to monetary policy.
Senator BUNNING. Mr. Chairman, would you please move that
microphone a little closer so we can all hear you?
Mr. BERNANKE. HOW is this?
Senator BUNNING. That is good.
Mr. BERNANKE. I will conclude with a quick update on the Federal Reserve's recent actions to help protect consumers in their financial dealings.
The economic situation has become distinctly less favorable since
the time of our July report. Strains in financial markets, which
first became evident late last summer, have persisted; and pressures on bank capital and the continued poor functioning of markets for securitized credit have led to tighter credit conditions for
many households and businesses. The growth of real gross domestic product held up well through the third quarter despite the financial turmoil, but it has since slowed sharply. Labor market conditions have similarly softened, as job creation has slowed and the
unemployment rate—at 4.9 percent in January—has moved up
somewhat.
Many of the challenges now facing our economy stem from the
continuing contraction of the U.S. housing market. In 2006, after
a multiyear boom in residential construction and house prices, the
housing market reversed course. Housing starts and sales of new
homes are now less than half of their respective peaks, and house
prices have flattened or declined in many areas. Changes in the
availability of mortgage credit amplified the swings in the housing
market.
During the housing sector's expansion phase, increasingly lax
lending standards, particularly in the subprime market, raised the
effective demand for housing, pushing up prices and stimulating
construction activity. As the housing market began to turn down,
however, the slump in subprime mortgage originations, together
with a more general tightening of credit conditions, has served to
increase the severity of the downturn. Weaker house prices in turn
have contributed to the deterioration in the performance of mortgage-related securities and reduced the availability of mortgage
credit.
The housing market is expected to continue to weigh on economic
activity in coming quarters. Home builders, still faced with abnormally high inventories of unsold homes, are likely to cut the pace
of their building activity further, which will subtract from overall
growth and reduce employment in residential construction and
closely related industries.
Consumer spending continued to increase at a solid pace through
much of the second half of 2007, despite the problems in the housing market, but it appears to have slowed significantly toward the
end of the year. The jump in the price of imported energy, which
eroded real incomes and wages, likely contributed to the slowdown
in spending, as did the declines in household wealth associated
with the weakness in house prices and equity prices.
Slowing job creation is yet another potential drag on household
spending, as gains in payroll employment averaged little more than
40,000 per month during the 3 months ending in January, compared with an average increase of almost 100,000 per month over
the previous 3 months. However, the recently enacted fiscal stimulus package should provide some support for household spending
during the second half of this year and into next year.
The business sector has also displayed signs of being affected by
the difficulties in the housing and credit markets. Reflecting a
downshift in the growth of final demand and tighter credit conditions for some firms, available indicators suggest that investment
in equipment and software will be subdued during the first half of
2008. Likewise, after growing robustly through much of 2007, nonresidential construction is likely to decelerate sharply in coming
quarters as business activity slows and funding becomes harder to
obtain, especially for more speculative projects. On a more encouraging note, we see few signs of any serious imbalances in business
inventories aside from the overhang of unsold homes. And, as a
whole, the nonfinancial business sector remains in good financial
condition, with strong profits, liquid balance sheets, and corporate
leverage near historical lows.
In addition, the vigor of the global economy has offset some of
the weakening of domestic demand. U.S. real exports of goods and
services increased at an annual rate of about 11 percent in the second half of last year, boosted by continuing economic growth
abroad and the lower foreign exchange value of the dollar.
Strengthening exports, together with moderating imports, have in
turn led to some improvement in the U.S. current account deficit,
which likely narrowed in 2007—on an annual basis—for the first
time since 2001. Although recent indicators point to some slowing
of foreign economic growth, U.S. exports should continue to expand
at a healthy pace in coming quarters, providing some impetus to
domestic economic activity and employment.
As I have mentioned, financial markets continue to be under considerable stress. Heightened investor concerns about the credit
quality of mortgages, especially subprime mortgages with adjustable interest rates, triggered the financial turmoil. However, other
factors, including a broader retrenchment in the willingness of investors to bear risk, difficulties in valuing complex or illiquid financial products, uncertainties about the exposures of major financial
institutions to credit losses, and concerns about the weaker outlook
for economic growth, have also roiled the financial markets in recent months. To help relieve the pressures in the market for interbank lending, the Federal Reserve—among other actions—recently
introduced a term auction facility, through which prespecified
amounts of discount window credit are auctioned to eligible borrowers, and we have been working with other central banks to address market strains that could hamper the achievement of our
broader economic objectives. These efforts appear to have contributed to some improvement in short-term funding markets. We will
continue to monitor financial developments closely.
As part of its ongoing commitment to improving the accountability and public understanding of monetary policymaking, the
Federal Open Market Committee—or FOMC—recently increased
the frequency and expanded the content of the economic projections
made by Federal Reserve Board members and Reserve Bank presidents and released to the public. The latest economic projections,
which were submitted in conjunction with the FOMC meeting at
the end of January and which are based on each participant's assessment of appropriate monetary policy, show that real GDP was
expected to grow only sluggishly in the next few quarters and that
the unemployment rate was likely to increase somewhat. In particular, the central tendency of the projections was for real GDP to
grow between 1.3 percent and 2.0 percent in 2008, down from 2Vz
percent to 23A percent projected in our report last July. FOMC participants' projections for the unemployment rate in the fourth quarter of 2008 have a central tendency of 5.2 percent to 5.3 percent,
up from the level of about 4% percent projected last July for the
same period. The downgrade in our projections for economic activity in 2008 since our report last July reflects the effects of the financial turmoil on real activity and a housing contraction that has
been more severe than previously expected. By 2010, our most recent projections show output growth picking up to rates close to or
a little above its longer-term trend and the unemployment rate
edging lower; the improvement reflects the effects of policy stimulus and an anticipated moderation of the contraction in housing
and the strains in financial and credit markets. The incoming information since our January meeting continues to suggest sluggish
economic activity in the near term.
The risks to this outlook remain to the downside. The risks include the possibilities that the housing market or the labor market
may deteriorate more than is currently anticipated and that credit
conditions may tighten substantially further.
Consumer price inflation has increased since our previous report,
in substantial part because of the steep run-up in the price of oil.
Last year, food prices also increased significantly, and the dollar
depreciated. Reflecting these influences, the price index for personal consumption expenditures—or PCE—increased 3.4 percent
over the four quarters of 2007, up from 1.9 percent in 2006. Core
price inflation—that is, inflation excluding food and energy prices—
also firmed toward the end of the year. The higher recent readings
likely reflected some pass-through of energy costs to the prices of
core consumer goods and services as well as the effect of the depreciation of the dollar on import prices. Moreover, core inflation in
the first half of 2007 was damped by a number of transitory factors—notably, unusually soft prices for apparel and for financial
services—which subsequently reversed. For the year as a whole,
however, core PCE prices increased 2.1 percent, down slightly from
2006.
The projections recently submitted by FOMC participants indicate that overall PCE inflation was expected to moderate significantly in 2008, to between 2.1 percent and 2.4 percent—the central
tendency of the projections. A key assumption underlying those
projections was that energy and food prices would begin to flatten
out, as implied by quotes on futures markets. In addition, dimin-
9
ishing pressure on resources is also consistent with the projected
slowing in inflation. The central tendency of the projections for core
PCE inflation in 2008, at 2.0 percent to 2.2 percent, was a bit higher than in our July report, largely because of some higher-than-expected recent readings on prices. Beyond 2008, both overall and
core inflation were projected to edge lower, as participants expected
inflation expectations to remain reasonably well anchored and
pressures on resource utilization to be muted. The inflation projections submitted by FOMC participants for 2010—which ranged
from 1.5 percent to 2.0 percent for overall PCE inflation—were importantly influenced by participants' judgments about the measured rates of inflation consistent with the Federal Reserve's dual
mandate and about the timeframe over which policy should aim to
achieve those rates.
The rate of inflation that is actually realized will, of course, depend on a variety of factors. Inflation could be lower than we anticipate if slower-than-expected global growth moderates the pressure on the prices of energy and other commodities or if rates of
domestic resource utilization fall more than we currently expect.
Upside risks to the inflation projection are also present, however,
including the possibilities that energy and food prices do not flatten
out or that the pass-through to core prices from higher commodity
prices and from the weaker dollar may be greater than we anticipate. Indeed, the further increases in the prices of energy and
other commodities in recent weeks, together with the latest data on
consumer prices, suggest slightly greater upside risks to the projections of both overall and core inflation than we saw last month.
Should high rates of overall inflation persist, the possibility also exists that inflation expectations could become less well anchored.
Any tendency of inflation expectations to become unmoored or for
the Fed's inflation-fighting credibility to be eroded could greatly
complicate the task of sustaining price stability and could reduce
the flexibility of the FOMC to counter shortfalls in growth in the
future. Accordingly, in the months ahead, the Federal Reserve will
continue to monitor closely inflation and inflation expectations.
Let me turn now to the implications of these developments for
monetary policy. The FOMC has responded aggressively to the
weaker outlook for economic activity, having reduced its target for
the Federal funds rate by 225 basis points since last summer. As
the Committee noted in its most recent post-meeting statement,
the intent of those actions has been to help promote moderate
growth over time and to mitigate the risks to economic activity.
A critical task for the Federal Reserve over the course of this
year will be to assess whether the stance of monetary policy is
properly calibrated to foster our mandated objectives of maximum
employment and price stability in an environment of downside
risks to growth, stressed financial conditions, and inflation pressures. In particular, the FOMC will need to judge whether the policy actions taken thus far are having their intended effects. Monetary policy works with a lag. Therefore, our policy stance must be
determined in light of the medium-term forecast for real activity
and inflation as well as by the risks to that forecast. Although the
FOMC participants' economic projections envision an improving
economic picture, it is important to recognize that downside risks
10
to growth remain. The FOMC will be carefully evaluating incoming
information bearing on the economic outlook and will act in a timely manner as needed to support growth and to provide adequate insurance against downside risks.
Finally, I would like to say a few words about the Federal Reserve's recent actions to protect consumers in their financial transactions. In December, following up on a commitment I made at the
time of our report last July, the Board issued for public comment
a comprehensive set of new regulations to prohibit unfair or deceptive practices in the mortgage market, under the authority granted
us by the Home Ownership and Equity Protection Act of 1994. The
proposed rules would apply to all mortgage lenders and would establish lending standards to help ensure that consumers who seek
mortgage credit receive loans whose terms are clearly disclosed and
that can reasonably be expected to be repaid. Accordingly, the rules
would prohibit lenders from engaging in a pattern or practice of
making higher-priced mortgage loans without due regard to consumers' ability to make the scheduled payments. In each case, a
lender making a higher-priced loan would have to use third-party
documents to verify the income relied on to make the credit decision. For higher-priced loans, the proposed rules would require the
lender to establish an escrow account for the payment of property
taxes and homeowners' insurance and would prevent the use of
prepayment penalties in circumstances where they might trap borrowers in unaffordable loans. In addition, for all mortgage loans,
our proposal addresses misleading and deceptive advertising practices, requires borrowers and brokers to agree in advance on the
maximum fee that the broker may receive, bans certain practices
by servicers that harm borrowers, and prohibits coercion of appraisers by lenders. We expect substantial public comment on our
proposal, and we will carefully consider all information and viewpoints while moving expeditiously to adopt final rules.
The effectiveness of the new regulations, however, will depend
critically on strong enforcement. To that end, in conjunction with
other Federal and State agencies, we are conducting compliance reviews of a range of mortgage lenders, including nondepository lenders. The agencies will collaborate in determining the lessons
learned and in seeking ways to better cooperate in ensuring effective and consistent examinations of, and improved enforcement for,
all categories of mortgage lenders.
The Federal Reserve continues to work with financial institutions, public officials, and community groups around the country to
help homeowners avoid foreclosures. We have called on mortgage
lenders and servicers to pursue prudent loan workouts and have
supported the development of a streamlined, systematic approach
to expedite the loan modification process. We also have been providing community groups, counseling agencies, regulators, and others with detailed analyses to help identify neighborhoods at high
risk from foreclosures so that local outreach efforts to help troubled
borrowers can be as focused and effective as possible. We are actively pursuing other ways to leverage the Federal Reserve's analytical resources, regional presence, and community connections to
address this critical issue.
11
In addition to our consumer protection efforts in the mortgage
area, we are working toward finalizing rules under the Truth in
Lending Act that will require new, more informative, and consumer-tested disclosures by credit card issuers. Separately, we are
actively reviewing potentially unfair and deceptive practices by
issuers of credit cards. Using the Board's authority under the Federal Trade Commission Act, we expect to issue proposed rules regarding these practices this spring.
Thank you. I would be pleased to take your questions.
Chairman DODD. Thank you very much, Mr. Chairman.
We will make these 7 to 8 minutes, and, again, I will not be rigid
about the time constraints.
Let me begin, Mr. Chairman, by going back to that old question
that was asked more than, I guess, 30 years ago. I will sort of paraphrase on it, and that is, are we better off today to respond to this
situation than we were—in this case I want to ask 7 years ago. The
question that Ronald Reagan asked, I think, in 1980 in that campaign, Are we better off today than we were yesterday? And the
reason I raise that is because I have been struck by the similarities
between 2001 and that period going into, potentially falling into a
recession, and here we are in 2008.
The parallel seems striking to me in some ways, and I want you
to comment on this, if you could. At both moments in this 7-year
period, we are on the brink of a recession—at least it seems so. The
Fed was cutting interest rates very aggressively. A major asset
bubble—in this case, it was the high-tech community rather than
housing—was bursting. Yet despite those similarities, the differences in the basic economic information seems to be very, very
different as well. Americans had just experienced the greatest economic boom in a generation. Real wages had gone up substantially.
Income inequality had narrowed. The Federal Government was in
a surplus. In fact, on this very Committee, your predecessor came
to a hearing—I do not know who else was on the Committee in
those days, but he came and talked about the things we ought to
think about by retiring the national debt entirely. There were some
downsides to that, and we actually had a very good hearing with
Alan Greenspan about that very question in 2001. The dollar was
at record highs as well, and, of course, today we are in the opposite
position, with the dollar at its lowest level since we began floating
currencies in 1973. Inflation is at a 17-year high. Real wages are
falling, and we are faced with record Government debt and deficits.
A very different fact situation than was the case in 2001.
In 2001, as well, one might argue that there were deliberate actions taken by the Federal Reserve to deal with rising inflation. So
the steps were in response to inflation here. Obviously, what is provoking, I think, the action—and you can certainly comment on
this—is a different fact situation.
So the question appears in a sense: Are we in a—what would be
your analysis? Are we in a—comparing these two periods in time
of history, relatively close to each other, faced with similar situations, it would appear to me that we are not in as strong a position
to respond to this as we were in 2001. And so the question is, Are
we better off? And if so, I would like you to explain why. And if
not, what should we be doing and what different steps should we
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be taking if we cannot rely on these basic underlying strengths
that occurred in 2001 that helped us at that time as opposed to
where we are today?
Mr. BERNANKE. Mr. Chairman, there are certainly some similarities with the 2001 experience, most obviously the sharp change in
asset price. In the previous case, it was the stock market, the tech
stocks; in this case, it is home prices. But there are some important
differences as well, as you point out. The decline in home prices is
creating a much broader set of issues, both for borrowers and
homeowners, but also for the credit markets. And so we have a sustained disruption in the credit process which has gone on now since
last August and is not yet near completion. That is a continuing
drag on the economy and a continuing problem for us as we try to
restore stronger growth.
The other problem is that we do have greater inflation pressure
at this point than we did in 2001, and that is coming from oil. In
2001, the price of oil was somewhere around $20. Today it is $100.
Chairman DODD. Right.
Mr. BERNANKE. The increase in commodity prices around the
world as the global economy expands and increases demand for
those commodities is creating an inflationary stress which is complicating the Federal Reserve's attempts to respond.
In some other ways, things are different. You pointed out the dollar was very strong in 2001. That was in part reflective of a large
trade deficit at that time. It has since depreciated. But, on the
other hand, part of the effect of that depreciation has been that we
are at least seeing some improvement in that trade deficit, which
is a positive factor.
On the fiscal situation, I agree we are in a less advantageous situation than we were. The deficit is certainly higher, and perhaps
even more seriously, we are now 7 years further on toward the retirement of the baby boomers and the entitlements, and those costs
that are certainly bearing down on us as we speak.
So it is a difficult situation, and there are multiple factors. I
think there are some similarities, but as a Russian novelist once
said, "Unhappy families are all unhappy in their own way," and
every period of financial and economic stress has unique characteristics.
Chairman DODD. Well, do you have any recommendations, then,
differently here? If we are responding in a very similar way with
different underlying economic fact situations, are there other
things we ought to be doing here, taking any kind of a different approach? Or are we secure in feeling that the present course of action being taken by the Fed and by the administration is going to
produce the desired results? That period of recession lasted about
8 months. There are fears that this one, if it takes hold, could be
far more long-lasting for the very reasons we have outlined in the
underlying problems economically that exist.
Mr. BERNANKE. Well, to some extent, the private sector is going
to have to work through the problems in the financial markets.
That is something that they will have to do with the help and guidance of the regulators and the supervisors, which we are certainly
doing. We are reviewing our practices and our policies and trying
to see how we can improve them.
13
With respect to the broader economy, of course, we have both
monetary and fiscal policy action now underway, which I hope will,
and we project will, lead to stronger growth in the second half of
this year. An important issue, as you have already alluded to, is
the effects of the home price declines on consumers and, in particular, the delinquencies and foreclosures which we are now seeing.
I have described briefly in my remarks some of the things that
we have done in calling on private servicers and lenders to scale
up their activities, to use more streamlined processes. I think it is
important for us and for the servicers to move beyond temporary
palliatives that they are using in many cases with delinquent borrowers and try to find more permanent, sustainable solutions in
terms of restructuring mortgages or refinancing into the FHA or
other mechanisms.
Congress has already taken some steps, as you mentioned, and
would urge you to continue to work on FHA modernization and
GSE reform.
Chairman DODD. Right.
Mr. BERNANKE. Those are two areas that can help us meet these
challenges.
Additional steps may be necessary in the future, but at this
point, I think we have taken a number of useful steps. We need
to keep thinking about possible future options, but I do not have
any additional recommendations right now.
Chairman DODD. I do not want to put words in your mouth, obviously, at all here, but I am looking at—obviously the housing burst
or bubble, the burst of that bubble is, I think, far more dangerous
than a high-tech problem, as you make those comparisons. Inflation and trade deficits are worse. Am I hearing you correctly that
we are actually in a worse position today to respond to this than
we were 8 years ago? Is that how I hear what you are saying?
Mr. BERNANKE. I think that is fair in that both fiscal and monetary policy face some additional constraints. Many people owned
stocks, too, of course, and so that affected their wealth and their
willingness to spend. But, in fact, the effects of the stock market
declines in 2001 were primarily on investment firms than on consumers. In this case, the consumers are taking the brunt of the effects.
Chairman DODD. That is a good additional point. I did not make
that.
Senator Shelby.
Senator SHELBY. Thank you, Mr. Chairman.
Chairman Bernanke, as I noted earlier, wholesale prices rose by
1 percent in January and 7.4 percent over the past year. This is
the fastest increase in 26 years. In your opening statement, you
noted greater upside risks to both overall and core inflation than
we saw previously. Additionally, the most recent minutes of the
Federal Open Market Committee gave anecdotal evidence that in
some instances these price increases were passed on to consumers.
The FOMC also noted a risk that inflation expectations could become less anchored.
14
Do you have any concern at all that the 225 basis-point cut to
the Federal funds rate has limited the options that can be used to
combat the upside risk of inflation?
Mr. BERNANKE. Well, Senator, to answer that question, the PPI,
the Producer Price Index, that you referred to mostly reflects the
effects of large increases in prices of energy and other commodities.
We live in a world where energy and metals and other commodities
are globally traded, food as well, and demand of emerging market
economies and a growing global economy has put pressure on the
available supplies of those resources and has driven up those
prices. And as I mentioned, the price of oil has quintupled or more.
Senator SHELBY. DO you see that abating?
Mr. BERNANKE. In 2007, the price of oil rose by about two-thirds,
and I suspect—and the futures markets agree—that it is much
more likely that oil prices, while remaining high, will not increase
by anything like that amount going forward. If oil prices and food
prices do stabilize to some extent, even if they do not fall, that will
be sufficient to bring inflation down as we have projected.
Now, you are correct, though, that we do have to be very cautious. While we cannot do much about oil prices or food prices in
the short run, we do have to be careful to make sure that those
prices do not either feed substantially into other types of prices,
other goods and services produced domestically, and that they do
not dislodge inflation expectations or make the public less confident
that the Federal Reserve will, in fact, control inflation, as we will.
So we do have to watch those things very carefully, and will
watch them very carefully.
Senator SHELBY. IS that what some of us would talk about, the
psychology of inflation?
Mr. BERNANKE. Well, that is another way to put it. But, yes, inflation expectations essentially are measured many different ways,
and I think the evidence is that they remain pretty stable. If you
look at forecasters' long-term inflation expectations, consumer surveys, and even the financial markets, they show that inflation expectations remain reasonably well anchored. But it is certainly
something we have to watch very carefully.
Senator SHELBY. DO you believe that setting a Fed funds rate
target lower than the inflation rate—that is, a negative real rate
of interest—can be an appropriate response to an economic slowdown? In other words, how long can the Fed run a negative real
rate before inflationary pressures grow to dangerous levels?
Mr. BERNANKE. Well, Senator, there are different ways to measure the real interest rate. The one that is relevant is the one that
is looking forward, and, again, if oil prices do not continue to rise
at this pace they have, I think we would still be on the positive
side of the real interest rate.
Now, in the past, the Fed has for short periods lowered the rate
to a negative level, but as you point out, that is not something you
want to do for a sustained period.
Senator SHELBY. The Fed cannot ignore price stability, can it,
when you are making these decisions to have more liquidity in the
financial market?
Mr. BERNANKE. Senator, we are facing a situation where we have
simultaneously a slowdown in the economy, stress in the financial
15
markets, and inflation pressure coining from these commodity
prices abroad. And each of those things represents a challenge. We
have to make our policy in trying to balance those different risks
in a way that will get the best possible outcome for the American
economy.
Senator SHELBY. Would you be trying to avoid stagflation, as
some people call it?
Mr. BERNANKE. I do not anticipate stagflation. I do not think we
are anywhere near the situation that prevailed in the 1970's. I do
expect inflation to come down. If it does not, we will have to react
to it, but I do expect that inflation will come down and that we will
have both return to growth and price stability as we move forward.
Senator SHELBY. DO you still believe that the fundamentals of
our economy is still robust, is strong, other than the housing market and some of the financial challenges that we have coming out
of that?
Mr. BERNANKE. Senator, I realize my testimony was not the most
cheerful thing you will hear today, and I was thinking very much
about the short-term challenges that we face in terms of the financial markets and growth and inflation. But I do very much believe
that the U.S. economy will return to a strong growth path with
price stability. We have enormous resources, resilience, productivity, and I am quite confident in the American economy and the
American people that we will have strong economic growth in the
next few years.
Senator SHELBY. Mr. Chairman, a commonly watched measure of
inflation, as you well know, is the core CPI. Housing constitutes,
I understand, almost a third of the core CPI. To what extent has
the recent decline in housing prices moderated recent increases in
the core CPI? As housing prices go down, inflation, you know,
should play here in a negative way, should it not?
Mr. BERNANKE. Well, Senator, not necessarily. You can get actually a perverse effect, which is that as house prices
Senator SHELBY. And how would that work?
Mr. BERNANKE. AS house prices fall, people will become more reluctant to buy a house because they are afraid that the house price
will keep falling, so they rent instead. And that puts pressure on
rents and actually could drive up the rent.
Senator SHELBY. Good for the landlords and bad for the sellers.
Mr. BERNANKE. It can be, and the way the Bureau of Labor Statistics calculates the cost of homeowner ship, it uses a lot of information from measured rents. So you can actually get—as we did
last year—a period where the cost of homeownership as measured
by the BLS actually went up, even though house prices were coming down, because of the fact that people were renting more and
rental costs were going up. That effect has moderated somewhat recently, and that has helped to keep down
Senator SHELBY. What would be the trend from your perspective
in the core CPI if house prices were excluded?
Mr. BERNANKE. House prices are not included
Senator SHELBY. I know they are not, but what if you did exclude
them? What would be the trend in the core CPI?
Mr. BERNANKE. I am sorry. House prices are not included in
the
16
Senator SHELBY. OK, they are not.
Mr. BERNANKE. In the CPI. What is included
Senator SHELBY. They are excluded.
Mr. BERNANKE. The measure of shelter costs is related to rents
drawn from various sources.
Senator SHELBY. One more question, Mr. Chairman.
What do you judge to be the threat of slow growth continuing
with inflation remaining above the Federal Reserve's comfort level?
What would you say to that? In other words, what do you judge to
be the threat of the slow growth continuing with inflation remaining above your comfort level?
Mr. BERNANKE. Well, we are certainly aiming to achieve our
mandate, which is maximum employment and price stability. We
project that that will be happening. We are watching very carefully
because there are risks to those projections. One of the risks, obviously, is the performance of the financial markets, and that again,
as I mentioned before, complicates the situation.
As events unfold—and certainly there are many things that we
cannot control or cannot anticipate at this point—we are simply
going to have to keep weighing the different risks and trying to
find an appropriate balance for policy going forward.
Senator SHELBY. AS a bank regulator, too—this will be my last
question, Mr. Chairman—do you fear some bank failures in this
country? I know there are big risks where they are heavily involved
in real estate lending. Does that bother you as a bank regulator?
Mr. BERNANKE. Well, I believe the FDIC and the OCC have recently provided some information. There probably will be some
bank failures. There are, for example, some small or in many cases
de novo banks that are heavily invested in real estate in locales
where prices have fallen, and, therefore, they would be under some
pressure. So I expect there will be some failures.
Among the largest banks, the capital ratios remain good, and I
do not anticipate any serious problems of that sort among the large
internationally active banks that make up a very substantial part
of our banking system.
Senator SHELBY. DO you see some of those larger banks seeking
additional capital to bolster themselves?
Mr. BERNANKE. They have already sought something on the
order of $75 billion in capital in the last quarter.
Senator SHELBY. IS that enough?
Mr. BERNANKE. I would like to see them get more. They have
enough now certainly to remain solvent and to remain above, well
above their minimum capital levels. But I am concerned that banks
will be pulling back and not making new loans and providing the
credit, which is the lifeblood of the economy. In order to be able to
do that, they need in many cases—not all cases, but in some cases
at least—they need to get more capital.
Senator SHELBY. Thank you.
Chairman DODD. Thank you very much, Mr. Chairman.
Let me just say to the Chairman, I said this to him privately, but
I really appreciate your candor in all of this. Your job is not to be
a cheerleader but to lay out for us exactly how you see things. And
I for one, anyway—I do not know if other Members feel likewise,
but I am very appreciative of the fact that you are very clear and
17
very straightforward on your assessment of these matters, and that
is important.
Senator Reed.
Senator REED. Well, thank you very much, Mr. Chairman. And,
Chairman Bernanke, welcome. I will say first that you bring to this
very challenging job great intellect and great integrity, and I appreciate it very much. And it is a daunting moment in our economic history.
You said in rather unemotional terms, characteristically talked
about the squeeze that families are feeling. What I have heard in
Rhode Island is exactly the same thing: increased costs for practically everything you need, flat wages, and then the housing problem taking away that sense of well reserve if something goes
wrong.
In fact, I was particularly struck by comments that were related
to me about the bakers in Rhode Island, the family bakeries who
have seen the price of wheat go up 200, 300, 400 percent. It is unprecedented, frankly. And if that continues, we are going to have
real serious, serious problems, as you alluded to.
The Fed has two major responsibilities: monetary policy but regulation of large financial institutions. And in that latter category,
I alluded to this in our last conversation in the Committee about
your take on, frankly, how well you have activated your regulatory
responsibilities in these last few years.
We have seen major institutions write off billions of dollars, and
mostly because of off-balance-sheet transactions. And it is quite
clear that the Fed is there on a daily basis in all the institutions.
I think the former Chairman of the CEA, Martin Feldstein, wrote,
"The Fed's banking examiners have complete access to all the financial transactions of the banks that they supervise and should
have the technical expertise to evaluate the risks that those banks
are taking."
Well, it seems quite clear now, with the restatement of balance
sheets that these banks are taking lots of risks that they did not
really see as risks.
Are you satisfied that you have in place the regulatory procedures? And are you—I do not know what the right word is—disappointed that your regulatory apparatus did not alert the banks
or monitor the banks more closely over the last several months?
Mr. BERNANKE. Well, Senator, you raise some important questions. First of all, we and our fellow regulators, both in the United
States and around the world, are engaged, as you might imagine,
in a very serious review of what has happened and what we can
do better in the future. The Federal Reserve itself is looking at our
own practices and staffing and all those issues. The President's
Working Group is working on a set of recommendations looking
broadly at the financial markets and the problems that arose. And
all of those discussions and information will be feeding into an
international analysis—the Financial Stability Forum, the Basel
Committee, international groups of financial regulators, central
banks, Finance Ministers, and so on—which will try to determine,
what the problems were, where we can do better, and what we
have learned from this episode. So we are certainly doing a lot of
stock taking and trying to determine where there were problems.
18
In terms of the banks it should be emphasized that we do work
very closely with the other regulators—the OCC, the FDIC, and
others, depending on the type of bank. Our focus, I think of necessity, is for the most part on things such as the overall structure
of risk management, the practices and procedures that the banks
follow.
It is very difficult for us to second-guess the specific asset price
or asset purchase decisions that they make. I think going forward
we do need to look in a much tougher way at the risk management
and risk measurement procedures that the banks have. But, again,
it is very difficult for us to tell a bank that—when they make a certain investment that they think it is a good investment, and they
have done all the due diligence—that it is a bad investment. That
is not usually our role.
Senator REED. Let me follow up with two questions and ask for
a brief response. First, when do you anticipate sharing with this
Committee the results of this analysis you are doing of your regulatory position within the next several months in a detailed basis?
Mr. BERNANKE. Well, the President's Working Group and then
the international bodies—the Financial Stability Forum, the Basel
Committee—are anticipating sharing these reports within the next
couple of months. The Financial Stability Forum has already
issued a preliminary interim report trying to identify the areas of
weakness and problems.
Senator REED. Another question, and this goes back to sort of the
level of detail. Do your examiners look at what is happening on the
trading desks of these large institutions in real time and then compare it to what is happening on the asset side? I mean, there has
been a suggestion in some institutions that while they were being
booked, some of these investments, at a reasonably high price, the
traders were selling at a deep discount. Is that something that you
did or propose to do in the future?
Mr. BERNANKE. Well, again, we cannot look over the shoulder of
every trader on every trade, but what we can try to do is ensure
that the systems exist so that the bank is ensuring that the appropriate markdowns are taking place so that they are consistent between the trade and the booking. So we do look at the systems and
the risk management systems to try to determine if they are properly managed.
Senator REED. Well, you know, I think we have a problem here,
frankly, maybe because—and, again, you can take a systematic
procedure, see that the procedures are all in place, but if the procedures are missing a major point or the assumptions underlying the
procedures are outdated—and I would hope that your review would
be prompt and timely and allow us to see details of what you have
been looking at.
Let me ask a question. You brought up Basel II. One of the aspects of Basel II, to my understanding, is a reliance on ratings and
rating agencies. In fact, it has been reported that Northern Rock,
the British institution that failed that has now been nationalized
by the British Government, was able to lower their risk-weighted
assets by 44 percent under Basel II. The CEO at the time described
it as the "benefits of Basel." I suspect he is not describing it as
19
that—certainly the Prime Minister is not describing it as the "benefits of Basel" now.
Does that give you pause with respect to rushing forward with
Basel II?
Mr. BERNANKE. Well, Basel II, I still believe, is the right direction. It is based on properly measuring risk and relating capital to
the amount of risk that you are taking. I think in the case of
Northern Rock, the real, most serious problems were not in the
asset quality but, in fact, were due to a lack of liquidity planning
because they did not have sources of liquidity when the run occurred, essentially. And we in our implementation of Basel II here
in the United States do make liquidity planning an important part
of our analysis.
You mentioned credit ratings. It is true that credit ratings do
play a role in some of the Basel II risk evaluations. They do not
play a unique role. It is generally the case that banks are expected
to make independent evaluations along with taking information
from the credit ratings. However, this is certainly one of the areas
where the Basel Committee, in reviewing the lessons of the recent
events, is looking carefully on how or whether to use credit ratings
in the risk measurement process.
Senator REED. Thank you, Mr. Chairman.
Thank you, Chairman Dodd.
Chairman DODD. Yes, excellent questions. And, Mr. Chairman,
just picking up on Jack Reed's questions here, it may be worth—
I had not thought about the Basel implications. We have looked at
this thing, obviously, in a more parochial way, but I might ask the
Chairman of the Fed to give us—we had one hearing on this. Senator Shelby cares deeply about this issue, as I do as well, the rating agencies. It is a complicated issue. But I think all of us would
be deeply appreciative of" some ideas from the Fed to us. If there
is any need here for legislative action at all in this area, we would
be very interested in hearing your thoughts and ideas on that as
well.
Mr. BERNANKE. Senator, the Basel Accord is implemented by regulation, and we have determined a joint action by the four bank
regulators. We are working together through regulation to try to
make improvements. We will certainly take a lot of advice from the
Basel Committee and the changes and suggestions that they make.
We have a very conservative process in place for introducing the
Basel II system, which includes several years of transition floors
that will not allow capital to decline very much, and a lookback
study that will review the experience both here in the United
States and elsewhere to try to understand and make sure that we
are confident that the system is going to develop appropriately and
provide enough capital for banks.
So we will be taking the lessons of the recent experience very
much to heart and incorporating them in the system. Basel II has
the virtue of being flexible enough that it can adjust when you
make changes like this. So I do not think at this point that legislation is necessary.
Chairman DODD. OK. Well, I am pleased to hear that, and as I
said, it is an excellent question that Senator Reed has asked.
Senator Bennett.
20
Senator BENNETT. Thank you very much, Mr. Chairman, and
welcome, Chairman Bernanke. I trust you saw the piece in this
morning's Wall Street Journal, the op-ed piece by Allan Meltzer.
Mr. BERNANKE. Yes.
Senator BENNETT. "That
1970's Show." I will give you an opportunity to comment on that.
Mr. BERNANKE. Well, Mr. Meltzer, who is an excellent economist
and indeed who is a historian of the Federal Reserve, is concerned
that the current situation will begin to look like the 1970s, with
very high inflation and high unemployment. I would dispute his
analysis on the grounds that I do believe that monetary policy has
to be forward looking, has to be based on where we think the economy and the inflation rate are heading. And as I said, the current
inflation is due primarily to commodity prices—oil and energy and
other prices—that are being set in global markets. I believe that
those prices are likely to stabilize, or at least not to continue to rise
at the pace that we have seen recently. If that is the case, then inflation should come down, and we should have, therefore, the ability to respond to what is both a slowdown in growth and a significant problem in the financial markets.
He is correct, however, that there is some risk, and if the inflation expectations look to be coming unmoored, or if the prices of energy and commodities begin to feed into other costs of goods and
services, we would have to take that very seriously. I mentioned
that core inflation last year was 2.1 percent, so it is food prices and
energy prices, which are internationally traded commodities, which
are the bulk of the inflation problem.
Again, we do have to watch it very carefully, but I do not think
we are anywhere near the 1970s type situation.
Senator BENNETT. Thank you. I wanted to get that on the record.
As I look at the housing market and talk to some of my friends
who are in the housing market, they tell me that the inventory is
not monolithic, the inventory overhang—that is that the bulk of the
overhang is in the higher-priced homes, because home builders
wanted to build places where they would get the highest margin
return, and if they built houses in the moderate housing area or
affordable housing, their margins were not nearly as great and
there were plenty of speculators willing to buy the bigger homes.
And, indeed, they tell me that for affordable housing, there is,
frankly, not a sufficient supply right now.
They are urging me to do something on fiscal policy to stimulate
people to build cheaper houses, that the housing construction
would begin to catch up—not catch up. Construction levels would
begin to pick up, whereas now they are dormant, waiting for the
overhang to be worked off.
Do you have any data that supports that anecdotal report?
Mr. BERNANKE. Well, we do have some data on investor-owned
properties, and that has been increasing quite a bit. And my recollection is that among the mortgages that are having problems,
something on the order of 20 percent of them are investor-owned;
therefore, it is not a family that is being in risk of losing their
home. So that is a significant consideration, and I think that in
those cases investors who make a bad investment should bear the
consequences.
21
Senator BENNETT. That is my own attitude as well. But we are
having conversations about stimulus packages around here, and it
had not occurred to me, until I had this information from people
in the housing market, that if we could stimulate people to buy the
lower-priced houses, and those are the people who need the shelter,
anyway, and there is not a surplus of inventory there, that that
would have a very salutary effect both in terms of taking care of
people's needs and on the economy, because home builders would
start to build again, they just would not be building in that portion
of the housing market where there is an oversupply. But you do
not have any specific data as to where the price points are in the
inventory overhang?
Mr. BERNANKE. I could probably obtain such data. I am not sure
that directly trying to stimulate specific types of house construction
is necessarily the most efficient way to go about it. Probably the
better thing is to try to ensure strong employment so people have
the income and they can purchase the home they want to have, or
they can rent if they prefer. But I do not have the data with me.
Senator BENNETT. Well, I would appreciate it if we could get
some because I find this an intriguing idea. I know in Utah, which
has not been hurt as badly by the housing problem as some other
States—because we generate something like 30,000 new families
every year that need houses. But in Utah, above a certain level,
around $400,000, there is a glut of houses on the market and,
therefore, nobody in that market or above can sell their house. But
for houses in the $200,000 area, which we would now begin to
think of as an affordable housing range, there does seem to be
something of a shortage.
So if you have any data on that that you could share with us,
I would appreciate it. Because as we formulate the stimulus package, Mr. Chairman, this is something I think we ought to look at.
It is a little more sophisticated and has drilled down through the
data to a more granular level. But anything we can do to get the
construction business started—you say, well, it is maybe too long
term out, but there are a lot of jobs that people can get in the construction business if they are building the lower-priced houses that
right now the construction workers do not have anything to do.
Mr. BERNANKE. Senator, one thing that is certainly true is that
a lot of the big house price declines are taking place in high-priced
areas like California and Florida, Nevada, Arizona, where prices
went up a lot before, and now they are coming back down.
Senator BENNETT. That is the price range that it is hitting in
Utah as well.
Thank you, Mr. Chairman.
Chairman DODD. Not at all. And I might have missed this in
your point here, but seemingly one of the issues we are grappling
with here is the oversupply. And you are raising a different question. Where is that oversupply occurring? But one of the concerns
I have is that allowing the market to take over here, if your supply
increases and demand is not keeping pace, then obviously your
ability for the market to really help stabilize this problem here is
going to be de minimis, it seems to me.
22
Senator BENNETT. My point is that the market is not monolithic.
There is an oversupply at the high range, but I am being told that
in the lower range
Chairman DODD. Well, that is a good question and one we ought
to—if you have the ability to give us some information on that, I
would be very interested in that as well, Mr. Chairman.
Let me turn to Senator Menendez.
Senator MENENDEZ. Thank you.
Thank you, Mr. Chairman, for your testimony and your service.
It seems to me—and I am sure all of us—that the central bank is
faced increasingly with the contradictory pressures of the slowing
economy and rising consumer prices—gas prices, food prices, energy prices as a whole, to name a few. Isn't revving up a slow economy far easier than slowing inflation once it has become entrenched?
Mr. BERNANKE. AS you say, if it becomes entrenched, if inflation
expectations were to rise and that were to lead to a wage-price spiral, for example, or, non-energy, non-food prices rising more quickly, that would be more of a concern. As I said, we are concerned.
I do not wish to convey in any way that we are not concerned about
it. We are trying to balance a number of different risks against
each other.
With respect to inflation, as I said, our anticipation is that inflation will come down this year and be close to price stability this
year and next year. If it does not, then what we will be watching
particularly carefully is whether or not inflation expectations or
non-energy, non-food prices are beginning to show evidence of entrenchment, of higher inflation, as you point out. That would certainly be of significant concern to us and one that we are watching
very carefully.
Senator MENENDEZ. Let me ask you, with consumers reluctant to
spend and businesses reluctant to invest and lenders reluctant to
lend and home prices going downwards, is the lower interest rates,
do you believe, going to be enough to do the trick?
Mr. BERNANKE. Well, I think it is certainly helpful, and we also
have a fiscal package, as you know. A lot is going to depend on the
underlying resilience of the economy itself and of the financial system to work through these problems and to bring us back to a situation where we can grow in a normal way.
Senator MENENDEZ. HOW about something that you do not have
control over, which is the foreign confidence in the American dollar? Isn't your ability to continue to cut rates to some degree restrained by the willingness of foreign countries to continue to finance the current account deficit?
Mr. BERNANKE. Well, it is a complex question. We
Senator MENENDEZ. Can you give me a simple answer?
Mr. BERNANKE. I will try. It is important for the U.S. economy
to be strong and an attractive place for investment. And I think we
are better off in the medium term trying to ensure good, strong
growth in the economy to attract foreign investment than we are
falling behind and allowing the economy to drop into a severe decline.
So there is a balance there. We have to think about the shortterm return, which is partly related to our interest rate decisions,
23
but we also need to think about the medium term, where we want
to make sure the economy is growing in a stable and healthy way
which will attract foreign investment.
Foreign investment, I should emphasize, continues to be strong.
We are not seeing any significant shifts of out of dollars among official holders, for example. And I anticipate that we will continue to
have the capital inflows we need, in part, going back to my earlier
comments, because I do think that the world recognizes that the
U.S. economy has underlying strengths and resilience that will
bring us back to a strong growth path within the next couple of
years.
Senator MENENDEZ. If then the Fed's decision at this point in
time—of course, it always depends upon the point in time—is that
dealing with the slowing economy is the present priority, and as
the Chairman has said on more than one occasion, that if there is
a great challenge in the economy, it stems from the mortgage meltdown, the housing market meltdown, are we—I have a real concern. You know, in March of last year, I and a few others said we
are going to have a foreclosure tsunami, and everybody poohpoohed that and said that is an overexaggeration. And, unfortunately, we are well on our way, and we have not even seen the totality of it.
The question is, when I see the Center for Responsible Lending
say that basically the present administration's plans will only deal
with 3 percent of the properties, removing them from foreclosure,
and I see Moody's saying that the experience of 2007 is largely
around 3.5 percent of workout, at the end of the day is a 97-percent
market correction something that we are willing to accept and
something that we need to accept? Or is that a percentage that is
far too high?
Mr. BERNANKE. Senator, there have been about four or five studies reviewing the experience of servicers and lenders and trying to
work out mortgages, and, unfortunately, we are still getting a very
mixed and fuzzy picture about exactly what is happening. One of
the benefits, I think, of some of the recent actions associated with
the Hope Now Alliance, for example, is that I hope we will be getting better, more up-to-date, and more consistent data on what is
actually happening in the field.
I do agree that while the servicers seem to have made some
progress in scaling up their activities, they are not yet to the point
where they can deal with what you called the "tsunami of foreclosures," which is already well underway. And for that reason, we
continue to urge them to expand their efforts further, to work toward more permanent solutions.
Senator MENENDEZ. But if that were to be the figure, is that an
acceptable market correction figure, 97 percent of the couple of million families in this country ready to lose their home? Is that what
we are willing to accept, both in the context of public policy as well
as in the context of our economy?
Mr. BERNANKE. Well, even under regular circumstances, unlike
what we have today, the number of foreclosure starts that actually
ends in an eviction or a sale is well less than 97 percent. So I am
not quite sure what to compare it to. Obviously, the more people
who are able and desire to stay in their home, the more we can
24
help, the better that is going to be. And I strongly support increased efforts by the servicers and lenders to address this issue.
Senator MENENDEZ. Well, my concern is we were behind the
curve in trying to deal with the issue, and my concern is now we
seem to be continuing behind the curve in stemming the hemorrhaging that is going on.
One last question. The central bank has always seen its core mission as safety and soundness. Consumer protection I hope is going
to increasingly be something that you will consider a core mission
as well. And I heard your remarks at the very end of your testimony.
Is it your intention—when you talk about issuing something on
unfair and deceptive practices, is that in relation to credit cards,
mortgages, to REITs? Is it cross-cutting?
Mr. BERNANKE. We have already issued the HOEPA rules, which
address unfair, deceptive acts and practices relating to mortgages,
for comment. We are currently receiving comments on those.
The new rules, which I alluded to, for the spring are under the
FTC unfair, deceptive acts and practices code, and they would
apply to credit cards, and possibly other things, but primarily credit cards.
Senator MENENDEZ. Thank you, Mr. Chairman.
Chairman DODD. Thank you very much.
Senator Allard.
Senator ALLARD. Thank you, Mr. Chairman, and thank you,
Chairman Bernanke.
Mr. Chairman, we have to, I think, remind ourselves exactly
what is involved in a recession. I hear the reporters, I think erroneously, reporting a recession when actually we are having an economic slowdown. I would like to have you define for the Committee
what would constitute a recession.
Mr. BERNANKE. Well, recessions are generally called, so to speak,
by a committee called the Business Cycle Dating Committee, which
is part of the National Bureau of Economic Research—a committee
of which I was once a member, by the way—which looks at a wide
variety of indicators to see essentially if the economy contracted
over a period of time. It is a somewhat subjective decision, and it
is often made well after the fact because of the revisions of data
and so on.
A more informal but widely used definition of recession is two
consecutive quarters of negative growth. That would be an alternative that people use.
Senator ALLARD. There was a newspaper article or report that
came out, I think in the last day or two, suggesting that somehow
or other the Federal—or you and the Fed may be running out of
tools to control inflation. Do you have a comment on that comment?
Mr. BERNANKE. Well, as I said, we are trying to use our principal
tool, which is the Federal funds rate, to balance the various risks
that we see in inflation and growth and financial stability. We do
not really have additional tools on inflation. We do have additional
tools to deal with financial problems, such as, the term auction facility, which we are currently using, and other steps that we have
taken or could take.
25
With respect to inflation, I think our principal tool would be the
interest rate.
Senator ALLARD. NOW, the Congress, through public policy, I
think on a macro scale, may have some impact on the economy.
And in general terms, if the Congress was to increase spending,
what do you feel would—what kind of an impact would that have
on the economy? And then look at the other side. Suppose Congress
would increase taxes. What kind of an impact would that have perhaps on today's economy where we are standing?
Mr. BERNANKE. Well, from a short-term aggregate demand viewpoint, spending tends to add to demand, and if the economy is at
a point where its resources are not being fully utilized, it could lead
to more increased utilization of resources; whereas, higher taxes in
a short period of time, if it reduces consumer spending, for example, could lead to less use of resources.
The Congress has passed a fiscal stimulus package which tries
to address the issues of aggregate demand and sufficient demand
for utilization of resources. I would urge the Congress, in looking
at additional spending and tax plans, to think about the underlying
effects on the efficiency and effectiveness of the economy, that is,
not to make decisions based on short-term demand considerations
but to think about how these spending programs or tax programs
affect how well the economy will grow over the long term.
Senator ALLARD. SO you are thinking about Social Security,
Medicare, and Medicaid primarily on those costs, I would assume?
Mr. BERNANKE. Well, and from a fiscal perspective in the longer
term—and by longer term, I means only a few years from now because we are coming very close to the point where the baby-boom
generation is going to begin to retire in large number. By far, the
biggest issue is entitlements, particularly the Medicare part, but
Social Security as well.
Senator ALLARD. Yes, I appreciate those comments.
The other thing, you talk about, you know, inflation being
pushed by energy and food costs. What is offsetting that? There
must be some—to come out with an average of 2 percent, a little
over 2 percent, there must be somewhere over here where we are
getting a lesser amount that is offsetting those increases. Where do
you see that happening?
Mr. BERNANKE. Well, what we saw in 2007 was about 2-percent
inflation excluding energy and food. When you add on the energy
and food, you get something more like 3.5 percent by our preferred
indicator, which is obviously a high rate of inflation and we are not
comfortable with.
Senator ALLARD. SO you do not see a sector of the economy that
is being driven down in a way that it has an offsetting effect. You
are just seeing this just averaging out as a part of the average. OK.
We have on ethanol, for example, on energy, we have a really
high tariff. It is 51, 52 percent. And energy builds into the whole
economy. It is a fundamental driver.
What do you think about us looking at reducing some of those
high tariffs like that? What kind of an impact would that have on
our economy?
26
Mr. BERNANKE. Well, Senator, as you know, I favor open trade,
and I think that allowing Brazilian ethanol, for example, would reduce cost in the United States.
Senator ALLARD. And is that—when you look at the food—the
way I look at it is when you have an ethanol—you have your food
products being diverted to ethanol production, it has an impact on
both food as well as the cost of energy and whatnot. Is it a significant enough part of the economy that we need to look at that more
seriously?
Mr. BERNANKE. I do not have an estimate of the overall effect.
I think it would be hard to do. But it is the case that a significant
portion of the corn crop is now being diverted to ethanol, which
raises corn prices. And there are some knock-on effects; for example, some soybean acreage has been moved to corn production,
which probably has some effects on soybean prices, too. So there is
some price effect on foodstuffs coming through the conversion to energy use.
Senator ALLARD. Well, you know, the wheat farmers in my State
are saying that wheat is at a historic high for them, and so I wonder just, you know, how much of that—I suppose, again, that is a
dryland crop, but there is some conversion to dryland corn. But,
again, that seems to have some impact on the grains in general,
and the poultry people and the livestock people—well, all livestock
people—swine, poultry, and beef in particular—all have concerns
about that. So I was curious to see how you were evaluating that
policy in respect to the total economy, and obviously you do not
have too much to say on that because you do not think it is too
big a part of the economy. Is that right?
Mr. BERNANKE. Well, again, I do not know quantitatively how big
the effect is, but there is some inflationary pressure coming
through foods, including corn and soybeans, and obviously other
crops like wheat which have suffered various supply problems in
the last year.
Senator ALLARD. Yes, OK. Well, Mr. Chairman, I see my time
has run out.
Chairman DODD. Great questions, too, and we will come back to
those maybe in a little bit. Senator Reed was raising with me privately the issue as well, and I think it is worth exploring. The issue
of the question of the value of the dollar, the rising price of oil, the
dollar denomination oil pricing, whether or not that can shift in
these commodities generally is an interesting issue.
But let me turn to Senator Bayh.
Senator BAYH. Thank you, Mr. Chairman.
Mr. Bernanke, thank you for you—Chairman Bernanke, I should
say. Thank you for your presence today, and thank you for your
service to our country. I think you have your priorities right. You
mentioned that the risks in the forecast are to the downside and
that our principal concern at this moment—you have to strike a
balance, but our principal concern should be avoiding an economic
downturn of severity and duration while continuing to focus on inflation in the longer term.
As you and some of my colleagues have pointed out, the genesis
of much of this originated in the housing sector, particularly with
some of the subprime type mortgages. And it seems to me that you,
27
in setting monetary policy, erred on the side of—not erred, but you
have been more aggressive than less and tried to minimize the
downside risk to the economy. And that is as it should be.
My question to you is: Should not Congress do the same in addressing the housing problem? The President has the voluntary
Hope Now initiative you have outlined. I think it would be charitable to say that the results of that have been modest to date. You
indicate there is not a lot of data, but it certainly does not seem
as if it has had much of an impact.
There are some proposals, fairly narrowly circumscribed ones before us, that would focus on this issue, allowing bankruptcy courts,
only with regard to outstanding subprime mortgages, to revisit
some of these issues, only when the borrowers have passed a strict
means test. The interest rates would be set at prime plus a risk
premium, and if the homes were ever resold, the lenders would
participate in the upside, any potential upside, if the property
would revalue.
Now, the President has threatened to veto this initiative, and
some have claimed that it would add as much as 2 percent to the
cost of a mortgage. I find that to be not a credible analysis when
it, by definition, does not apply to future mortgages. This is a oneoff event, the greatest housing downturn in the last 50 years, fairly
narrowly circumscribed.
So my question to you is: Just as you have emphasized being
more aggressive at this moment, should not we? And as an economist, is it credible to think that this would add 2 percent to the
cost of a mortgage moving forward in this narrowly circumscribed
manner?
Mr. BERNANKE. I do not know how much it would add. I think
it would probably add something because the collateral would be
less secure.
Senator BAYH. This only applies to past loans, by definition, not
future ones.
Mr. BERNANKE. Well, then the question is raised: Will this happen again?
Senator BAYH. Well, every 50 years when we have a calamity
like this, maybe so.
Mr. BERNANKE. YOU know, I see concerns on both sides of this,
and I understand the rationale for wanting to make those changes.
I also see some concerns about the effects on the marketplace and,
for example, on holders of current loans, how they would react.
Senator BAYH. There are some implicit risks in the more aggressive monetary policy you have pursued.
Mr. BERNANKE. Monetary policy is my domain, and I
Senator BAYH. My point is and the question I am raising, just
as you have been more aggressive—and appropriately so—should
not we?
Mr. BERNANKE. I think there is an argument for being aggressive
in general, but I would just decline, if you would permit me, to endorse that particular action. I am really at this point focused on
FHA and GSE reform as being two useful steps in the direction of
helping the housing market. And we should continue to think
about alternatives. But at this point I do not have, good additional
measures to suggest to you.
28
Senator BAYH. Well, I do not want to put you in the business of
getting into the debate between the legislative and executive
branches here, but I do think at this moment, as we have all recognized, this is a perilous moment for the economy. It seems to me
that there are risks on either side, but the balance here, it seems
to me, lies on being a little more aggressive than less. And that
ought to apply to all aspects of our policy, not just one particular
subset.
We have had a big discussion here about inflation versus growth.
Again, I think you have your priorities right in that regard. You
have pointed out that the core rate, while modestly above target,
has—the principal thing driving this in the near term has been
food and energy costs, and that you do not see any persistent rise
in the core over the longer term.
My question, Mr. Chairman, is: What indicia of economic stability or greater growth would alleviate your concerns and would
allow you to then perhaps pivot and focus on the inflation concern
more than we currently are?
Mr. BERNANKE. Well, Senator, first, I do not want to leave the
impression that we are looking only at one
Senator BAYH. NO, no. You were very balanced.
Mr. BERNANKE. We are always trying to balance these risks and
always trying to continually re-weight our thinking about the different risks to the economy.
Senator BAYH. Maybe a better way to put my question would be:
When will the risks be back in equilibrium as opposed to—what indicia will you look at to reassure yourselves that the economy is
stabilized and growth is resumed at an acceptable level?
Mr. BERNANKE. One of the concerns that I have is that there is
some interaction between the credit market situation and the
growth situation—that is, if the economy slows considerably, which
reduces credit quality, that worsens potentially the condition of
credit markets, which then may tighten credit further in a somewhat adverse feedback loop, if you will. I think that is an undesirable situation. I would feel much more comfortable if the credit
markets were operating more nearly normally and if we saw forecasted growth—not necessarily current growth but forecasted
growth—that looked like it was moving closer toward a more normal level.
So what I would like to see essentially is a reduction in the
downside risks which I have talked about, particularly the risk
that a worsening economy will make the credit market situation
worse.
Senator BAYH. Well, let me ask you—but I have got only 1
minute so I am going to need to hurry. I did have two questions.
What aspect of the credit markets will you look to? And, in particular, I have been interested—you talked about the flight from
risk. There have been some aspects of the credit market that seem
to me to be almost without risk, and yet people are fleeing from
those as well. These auction rate securities, very short term, the
underlying assets, particularly in the municipal sector, virtually no
risk of default, and yet that seems to have seized up as well.
What do you think will lead people to begin to assume rational
levels of risk again? And what indicia will you look to in the credit
29
markets to reassure yourself that this situation is beginning to
work itself through?
Mr. BERNANKE. Well, there is reluctance to take risk, and there
are also concerns about understanding exactly what a particular financial asset consists of. And there are still some issues of transparency and so on that need to be worked out.
I think that a stable situation would be one in which good quality credits like, major municipal borrowers would not have difficulty in getting credit, and the issue would be the same for good
quality credits of firms and households as well.
So when you see a pulling back, and seeing the problem spread
through a variety of markets, which is interfering with the normal
flow of credit, then obviously that is not a normal, healthy situation.
Senator BAYH. Mr. Chairman, I have just one—my final question. Mr. Chairman, it has been visited by a couple of my colleagues; particularly Senator Reed I thought was excellent in his
questioning. It has to do with the credit agencies. We had a couple
of very capable individuals come before our caucus to focus on some
of these economic concerns, and the issue of the rating agencies
came up. And one of them, in response to my question about—markets can operate efficiently, but that presumes they have access to
accurate information. In this case, you know, clearly that was not
always so. And this is the problem with the credit markets in part
you have pointed out here. So what can we do to avoid this again?
You have mentioned that you and your people are looking at that.
But when I asked the question, this individual said, "Well, I am
not sure any additional action by the Government is necessary. The
market will work this out. These rating agencies, their share prices
will be punished and, therefore, they will have an incentive to not
do this again."
But whether it is in regard to certain types of Latin American
credit or other areas, it seems that the markets have a way of forgetting the lessons of history, focusing on short-term decision making, every 7, 8, 10 years or so, and we kind of end up in some of
these problems again. And the consequences to the broader economy here have been so profound and so great, it seems to me, that
in addition to relying on the market, perhaps there should be some
parameters to ensure that we do not end up in this situation again,
which leads us to either regulatory or legislative action.
So, just broadly speaking, do you think that some additional actions, either regulatory or legislative, may be in order to ensure
that this situation does not repeat itself in the future and that we
do not just simply rely upon the punishment of the market to prevent this in the future?
Mr. BERNANKE. Well, regulatory action is already being contemplated. The Securities and Exchange Commission, which has
authority over the credit rating agencies, is reviewing the situation,
and seeing whether additional steps need to be taken. Of course,
the Congress already gave the SEC some powers, which they have
begun to implement.
The fault lies on both sides of the equation, if you will—with the
credit rates, but also with the investors, who over-relied on those
ratings and did not do sufficient due diligence. In that respect, as
30
I mentioned before, the Basel Committee is looking at the use of
ratings in risk measurement for banks, and I would encourage the
regulators of pension funds and other investors, for example, to ensure that investors do due diligence over and above simply looking
at the rating and assuming that is all you need to know.
Senator BAYH. Thank you, Mr. Chairman.
Chairman DODD. Thank you, Senator, very, very much. Again,
some very, very good questions.
Senator Bunning.
Senator BUNNING. Thank you, Mr. Chairman. My opening statement I will submit for the record.
Chairman DODD. By the way, I should have made that point. All
opening statements and any supporting documents people want to
have will all be included in the record, and I appreciate you raising
that.
Senator BUNNING. Chairman Bernanke, can you explain what information or event caused the Fed to change its view on the conditions of the economy and the financial markets and led to the January 21 intermeeting rate cuts?
Mr. BERNANKE. Yes, Senator. First of all, as you know, we cut
rates by about 100 basis points during the fall, reacting to the drag
on the economy arising from the housing markets and from the
credit market situation. Around the turn of the year and early in
January, the data took a significant turn for the worse, and it
seemed clear that the economy was slowing, and slowing more than
anticipated, and that the credit market condition situation was continuing.
On January 9, I called a meeting of the Federal Open Market
Committee by video conference to discuss the situation. It was
agreed by the committee that some substantial additional cuts in
the Federal funds rate were likely to be necessary. The thought at
the time of that meeting was that it might be worth waiting until
the regular meeting at the end of the month where we could have
a fuller discussion and see the revised forecast and so on, taking
into account the possibility that we could also move intermeeting,
if necessary.
On January 10, I gave a speech where I informed the public that
I thought that substantive additional action might well be necessary, thereby signaling that the conditions had changed and that
further rate cuts were likely to happen.
In the days that followed that speech, the tone of the data deteriorated considerably further, which made me think that the outlook was, in fact, much weaker and the risks were greater. That
was showing up both in the data and in the financial markets. We
were seeing sharp declines in equity prices. We were seeing widening of spreads. And we were also seeing, again, adverse data.
On January 21, I became concerned that the continued deterioration of financial markets was signaling a loss of confidence in the
economy, and I felt the Fed, instead of waiting until the meeting,
really needed to get ahead of that and take action. So I called an
FOMC conference call, and we agreed at that point to cut the Federal funds rate target by 75 basis points.
There was an understanding at that meeting that further additional action was very likely to be needed, but we felt that we could
31
wait another 10 days until the regular meeting to determine exactly how much additional action. At the meeting at the end of
January, we had a full review, discussion, forecast round and so on
and determined that an additional 50 points was justified.
Looking back, as the data have evolved, I think that the 125
basis points was appropriate for the change in the tone of the economy, and I think it was the right thing to do.
Senator BUNNING. Are the days of constant and gradual Fed rate
changes over? In other words, are large and intermeeting rate
changes going to become a regular part of the Fed toolbox now?
Mr. BERNANKE. I cannot make any guarantees, Senator, but in
general, we prefer to move at the regularly scheduled meetings. As
I said, that is a chance to get together in Washington and to have
a full briefing by the staff and to have all the information made
available to us.
Senator BUNNING. How about which do you see as a greater
threat to the economy, a credit crunch now or higher inflation in
the future as a result of efforts to stop a credit crunch?
Mr. BERNANKE. Senator, we have to keep balancing those things.
As I said, our current view is that inflation will moderate this year
as oil and food prices do not rise as much this year as they did last
year. We are also watching very carefully to make sure that higher
oil and food prices do not feed into other costs and into other prices
or that inflation expectations do not become unanchored. If those
developments began to happen, that would certainly force us to pay
very serious attention.
At the moment, I think the greater risks are to the downside—
that is, to growth and to the financial markets; but, again, we are
always vigilant on all of our objectives and are always trying to
balance those risks against each other.
Senator BUNNING. YOU read the Wall Street Journal. I am very
sure of that. Today, in the Wall Street Journal, "Report on profits
a bright spot in the gloom. The Dow Jones Industrial Average has
gained 6 percentage points since the first day of the year." In the
Standard & Poor's index, 462 corporations have reported their
earnings for the fourth quarter; 62 percent of those that have reported topped their earnings estimates—62 percent. If you drop out
financials, carve out financials, which were 12 percent lower, the
gloom and doom that I have heard here today is not gloom and
doom. Are you going to tell me that these same corporations that
reported—and we had a really low growth rate in the fourth quarter—are going to be worse in the first quarter? Or are we also
going to have the same kind of reporting in the first quarter of
2008 that this profit report on the Standard & Poor's and the Dow
is not as accurate in the first quarter as it was in the fourth?
Mr. BERNANKE. Well, Senator, you are absolutely correct that
profits at the nonfinancial firms have remained pretty good. I do
not have with me an estimate of the profits for the first quarter.
But firms seem to be indicating concerns about the future. For example, if you look at the ISM survey of non-manufacturing industries, it dropped very significantly a few weeks ago, suggesting a
good bit more pessimism on the part of firms.
Senator BUNNING. But isn't one of the real signals that we really
have to watch the unemployment rate in the United States of
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America? And that moved from 4.9 to 5 percent in the fourth quarter. And where is it now? Where do you estimate it to go in the
first quarter of 2008?
Mr. BERNANKE. It jumped in December from 4.7 to 5.0, which is
a pretty significant jump, and it was certainly something that we
looked at. And
Senator BUNNING. Well, that was kind of indicated by the low
growth rate and the reasonable expectation that the job rate would
be higher, unemployment in the fourth quarter. I am asking about
2008.
Mr. BERNANKE. Well, I reported our projections for the fourth
quarter, which were 5.2 to 5.3 percent in the fourth quarter. We
are seeing unemployment insurance claims rising, which I think is
consistent with the somewhat higher unemployment rate going forward.
Senator BUNNING. What are you telling me?
Mr. BERNANKE. That the unemployment rate is likely to go up
from here.
Senator BUNNING. HOW bad? Are you saying 5.6, 5.7?
Mr. BERNANKE. The baseline projection we have made for the
fourth quarter is 5.2 to 5.3, but there are downside risks. Things
could get worse than that. We do not know. But it is not our main
projection. It is just a risk that we see out there.
Senator BUNNING. Then does that bode well with the lowering of
interest rates and the higher rate of unemployment? That indicates
to me that someone in the Journal today that talked about stagflation might be talking more sense than we might anticipate.
Mr. BERNANKE. Well, again, Senator, we are just trying to balance the risk of growth, inflation, and financial stability. Monetary
policy works with a lag, and, therefore, we have to
Senator BUNNING. Well, I understand that very clearly. We
should have lowered rates earlier, and all of a sudden we lowered
them 2.25 points—225 basis points in less than—what?—6 weeks,
8 weeks.
Mr. BERNANKE. It was 125.
Senator BUNNING. 125.
Mr. BERNANKE. Yes, Senator.
Senator BUNNING. Well, if you
count the fourth quarter of last
year, what was the total?
Mr. BERNANKE. We lowered 50 basis points in September, 25 in
October, 25 in December, and 125 in January.
Senator BUNNING. Then it was 225.
Mr. BERNANKE. Not in the fourth quarter.
Senator BUNNING. NO, no. Total. Total since the last
Mr. BERNANKE. That is right.
Senator BUNNING. That is considerable, and the market conditions indicated that that was absolutely necessary.
Mr. BERNANKE. I think so. The housing market decline and the
weakness in the credit markets were suggestive of
Senator BUNNING. Well, the weakness in the credit markets,
Chairman Bernanke, were signaled last year, early in the year. I
mean, it was not—it did not take a rocket scientist to figure that
out. And I know with all the great economists that you have on the
Federal Reserve and your members of the Federal Open Market
33
Committee are a lot sharper than the people sitting up here at this
table. And you had a big heads-up signal that the housing market
was in the tank early last year.
Mr. BERNANKE. But the housing market was not affecting the
broad economy. When we lowered interest rates on the last day of
October, that morning we received a GDP report for the third quarter of 3.9 percent, which was subsequently revised to 4.9 percent,
and inflation was a problem. So, in fact, I think if we look back on
this episode, we will see that the Fed lowered interest rates faster
and more proactively in this episode probably than any other previous episode.
As you point out, the unemployment rate is still below 5 percent,
and
Senator BUNNING. I lived through the Greenspan years. I know
exactly what you are talking about.
Thank you.
Chairman DODD. Thanks very much.
Senator Schumer.
Senator SCHUMER. Mr. Chairman, with your and the Committee's permission, Senator Tester has to be somewhere at noon and
so do I, so I volunteered to split my time with him and let him ask
the first question and leave, and then I will—if that is OK with you
and the rest of the Committee.
Chairman DODD. Fine.
Senator TESTER. Thank you, Senator Schumer, and thank you,
Mr. Chairman, and thank you, Chairman Bernanke. I appreciate
your forthrightness today and always.
I want to talk about commodities for a little bit. I am a farmer.
I am happy when commodities go up. But as was earlier pointed
out today, oftentimes this can end up potentially like it was in the
1970s when we saw a big commodity raise; we saw the inputs that
went into agriculture go through the roof; we saw food prices on
the shelf go up because commodity prices were higher; and then
commodity prices fell back. Those inputs that went into production
agriculture stayed up, and the food on the shelf stayed up, too, because they said there was not enough wheat in a loaf of" bread to
make a difference after they raised the prices because commodities
went up.
My question to you is: Do you see that playing out the same
way? I mean, we are going to see food prices go up probably, it
would be my guess. We already have. And we have already seen
inputs go up on the farm for production agriculture. I anticipate
this commodity price will not stay where it is at forever. They usually do adjust, and they usually adjust down. And food prices will
stay up, inputs will stay up. Do you see that same thing happening
again? And is there anything we can do if it is that way?
Mr. BERNANKE. If commodity prices come down, including energy
prices and raw food prices, I would expect to see, perhaps with a
lag, finished food prices come down as well. As we have been discussing, the commodity prices, both food and energy, have been the
primary source of the recent inflation. If they stabilize, even if they
remain high, then inflation will moderate. And I expect that would
happen, at least over time, at the finished level as well as at the
raw level.
34
Senator TESTER. OK. Thank you very much, and I want to thank
Senator Schumer again. Thank you very much.
Senator SCHUMER. My pleasure.
Two questions, Mr. Chairman. The first involves these sort of
combination, creating problems now, of marking to market and the
credit crunch, freeze, call it what you will. You know, when I first
got here on the Banking Committee, banks really did not mark to
market, and we regarded it as great progress that they now have
to mark to market, like securities firms and others always did. It
is a proper valuation of their assets.
The problem here is nobody knows how to mark to market because there is no market. In too many areas, no one is buying. And
so you do not know what they do when they make a valuation. I
have heard from many people that that valuation is—they make it
artificially low, and that further exacerbates. It is a vicious cycle
because then they do not have the capital, they cannot do any more
lending, and everything is frozen up.
Is there a way to deal with that problem now? Is there a way
to say, yes, you have to mark to market, but in these unusual circumstances you can do it 6 months from now, or something to that
effect, quarterly, yearly?
I am not an expert here, but I do know it is a real problem. How
do you mark to market when there is no market? And because
there is no market, rare, almost never occurred in such large parts
of the credit market before, is this an unusual circumstance where
this does not work?
And my second question—and I will ask you to answer both—is
this: The worry I think people have—and we have seen some questions on this—is that it is a lot easier to get the economy going
than to shut inflation off. And the worry is that we go back to the
situation in the late 1970s where the economy was stalling, rates
were lowered, and then there was nothing that the Fed could do
other than very late and drastic action to curb inflation. It was a
difficult struggle. We went through it in the 1980s, and I remember
paying 21 percent on my mortgage when I first signed my mortgage in 1982.
Do we have better tools now that can control, you know, if inflation should start going beyond what you imagine for all the—we
are global economy. You have less experience and less tests in this
interconnected world than you did 20 years ago. Do we have better
tools? Are you worried that if inflation really starts chugging along,
that even a quick raise in interest rates will not be able really to
head it off without really severe damage to the economy?
So those are my two questions.
Mr. BERNANKE. Thank you, Senator. On the first one, you raise
a very good point. The Federal Reserve has long had sort of a
mixed view about fair-value accounting. We think that markettraded assets should be valued at the market price and that investors are entitled to know what that price is. But we have always
recognized—and we had in mind things like bank loans, for example, that are relatively illiquid—that it might be difficult to value
them on a fair-value basis and that there could be problems arising
there.
35
As you point out, we now have a situation where some assets
which are normally tradable are perhaps not generally tradable.
The accounting profession has created a system which, attempts to
get around that problem. There are these three different levels
where you have a market valuation or a model valuation or a judgment valuation.
I think that is one of the major problems that we have in the
current environment. I do not know how to fix it. I do not know
what to do about it. I think the accountants need to make the best
judgment they can.
Senator SCHUMER. Some have suggested, you know, delaying a
mark to market, even using this system until there is a market
and letting the—because you really do not know the value of the
asset. And if you undervalue it, you may be hurting things as much
as if you overvalue it.
Mr. BERNANKE. I understand your concern, Senator, but the risk
on the other side is that if you do too much forbearance or delay
mark to market, that the suspicion will arise among investors that
you are hiding something.
Senator SCHUMER. Right. What about a rolling average that
takes into account 6 months back?
Mr. BERNANKE. Senator, I have not worked through any proposals like that. This is really an Accounting Board responsibility.
I agree there is a severe problem. It is difficult to change the rules
in the middle of a crisis.
Senator SCHUMER. I know.
Mr. BERNANKE. It is one of those things that we are going to
have to put on the list of issues to evaluate as we try to learn the
lessons from this experience.
Senator SCHUMER. But you do admit it is a serious—it is one of
the nubs of the problem now, even though it has not been talked
about that much.
Mr. BERNANKE. And the direction of how to fix it is not at all
clear.
Senator SCHUMER. OK. Second question.
Mr. BERNANKE. On your second concern, I think we are better off
now than we were in the 1970s in that there is a much broader
recognition of the importance of price stability and greater confidence that central banks will deliver price stability. The indicia
of inflation expectations, where some of them have moved a bit, are
basically stable. We have not seen any major shift in views about
inflation and where inflation is likely to go. The Federal Reserve
has emphasized the importance of maintaining price stability and
has indicated that we will watch very carefully and make sure that
we do not see any deterioration in either broad measures of inflation expectations or increased pass-through of food and energy
prices into other prices. We will watch those carefully and we will
respond
Senator SCHUMER. But do you believe if you miscalculate and inflation starts coming out of the box more quickly than you think,
do you have tools to deal with that or is that still a very difficult
area, once inflation rears its head, it is very hard to put the genie
back in the bottle? Or are we much better at it now than we were
20 years ago?
36
Mr. BERNANKE. Well, if higher inflation were to become well embedded in inflation expectations and wages and other parts of the
economy, it would be difficult, and we do not really have new methods. It is a risk, and we take it very seriously, and we are monitoring it very closely. But as I have said several times, we are dealing with a number of different concerns here, and we are trying
Senator SCHUMER. I know. It is not easy.
Mr. BERNANKE.
the risks as best we can.
Senator SCHUMER. Thank you, Mr. Chairman, and I thank my
colleagues.
Chairman DODD. Well, thank you very much, Senator, very
much.
Senator Dole.
Senator DOLE. Thank you.
Mr. Chairman, I do not have to tell you that my State of North
Carolina has lost a lot of manufacturing jobs over recent years, and
you and I have had discussions about job retraining programs. I
am very pleased that Congress has now begun to debate the best
way to reform the Trade Adjustment Assistance, the TAA Program.
And I would like to ask your opinion about what you feel the impact would be of congressional reauthorization and if there are any
particular aspects of reform that you would want to suggest for the
workforce of the 21st century.
Mr. BERNANKE. Well, Senator, as I have argued in a number of
speeches, for example, globalization and trade have a lot of benefits, but they also have some costs. They cause dislocation. They
cause loss of jobs. And my view is that the best way to deal with
that problem is not to shut down trade but, rather, to help those
who are affected adjust to their circumstances.
Senator DOLE. Right.
Mr. BERNANKE. And so as a general matter, we should look for
ways to help people through skill acquisition or other kinds of assistance that allow them to take advantage of the new opportunities to replace the ones that they lost.
I do not want to comment on specific elements. I know there are
some competing TAA bills being considered, and I think that is
really up to Congress to make those detailed decisions. But I do
think that it is much better than shutting down trade to try to help
people adjust to the effects of trade.
I had the opportunity recently to speak in Charlotte, and one of
my themes there was although North Carolina certainly has lost a
lot of manufacturing jobs, if you look at the city of Charlotte and
how it has reinvented itself to become a financial center, a services
center and a center for the arts and many other things, there is
a tremendous opportunity in a dynamic economy, as the one we
have, to find new opportunities, to find new businesses and industries.
And so rather than try to freeze the industrial structure the way
it is, we are better off helping people move to the new opportunities, and TAA is one potential way of trying to assist that process.
Senator DOLE. Thank you. Mr. Chairman, let me ask you about
Sarbanes-Oxley. Some smaller banks appear to be clearly overburdened by compliance with Sections 404 and 302. These financial in-
37
stitutions are already highly regulated, and it has become increasingly apparent that these regulations, while they were well intended, only increased the cost of doing business. I would really appreciate your comments on what needs to be done here.
Mr. BERNANKE. Well, it has been recognized that Section 404, in
particular, imposes a lot of costs. It does have some benefits and
helps improve internal controls. The Securities and Exchange Commission and the PCAOB have recently issued an audit standard
which tries to take a more balanced, risk-focused approach to enforcement of 404. And I hope as a general matter that that will reduce the costs while preserving the benefits of Sarbanes-Oxley.
In the case of banks in particular, there is a good bit of overlap,
obviously, already with some of the rules that they have to follow
under existing bank regulations. And I think it would be useful to
consider where there are redundancies or overlaps that could be reduced in the future.
Senator DOLE. Thank you, Mr. Chairman. Over recent months,
much has been written in the financial press regarding whether or
not key worldwide central bankers—the Bank of England, Bank of
Japan, European Central Bank, and the United States, et cetera—
should become more coordinated in their monetary policy efforts.
Proponents of such efforts point to the current spread between various key country lending rates.
What is your reaction to this debate?
Mr. BERNANKE. Well, Senator, first of all, the major central
banks do cooperate on many things. We meet quite often. I see my
colleagues at international meetings here and in other countries
very frequently. We are on the phone together, and we try to keep
each other apprised of what is happening in our own economies
and in the global economy, what we are planning, what we are
thinking.
We have worked together on some measures recently. In December, when we introduced the term auction facility, we did that in
a coordinated way with the ECB, the Swiss National Bank, the
Bank of England, and the Bank of Canada—who also undertook
various liquidity options at that time. So there is a lot of coordination and cooperation in that respect.
With respect to monetary policy per se, although we keep each
other apprised, each economy is in a different place, in a different
situation, and there is no necessity that each country has to have
the same policy. I think the policy that is chosen depends on the
particular circumstances of that country or that region. And so that
is one of the benefits of having flexible exchange rates to provide
some insulation, some ability for countries to run independent
monetary policies.
And so it has been our practice, as you know, for each major central bank to run an independent monetary policy, and while we
keep each other apprised, I do not expect to see any extensive coordination in the near future.
Senator DOLE. Thank you very much.
Thank you, Mr. Chairman.
Chairman DODD. Thank you very much.
Senator Corker.
38
Senator CORKER. Mr. Chairman, thank you, and I thank you for
your testimony. I listened carefully to what you had to say because
I know you choose your words carefully. You need to because everybody in the world is listening to what you have to say. But I did
notice that, you know, you mentioned that in every other sector of
our economy, we are doing well except in the financial area. And
I noticed that you have mentioned not to make—we shouldn't make
decisions for the short term, that as it related to the housing issue
itself, that you knew of no good additional measures, that you are
focused on GSE reform and FHA reform. And I know the Senator
from Indiana talked about on our side being aggressive. I would
say that what we do ends up being a law that cannot be changed.
What you do can be changed at the very next meeting, and so you
have a great deal more flexibility to really look at indicators and
make changes than we do. Our changes usually stay there for a
long time.
I was up at the New York Stock Exchange last week and noticed
that they are trying to put in place the ability for people to know
quickly what the value of their credit instruments are, that there
is not the transparency there that we have in the equity markets.
And my sense is because there is no transparency today, that even
if we did not have the subprime issue, because people are making
money packaging things and selling them off to the next person,
that even if the subprime market had not tanked the way that it
had, we still would have had writedowns because people were making so much money off of fees.
Is that a fair assessment?
Mr. BERNANKE. Well, I think the subprime crisis sort of triggered
these events. But it is true that investors have lost confidence in
a lot of different assets at this point, including, it was mentioned,
some student loans and other things as well. And part of the problem—not all of the problem, but part of the problem—is that in
these complex structured credit products, it is very difficult for the
investor to know exactly what is in there and what derivative support or credit liquidity support is involved.
Senator CORKER. SO, in essence, the subprime issue that has occurred has caused us to look at those in a more healthy way, and
hopefully the market will create some mechanisms for us to actually value those in real time and create a way for us to have some
transparency there. Is that correct?
Mr. BERNANKE. I hope so. But, again, as Senator Schumer suggested, if the accounting industry or the regulators can be of help
there, I think we ought to try to be of assistance.
Senator CORKER. YOU mentioned that leverage was at all-time
lows in other sectors, and, you know, I still am shocked that when
we had a credit problem, it was our wisdom to sprinkle money
around America in an America that already had an incredibly low
savings rate and ask them to spend it as quickly as possible. And
I get concerned about actions that we might take here that, in essence—I know you mentioned at the last meeting several times the
word "correction." I know Chairman Dodd somewhat chastised me
at the end because I was pressing for an answer. But do you still
believe that—and he did so in a very amicable way. I appreciate
39
that. But, in fact, do we have a crisis right now in housing, or do
we have a correction?
The reason I ask, I look at delinquencies over 30 days. Everything is over 30 days, all the way through foreclosure. And even
though I know we are having some extreme issues in some of the
higher-cost housing, it really is not very much different than it has
been over the last 30 years, only about a percent and a half different as far as delinquencies go. Is this a correction or is this a
crisis as it relates to housing itself?
Mr. BERNANKE. Senator, I do not know what terms to use. The
housing market certainly has come down quite a bit, down to less
than half the amount of construction that we had a couple years
ago. Prices are falling. Foreclosures are up probably this year about
50 to 75 percent over last year. So, you know, there are certainly
some major things going on in the housing market, and they have
created some problems in the credit markets and the rest of the
economy as well.
Senator CORKER. IS this the kind of thing, though, that the market can take care of itself? You know, you do not seem to have any
other ideas legislatively that we might come forward with to deal
with this problem. Is this something the market itself can deal
with?
Mr. BERNANKE. Well, the first line of defense for dealing particularly with foreclosures is to have servicers and lenders work with
the borrowers to try to restructure their mortgages or otherwise
find a solution. And the Treasury, the Fed and other regulators
and the Congress certainly have encouraged the private sector to
ramp up their efforts as much as possible to try to deal with as
many people as possible, because there certainly is a significant increase in the number of troubled borrowers.
I have suggested other things—and things that this Congress has
undertaken, like FHA modernization and GSE reform—that could
be helpful in bringing the housing market back.
Senator CORKER. And, obviously, we have two instruments—either monetary policy or fiscal policy. You are dealing with the monetary side. I guess on our side we deal with the fiscal.
What I am taking away from what you are saying—a very intelligent person who certainly has a much broader view of what is
happening not only here but also in the world—is that you know
of nothing today, you have no additional ideas legislatively or fiscally for us to deal with other than GSE reform and FHA reform.
You know of nothing else today other than the existing efforts by
the marketplace itself to work out some issues between lenders and
borrowers. You know of nothing else today that we might do constructively to solve this problem.
Mr. BERNANKE. Senator, I see no harm in trying to think about
other alternatives, and there are things that have been suggested.
But at this point, I am not prepared to support any additional
Senator CORKER. I am all for us thinking. I am a little worried
there is a package that is actually coming to the floor, and that
moves something into law. But I just appreciate your testimony,
and I want to say that just in general I do think that sometimes
when issues occur here, our hair gets on fire to act in ways that
I think can actually create other problems down the road. And my
40
sense is that what you are saying is we are doing the things that
we know to do today that make sense. And I hope that what you
are also saying is that before we take any other action, we will
think about those fully and look at the long-term implications of
the market, not just trying to deal with something in the short
term. I think that is what—thank you, Mr. Chairman.
Chairman DODD. Thank you very much, Senator, and I appreciate that, and I appreciate the Chairman's response to your questions as well. And as he points out, and I pointed out, back a year
ago we—in fact, I feel very strongly that the best line of defense
is exactly what the Chairman has said, and that is, hopefully the
servicers and others can work out things here so that you do not
have to engage in extraordinary steps to try and minimize these
problems. And that is the first line of defense, and we are very
hopeful that will produce some results.
I also just want to point out quickly to my good friend from Tennessee here, Residential Fixed Investment, the GDP component
that includes spending on housing, plunged by 25.2 percent in the
fourth quarter, a bigger drop than the earlier 23.9 percent; third
quarter spending fell by 20.5 percent. To give you some sense of
proportionality, that is the worst plunge since the fourth quarter
of 1981. This is a larger issue than just a correction problem. I say
that respectfully, but I think it is bigger than that is the case.
Senator CORKER. If I could respond to that, I would say, too, that
is coming off of an extreme high. I mean, we have had an exuberance in the housing market, and I think we should measure
those drops off of a mean, if you will, versus a high. I think that
the housing industry has enjoyed extreme free credit for many,
many years. We have had an exuberant market that we have
known for some time—as a matter of fact, I would say that actually
a few years ago we were concerned in California, for instance, that
housing prices were going up so rapidly. And so I would say that
that drop is off an extreme high, and I thank you for pointing that
out to me.
Chairman DODD. Let me, if I can, Mr. Chairman, I want to raise
a couple of questions, if I can for you, and some of them have been
touched on. I do not want to take a long time here with you, but
I am just intrigued by the correlation of some of these issues.
Sometimes we cite a bunch of statistics and wonder what the correlations are between them.
There are two factors that I want your thoughts on, if I can, that
contribute to this huge run-up in commodity prices that we heard
Senator Tester talk about and others. Oil is the first thing I think
about, but obviously, if you are a farmer or a baker in Rhode Island, it can be the cost of wheat and others. The first is the increase in the demand for these goods. That is obviously one set of
issues. The second is that these goods are priced in dollar terms.
Sometimes we pass over that idea, but we talked about the price
of oil a barrel, it is in dollar terms. And to what extent is the decline in the value of the dollar driving this? And beyond that concern, is that decline in the dollar—does that decline represent a decrease in confidence in the U.S. financial system?
As the Fed report indicates—and I mentioned this at the outset—there was a net sale of U.S. securities by private foreign inves-
41
tors in the third quarter of 2007, the first quarterly net sale in
more than 15 years. And I wonder how is that loss of confidence
in the U.S. by foreign investors leading into a decline in the dollar,
which leads to the rising commodity prices. I am trying to connect
these questions, if at all.
I was talking to a friend of mine in Europe this morning who is
involved in the financial services sector—a totally different matter—and I told him I was going to be having the hearing this morning with you. And he was saying that one of the problems we have
got is the fact that Europe is not cutting its interest rates at all,
and so you are getting that comparison as well, which probably exacerbates this problem to some extent, at least in that market.
And I was curious, because we have had a lot of questions of
you—and I will come back to this in a minute—on the sovereign
wealth funds, and I was trying to get some sense of proportionality
about private investment versus sovereign wealth funds. And I do
not minimize the importance of the sovereign wealth funds issues,
but I asked staff to give me some sense of the proportionality of
numbers. And out of the estimated $150 trillion in global capital
stock, $2.2 trillion is held by sovereign wealth funds. And while
sovereign wealth funds are about double the size of hedge fund assets, they represent less than 5 percent of global assets. And while
China's sovereign wealth fund hold is about $200 billion in assets,
the size of China's foreign exchange reserves is about $1.3 trillion.
And so you have got—putting aside that for a second, the private
investment sector here is an important one, and maybe I—am I
making too much of this bar graph I saw in the Monetary Report
Fund where you see for the first time that looks like a selling off
here? And I noticed in your response to one of the—I forget who
it was raised the question earlier. At least I thought I heard you
say this was not as—that foreign investment is still coming in and
that is a source of some confidence here.
Anyway, could you try and connect those things for me? Is it a
false connection? But I am curious how that relates to the decline
in the dollar, the rise in commodity prices, and whether or not
there is some connection here.
Mr. BERNANKE. Well, I do not think that foreign investors have
lost confidence in the United States by any means. The data you
are referring to shows some desire by foreign investors to shift out
of corporate credits and other credit products and into treasuries.
That is the same shift that American investors are making. They
are getting away from what they view as risky credits toward the
safety of U.S. Government debt. And, indeed, U.S. Government
debt is still the safest, most liquid, desired asset in the world.
There is some effect of the dollar on commodities. Oil and other
commodities are traded globally. You can think of the price as
being set by global supply and demand. If the dollar depreciates a
bit, then you would expect to see commodity prices rise to offset
that depreciation. But it is important to understand that, for example, oil has risen in euros as well as in dollars. I mean, it is not
simply an issue of currencies. It also has to do with global supply
and demand for the commodity. So the European Central Bank is
concerned about food and energy inflation as well.
42
With respect to the sovereign wealth funds, that is just another
indication that foreigners have not lost confidence in the U.S. economy and that there has been a good bit of inflow. In particular,
about something close to half of the capital that financial institutions have raised in the last few months has come from sovereign
wealth funds, from other countries.
I think that, in general, that is quite constructive. If we are confident, as I think we are in this case, that the investments are
made for economic reasons and not for political reasons or other
noneconomic reasons, and there is no issue of national defense,
which the CFIUS process takes care of, then that inflow of investment is good for our economy and certainly is helping, in this case,
the financial system. At the same time, allowing inflows of foreign
capital through reciprocity gives us more opportunities to invest
abroad.
I know that Congress is very interested in sovereign wealth
funds, and you should certainly take a close look at it. International agencies, like the International Monetary Fund and the
OECD, are developing codes of conduct. The basic idea there is that
sovereign wealth funds should be as transparent as possible. We
should understand their governance and their motivations, and, in
particular, we should be confident that they are investing, again,
for economic rather than political or other purposes. If we are confident in that, then it is in our interest to keep our borders open
and to allow that capital to flow in. And I think it will continue
to flow in.
Chairman DODD. You raise a good point here and one I wanted
to raise with you. This is a statement you made yesterday as well
before the House Financial Services Committee, talking about it.
And I do not disagree. It is quite constructive. And I think there
has to be a sense of balance in how we look at sovereign wealth
funds, and I think we run the danger of becoming a pejorative
without understanding the value of it. So we have to be careful
about it.
And you pointed out, and you did again here just now, you mentioned CFIUS, which, of course, we developed good legislation, I
think, out of the Committee on that, the IMF, the OECD, and looking at these investments from their various perspectives in terms
of these issues, which are a very legitimate point.
But what is the Fed's role in a sense? I mean, this is, it seems
to me, while all these other institutions have an important role to
play, I would make a case here that the Fed also has an important
role. They are investing in bank holding companies. This is the jurisdiction of the Federal Reserve Board, and it seems to me you did
not mention the Federal Reserve's obligation to be looking at these
questions as well. And, obviously, we have had major investments
here in bank holding companies. So tell me what you think is—
what is the Fed doing about this, and what is the responsibility of
the Fed in looking at this issue as well?
Mr. BERNANKE. YOU are quite correct, Senator. I should have
mentioned that.
Well, first, of course, we are very involved with the banks themselves, and we are very interested in their capital-raising efforts
and making sure that they raise enough capital to meet the well-
43
capitalized standards and to remain safe and sound. And so that
whole process is something we pay very close attention to.
We have statutory responsibilities. If the investment by any single person or group, whether it is a sovereign wealth fund or someone else, reaches certain levels that, imply a significant degree of
control, then we have to look at that, make sure it is appropriate.
Chairman DODD. Is that a sort of objective test rather than a
subjective test?
Mr. BERNANKE. I believe that 25 percent is the threshold.
Chairman DODD. But I was looking and thinking—I am just curious to get your reaction to this. And, again, I do not want to overdramatize this point, but I was curious in one of these—and you
will know which one I am talking about. One of these major investment houses, when the decision was made as to who the new CEO
was going to be, there was a flight I think occurred that went to
a country that was making major investment to get the OK in a
sense. Now, the amount invested would represent an amount far
smaller than the 25-percent threshold. But clearly, at least, if you
will, the visuals of going over and getting sort of a sign-off indicated that there was more of an influence than the dollar amount
would indicate. I mean, does that trigger something? Or should it
trigger something?
Mr. BERNANKE. Well, I think if the investor is making that big
an investment, they need to understand what is going on. I am not
sure whether it was a case of their deciding who was the CEO or
just simply being informed of the plans of the company.
In the cases that we have seen, the investments have been significant in absolute terms, but small in percentage of equity terms.
And in most cases, the amount of control—rights, board of directors, membership and so on—has been quite limited. So there has
not been any significant change in the control of these institutions.
If there were, then the Federal Reserve would want to
Chairman DODD. No, absolutely. I understand that. And, again,
I am not trying to expand your portfolio here by suggesting an earlier intervention, but it would seem to me that there may be some
signals here that may fall short of the 25 percent. I would rather
have you taking a look at those things where—and come to me and
say, "I think this is"—not to me necessarily, but to say we think
we ought to take a look at this, it may fall short of that absolute
trigger. That is why I say objective/subjective kind of analysis as
to what this could mean, so look at that.
Is there any chance, any worry you have at all—coming back to
the first question I raised with you, the declining value of the dollar, the 24-percent decline, the lowest since 1973, compared to the
six other major currencies. Is there any chance in your mind that
we would watch something moving away from a dollar denomination in these areas, in these commodities, such as oil going to the
euro, for instance? Do you see any danger in that? Or is it—do you
worry about that at all?
Mr. BERNANKE. I know of no plans of that, but the denomination,
as I said, is of second-order importance. There is some importance
in the willingness of foreigners to hold dollar assets, which is a different matter entirely. And as I said, I know of no evidence that
there is any reduction in interest.
44
Chairman DODD. Would that concern you if that happened? I
mean, is there
Mr. BERNANKE. If there was a change in denomination?
Chairman DODD. Yes, if they moved all of a sudden, went from
the price of a barrel of oil measured not in dollars but in euros,
what does that say about us and our economy? Does that have—
I mean, it seems to me that would be rather a dramatic piece of
news.
Mr. BERNANKE. Well, it might be symbolic. It might have symbolic value. But from an economic point of view, it is a global market, and foreign currencies are traded all the time. You know, if I
want to buy a barrel of oil, I can do it in euro or yen or any other
way I like. So from a fundamental sense point of view, it is not significant. There might be some symbolic value to it if that happened.
Chairman DODD. I was going to ask you a question to follow up
on Senator Menendez who asked questions about the housing
issue. But I think your answers in response to Senator Corker were
good ones in thinking about this issue. And I sense in your comments here today that this housing issue is a serious one. And I
am not going to try and put words in your mouth again, but I realize you put an adjective on this, and that becomes the headline.
But it is serious and warrants serious thought as to what we can
do to minimize this and to try and keep people in their homes, minimize this from happening again, and dealing with related issues.
And I appreciate those comments. And we are going to continue
talking with you about these various ideas that we have. And I certainly appreciate, having been here long enough to know, that
sometimes actions, however well intended, can have unintended
consequences, and so you need to think through things carefully.
And so we are going to want to be in touch with you during that
process.
But we also want to make sure we are not looking back and wondering if we could have done some things here that would have
minimized this from getting worse. So it is important.
I will leave the record open for a couple of days here. Members
who did not make it here may have some additional questions for
you. You have been before this Committee a lot now in the last couple of weeks, and we are grateful to you for that, and we will continue working with you.
The Committee will stand adjourned.
[Whereupon, at 12:32 p.m., the hearing was adjourned.]
[Prepared statements, response to written questions, and additional material supplied for the record follow:]
45
PREPARED STATEMENT OF SENATOR JEM BUNNING
Thank you, Mr. Chairman.
The health of our economy and financial markets is a concern to everyone here
today. Growth has slowed and we have been through a rough patch in the credit
markets. Everyone wants to see stability and growth return. Congress has acted to
restore confidence in the economy. The Fed has taken steps to thaw the credit
freeze. We hope that these policy actions will head off further damage, but no policy
can reverse the busting of the housing bubble and we are not going to regulate away
problems in the economy.
While I have supported actions taken to respond to our economic problems, I fear
they will have unintended consequences. I am most concerned about inflation and
the fall of the dollar. We need to think beyond what we have already done and take
steps to encourage long term growth. Congress can give taxpayers, businesses, and
investors certainty that their taxes are not going to go up. Congress can knock down
roadblocks to growth such as artificial limits on our energy supply. Congress can
make it more appealing for corporations to stay in the United States by easing regulations and lowering the corporate tax rate. Only with long term permanent policies
can we ensure a healthy economy for our grandchildren.
I look forward to hearing from the Chairman.
PREPARED STATEMENT OF SENATOR ELIZABETH DOLE
Thank you, Chairman Dodd and Ranking Member Shelby for holding this very
important hearing today. Chairman Bernanke, I join my colleagues in extending you
a warm welcome.
Since last August, our financial markets have experienced tremendous uncertainty. Credit and capital markets around the world have struggled to comprehend
the ramifications of the U.S. subprime lending and housing crisis. Fortunately, the
Federal Reserve has been quick to act, lowering the federal funds rate from 5.25
percent to 3 percent. Congress also is working to help boost our economy.
Several recent reports have highlighted ongoing economic challenges. Such as last
week, the Wall Street Journal said that the "leading economic indicators" fell for
the fourth straight month. Since its July 2007 high, the index has fallen by 2 percent, which is the largest 6-month drop since 2001. Additionally, for the week ending on February 16, the 4-week average of initial unemployment claims rose by
10,750 to 360,500, pointing to a softening of the labor market.
Furthermore, by the third quarter of 2007, household debt rose to $13.6 trillion
from $7.2 trillion in 2001, a 10-percent annual increase. Over this same time period,
mortgage borrowing more than doubled. As a result, one out of every seven dollars
of disposable income earned by Americans goes towards paying down debt.
Fears loom of higher inflation and more "pain at the pump." The price of a barrel
of oil has hovered around the $90 mark and recently closed above $100 per barrel.
If these higher gas prices and inflationary pressures continue, coupled with the
well-known weakness in across our housing sector, I—like many folks I hear from—
am very concerned that future economic growth could be hindered.
No question, the health of our economy is influenced by many complex issues and
expected and unexpected events. That said, I would like to highlight a few areas
where I am focused to help spur growth and job creation.
I strongly support Trade Adjustment Assistance, which helps ensure that displaced workers have the ability to train for new careers. In recent years, my home
state of North Carolina has undergone a difficult economic transition, as our state
continues to evolve from a manufacturing and agriculture-based economy to a more
services-oriented economy. In North Carolina and across the country, there is a need
to address the growing gap between skilled and unskilled workers. Senator Cantwell
and I have introduced legislation that would allow more workers to receive TAA
benefits, including training, job search and relocation allowances, income support
and other reemployment services.
Additionally, with respect to current regulation of financial institutions, it has
come to my attention that some smaller banks are overburdened by compliance with
Sections 404 and 302 of the Sarbanes-Oxley corporate accountability law. Mr. Chairman, these financial institutions are already highly-regulated, and it has become increasingly apparent that these regulations, while well-intended, only increase their
costs of doing business. I hope this committee will soon consider legislation that
would provide true regulatory relief for all financial institutions.
Chairman Bernanke, thank you again for being here today. I look forward to hearing from you—and working with you—on these and other important issues.
46
PREPARED STATEMENT OF BEN S. BERNANKE
CHAIRMAN,
BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
FEBRUARY 28, 2008
Chairman Dodd, Ranking Member Shelby, and other Members of the Committee,
I am pleased to present the Federal Reserve's Monetary Policy Report to the Congress. In my testimony this morning I will briefly review the economic situation and
outlook, beginning with developments in real activity and inflation, then turn to
monetary policy. I will conclude with a quick update on the Federal Reserve's recent
actions to help protect consumers in their financial dealings.
The economic situation has become distinctly less favorable since the time of our
July report. Strains in financial markets, which first became evident late last summer, have persisted; and pressures on bank capital and the continued poor functioning of markets for securitized credit have led to tighter credit conditions for
many households and businesses. The growth of real gross domestic product (GDP)
held up well through the third quarter despite the financial turmoil, but it has since
slowed sharply. Labor market conditions have similarly softened, as job creation has
slowed and the unemployment rate—at 4.9 percent in January—has moved up
somewhat.
Many of the challenges now facing our economy stem from the continuing contraction of the U.S. housing market. In 2006, after a multiyear boom in residential construction and house prices, the housing market reversed course. Housing starts and
sales of new homes are now less than half of their respective peaks, and house
prices have flattened or declined in most areas. Changes in the availability of mortgage credit amplified the swings in the housing market. During the housing sector's
expansion phase, increasingly lax lending standards, particularly in the subprime
market, raised the effective demand for housing, pushing up prices and stimulating
construction activity. As the housing market began to turn down, however, the
slump in subprime mortgage originations, together with a more general tightening
of credit conditions, has served to increase the severity of the downturn. Weaker
house prices in turn have contributed to the deterioration in the performance of
mortgage-related securities and reduced the availability of mortgage credit.
The housing market is expected to continue to weigh on economic activity in coming quarters. Homebuilders, still faced with abnormally high inventories of unsold
homes, are likely to cut the pace of their building activity further, which will subtract from overall growth and reduce employment in residential construction and
closely related industries.
Consumer spending continued to increase at a solid pace through much of the second half of 2007, despite the problems in the housing market, but it appears to have
slowed significantly toward the end of the year. The jump in the price of imported
energy, which eroded real incomes and wages, likely contributed to the slowdown
in spending, as did the declines in household wealth associated with the weakness
in house prices and equity prices. Slowing job creation is yet another potential drag
on household spending, as gains in payroll employment averaged little more than
40,000 per month during the 3 months ending in January, compared with an average increase of almost 100,000 per month over the previous 3 months. However, the
recently enacted fiscal stimulus package should provide some support for household
spending during the second half of this year and into next year.
The business sector has also displayed signs of being affected by the difficulties
in the housing and credit markets. Reflecting a downshift in the growth of final demand and tighter credit conditions for some firms, available indicators suggest that
investment in equipment and software will be subdued during the first half of 2008.
Likewise, after growing robustly through much of 2007, nonresidential construction
is likely to decelerate sharply in coming quarters as business activity slows and
funding becomes harder to obtain, especially for more speculative projects. On a
more encouraging note, we see few signs of any serious imbalances in business inventories aside from the overhang of unsold homes. And, as a whole, the nonfinancial business sector remains in good financial condition, with strong profits, liquid balance sheets, and corporate leverage near historical lows.
In addition, the vigor of the global economy has offset some of the weakening of
domestic demand. U.S. real exports of goods and services increased at an annual
rate of about 11 percent in the second half of last year, boosted by continuing economic growth abroad and the lower foreign exchange value of the dollar. Strengthening exports, together with moderating imports, have in turn led to some improvement in the U.S. current account deficit, which likely narrowed in 2007 (on an annual basis) for the first time since 2001. Although recent indicators point to some
47
slowing of foreign economic growth, U.S. exports should continue to expand at a
healthy pace in coining quarters, providing some impetus to domestic economic activity and employment.
As I have mentioned, financial markets continue to be under considerable stress.
Heightened investor concerns about the credit quality of mortgages, especially
subprime mortgages with adjustable interest rates, triggered the financial turmoil.
However, other factors, including a broader retrenchment in the willingness of investors to bear risk, difficulties in valuing complex or illiquid financial products, uncertainties about the exposures of major financial institutions to credit losses, and
concerns about the weaker outlook for economic growth, have also roiled the financial markets in recent months. To help relieve the pressures in the market for interbank lending, the Federal Reserve—among other actions—recently introduced a
term auction facility (TAF), through which prespecified amounts of discount window
credit are auctioned to eligible borrowers, and we have been working with other central banks to address market strains that could hamper the achievement of our
broader economic objectives. These efforts appear to have contributed to some improvement in short-term funding markets. We will continue to monitor financial developments closely.
As part of its ongoing commitment to improving the accountability and public understanding of monetary policy making, the Federal Open Market Committee
(FOMC) recently increased the frequency and expanded the content of the economic
projections made by Federal Reserve Board members and Reserve Bank presidents
and released to the public. The latest economic projections, which were submitted
in conjunction with the FOMC meeting at the end of January and which are based
on each participant's assessment of appropriate monetary policy, show that real
GDP was expected to grow only sluggishly in the next few quarters and that the
unemployment rate was seen as likely to increase somewhat. In particular, the central tendency of the projections was for real GDP to grow between 1.3 percent and
2.0 percent in 2008, down from 2V2 percent to 2% percent projected in our report
last July. FOMC participants' projections for the unemployment rate in the fourth
quarter of 2008 have a central tendency of 5.2 percent to 5.3 percent, up from the
level of about 4% percent projected last July for the same period. The downgrade
in our projections for economic activity in 2008 since our report last July reflects
the effects of the financial turmoil on real activity and a housing contraction that
has been more severe than previously expected. By 2010, our most recent projections show output growth picking up to rates close to or a little above its longerterm trend and the unemployment rate edging lower; the improvement reflects the
effects of policy stimulus and an anticipated moderation of the contraction in housing and the strains in financial and credit markets. The incoming information since
our January meeting continues to suggest sluggish economic activity in the near
term.
The risks to this outlook remain to the downside. The risks include the possibilities that the housing market or labor market may deteriorate more than is currently anticipated and that credit conditions may tighten substantially further.
Consumer price inflation has increased since our previous report, in substantial
part because of the steep run-up in the price of oil. Last year, food prices also increased significantly, and the dollar depreciated. Reflecting these influences, the
price index for personal consumption expenditures (PCE) increased 3.4 percent over
the four quarters of 2007, up from 1.9 percent in 2006. Core price inflation—that
is, inflation excluding food and energy prices—also firmed toward the end of the
year. The higher recent readings likely reflected some pass-through of energy costs
to the prices of core consumer goods and services as well as the effect of the depreciation of the dollar on import prices. Moreover, core inflation in the first half of
2007 was damped by a number of transitory factors—notably, unusually soft prices
for apparel and for financial services—which subsequently reversed. For the year as
a whole, however, core PCE prices increased 2.1 percent, down slightly from 2006.
The projections recently submitted by FOMC participants indicate that overall
PCE inflation was expected to moderate significantly in 2008, to between 2.1 percent and 2.4 percent (the central tendency of the projections). A key assumption underlying those projections was that energy and food prices would begin to flatten
out, as was implied by quotes on futures markets. In addition, diminishing pressure
on resources is also consistent with the projected slowing in inflation. The central
tendency of the projections for core PCE inflation in 2008, at 2.0 percent to 2.2 percent, was a bit higher than in our July report, largely because of some higher-thanexpected recent readings on prices. Beyond 2008, both overall and core inflation
were projected to edge lower, as participants expected inflation expectations to remain reasonably well-anchored and pressures on resource utilization to be muted.
The inflation projections submitted by FOMC participants for 2010—which ranged
48
from 1.5 percent to 2.0 percent for overall PCE inflation—were importantly influenced by participants' judgments about the measured rates of inflation consistent
with the Federal Reserve's dual mandate and about the time frame over which policy should aim to attain those rates.
The rate of inflation that is actually realized will of course depend on a variety
of factors. Inflation could be lower than we anticipate if slower-than-expected global
growth moderates the pressure on the prices of energy and other commodities or if
rates of domestic resource utilization fall more than we currently expect. Upside
risks to the inflation projection are also present, however, including the possibilities
that energy and food prices do not flatten out or that the pass-through to core prices
from higher commodity prices and from the weaker dollar may be greater than we
anticipate. Indeed, the further increases in the prices of energy and other commodities in recent weeks, together with the latest data on consumer prices, suggest
slightly greater upside risks to the projections of both overall and core inflation than
we saw last month. Should high rates of overall inflation persist, the possibility also
exists that inflation expectations could become less well anchored. Any tendency of
inflation expectations to become unmoored or for the Fed's inflation-fighting credibility to be eroded could greatly complicate the task of sustaining price stability and
could reduce the flexibility of the FOMC to counter shortfalls in growth in the future. Accordingly, in the months ahead, the Federal Reserve will continue to monitor closely inflation and inflation expectations.
Let me turn now to the implications of these developments for monetary policy.
The FOMC has responded aggressively to the weaker outlook for economic activity,
having reduced its target for the federal funds rate by 225 basis points since last
summer. As the Committee noted in its most recent post-meeting statement, the intent of those actions has been to help promote moderate growth over time and to
mitigate the risks to economic activity.
A critical task for the Federal Reserve over the course of this year will be to assess whether the stance of monetary policy is properly calibrated to foster our mandated objectives of maximum employment and price stability in an environment of
downside risks to growth, stressed financial conditions, and inflation pressures. In
particular, the FOMC will need to judge whether the policy actions taken thus far
are having their intended effects. Monetary policy works with a lag. Therefore, our
policy stance must be determined in light of the medium-term forecast for real activity and inflation as well as the risks to that forecast. Although the FOMC participants' economic projections envision an improving economic picture, it is important
to recognize that downside risks to growth remain. The FOMC will be carefully evaluating incoming information bearing on the economic outlook and will act in a timely manner as needed to support growth and to provide adequate insurance against
downside risks.
Finally, I would like to say a few words about the Federal Reserve's recent actions
to protect consumers in their financial transactions. In December, following up on
a commitment I made at the time of our report last July, the Board issued for public
comment a comprehensive set of new regulations to prohibit unfair or deceptive
practices in the mortgage market, under the authority granted us by the Home
Ownership and Equity Protection Act of 1994. The proposed rules would apply to
all mortgage lenders and would establish lending standards to help ensure that consumers who seek mortgage credit receive loans whose terms are clearly disclosed
and that can reasonably be expected to be repaid. Accordingly, the rules would prohibit lenders from engaging in a pattern or practice of making higher-priced mortgage loans without due regard to consumers' ability to make the scheduled payments. In each case, a lender making a higher priced loan would have to use thirdparty documents to verify the income relied on to make the credit decision. For
higher-priced loans, the proposed rules would require the lender to establish an escrow account for the payment of property taxes and homeowners' insurance and
would prevent the use of prepayment penalties in circumstances where they might
trap borrowers in unaffordable loans. In addition, for all mortgage loans, our proposal addresses misleading and deceptive advertising practices, requires borrowers
and brokers to agree in advance on the maximum fee that the broker may receive,
bans certain practices by servicers that harm borrowers, and prohibits coercion of
appraisers by lenders. We expect substantial public comment on our proposal, and
we will carefully consider all information and viewpoints while moving expeditiously
to adopt final rules.
The effectiveness of the new regulations, however, will depend critically on strong
enforcement. To that end, in conjunction with other federal and state agencies, we
are conducting compliance reviews of a range of mortgage lenders, including nondepository lenders. The agencies will collaborate in determining the lessons learned
49
and in seeking ways to better cooperate in ensuring effective and consistent examinations of, and improved enforcement for, all categories of mortgage lenders.
The Federal Reserve continues to work with financial institutions, public officials,
and community groups around the country to help homeowners avoid foreclosures.
We have called on mortgage lenders and servicers to pursue prudent loan workouts
and have supported the development of streamlined, systematic approaches to expedite the loan modification process. We also have been providing community groups,
counseling agencies, regulators, and others with detailed analyses to help identify
neighborhoods at high risk from foreclosures so that local outreach efforts to help
troubled borrowers can be as focused and effective as possible. We are actively pursuing other ways to leverage the Federal Reserve's analytical resources, regional
presence, and community connections to address this critical issue.
In addition to our consumer protection efforts in the mortgage area, we are working toward finalizing rules under the Truth in Lending Act that will require new,
more informative, and consumer-tested disclosures by credit card issuers. Separately, we are actively reviewing potentially unfair and deceptive practices by
issuers of credit cards. Using the Board's authority under the Federal Trade Commission Act, we expect to issue proposed rules regarding these practices this spring.
Thank you. I would be pleased to take your questions.
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RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY
FROM BEN S. BERNANKE
Q.I. Increases in the GSE/FHA Conforming Loan Limits: The stimulus bill recently passed by Congress includes an increase in the
conforming loan limit amount for mortgages that the Government
Sponsored Entities (GSEs) and the Federal Housing Administration can guarantee.
Do you believe that increasing these loan amounts adds to the
systemic risks associated with the GSEs' operations?
While these increases are only temporary, some have raised the
idea of permanently increasing the amounts. Are there additional
risks associated with a permanent increase?
A.1. Temporarily raising the conforming loan limit allows the GSEs
to securitize an expanded range of mortgage loans and likely would
increase liquidity in the secondary market for loans covered by the
expansion. The GSEs should be strongly encouraged to rapidly use
this authority, even if it requires that they raise substantial
amounts of capital.
Over a longer horizon, it is important to realize that raising the
conforming loan limits extends the implicit government-backing of
the GSEs into a larger portion of the mortgage market. While the
jumbo mortgage market has experienced substantial liquidity problems during the past year, this market historically has operated efficiently and functioned well without GSE involvement. Moreover,
prime quality homeowners who use jumbo mortgages are, in general, the highest income and wealthiest members of our society. Extending the reach of the GSEs to these borrowers would do little
to expand homeownership or to extend mortgage credit to those
that cannot obtain mortgages otherwise.
Thus, raising the conforming loan limit involves the larger question of how far to extend government guarantees, either explicit or
implicit, to resolve short-term liquidity problems in secondary asset
markets. Temporary expansions of the safety net, such as those undertaken by the Federal Reserve, can boost short-term liquidity
without distorting private market credit analysis. In contrast, permanent expansions of the safety net, such as raising the conforming loan limit permanently, may well cause greater problems
in the long-run. There are many reasons for the recent breakdown
in private market credit analysis, but it is not clear to me that the
best approach to rectify the current situation is simply to substitute implicit government guarantees for much needed private
market discipline. If private markets are unable to provide a secondary market for some assets, we should first endeavor to understand why this is the case rather than immediately turn to a
broader expansion of GSE guarantees.
Any permanent expansion of GSE guarantees must, be accompanied by comprehensive GSE reform to mitigate further systemic
risks. In particular, capital standards for the GSEs must be significantly toughened and clear and credible receivership procedures for
the GSEs should be established. Moreover, the role and function of
the GSE portfolios should be clearly articulated by Congress. As
has been evident in recent months, this portfolio is managed mainly to meet needs of GSE shareholders and not to fulfill public policy
objectives.
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Q.2. International Liquidity Coordination: Chairman Bernanke, as
of the minutes of the last Federal Open Market Committee meeting, the Federal Reserve reaffirmed their commitment to working
with foreign central banks to coordinate international monetary
policy.
Please describe for us the details of the Federal Reserve's agreements with foreign central banks, such as the European Central
Bank and the Bank of England for exchanging assets into dollars.
Why have these agreements been made and are financial institutions using these tools?
A.2. The Federal Open Market Committee (FOMC) established
swap lines with the European Central Bank (ECB)and Swiss National Bank (SNB) in conjunction with the establishment of the
Term Auction Facility (TAF) on December 12, 2007. These swap
agreements were requested by the ECB and SNB and allowed them
to draw a maximum of $20 billion and $4 billion respectively, for
a period of up to 6 months. Under the agreements, both central
banks are allowed to purchase U.S. dollars with their foreign currencies based on the prevailing spot exchange rate, and they pay
interest on the foreign currency received by the Federal Reserve.
Given the strong financial position of the ECB and SNB, the swap
lies involve virtually no credit risk to the Federal Reserve. The
Federal Reserve has also maintained longstanding swap facilities
with the Bank of Mexico and the Bank of Canada as part of the
North American Framework Agreement. Those facilities amount to
$2 billion with the Bank of Canada and $3 billion with the Bank
of Mexico.
The agreements with the ECB and SNB were established to
allow dollar funding problems faced by European and Swiss banks
to be addressed directly by their respective home central banks. In
the absence of such agreements, European and Swiss banks were
believed to be more likely to seek dollar funding in U.S. markets,
potentially increasing volatility and adding to term funding pressures in U.S. markets. By providing dollars to the ECB and SNB
to use in their efforts to address term dollar funding problems
abroad, the FOMC believed that it would assist U.S. credit markets.
Both the ECB and SNB have used their swap agreements. The
first use of these swap lines was on Monday, December 17, when
the ECB drew upon $10 billion and the SNB drew upon $4 billion
for a 28-day period. The two central banks used the funds to auction dollar funding to their eligible depository institutions; the ECB
offered funds to its eligible depository institutions at the 4.65 percent rate set in the Federal Reserve's TAF auction, and the SNB
auctioned $4 billion at a weighted average rate of 4.79 percent. The
ECB drew upon a further $10 billion on Thursday, December 20,
in conjunction with the second TAF auction held by the Federal Reserve. At the expiration of its first use of its swap line, the ECB
renewed its draws in conjunction with the January 14 and January
28 TAF auctions, offering $10 billion in 28-day dollar funds both
times at a rate equal to the rate set in the TAF auction. The SNB
also renewed its draw of $4 billion on its swap line to participate
in the January 14 auction of dollar funds. On March 11, the FOMC
announced that it would increase its temporary swap line to the
52
ECB from $20 billion to $30 billion and its line to the SNB from
$4 billion to $6 billion, extending the swap lines through September 30, 2008. Both central banks have signaled that they would
draw upon the lines to offer 28-day dollar funding in auctions to
be held on March 25.
Q.3. Sovereign Wealth Funds and Systemic Risk: Chairman
Bernanke, recently we have seen an influx of capital into our domestic financial institutions from foreign governments, specifically
sovereign wealth funds. Previous foreign direct investments have
usually been in smaller quantities and from private investors, rather than governments. These investments may be under the threshold of control for each sale, but collectively could represent a large
proportion of U.S. financial services firms.
Is there a danger of systemic risk from one or more Sovereign
Wealth Funds holding noncontrolling stakes many financial firms?
A.3. The recent prominent equity investments by sovereign wealth
funds in large U.S. financial institutions permanently increased the
capital of these firms, enhancing their soundness and the soundness of the U.S. financial system. These investments also support
the ability of the financial institutions to provide credit to businesses and consumers. It is difficult to envision circumstances
under which non-controlling equity stakes in financial institutions,
could increase systemic risk in a financial system.
Sovereign wealth funds have been relatively stable investors. The
funds generally are neither highly leveraged nor exposed to liquidity risk arising from investor withdrawals or redemptions. Sovereign wealth funds often use professional private fund managers
who are tasked with seeking higher returns and greater diversification—relative to official reserves—for a portion of a country's foreign exchange assets.
Because sovereign wealth funds are government owned, there
has been concern, however, that these funds have the potential to
be motivated by political reasons To the extent these funds make
only smaller, noncontrolling investments, the ability of a sovereign
wealth fund to have an effect on the operation, strategic direction
or policies of a banking organization are minimal.
If two or more companies with noncontrolling investments in a
U.S. bank or bank holding company were to agree to act together
in an attempt to influence the operations of a U.S. bank or bank
holding company, the Federal Reserve has the authority to combine
the companies' shareholdings and treat the group as one company
(an "association") for purposes of the Bank Holding Company Act
(BHC Act). If the combined shareholding were significant enough,
the association could be treated as a bank holding company subject
to the requirements of the BHC Act. To date, the Board has not
found that sovereign wealth funds from different countries have in
fact acted together to control a U.S. financial institution.
Another important safeguard applies to the U.S. banking organization itself. U.S. banking organizations themselves are subject to
the supervisory and regulatory requirements of U.S. banking law.
For example, federal banking agencies are required under the Federal Deposit Insurance Act to establish certain safety and soundness standards by regulation or guideline for all U.S. insured de-
53
pository institutions. These standards are designed to identify potential safety and soundness concerns and ensure that action is
taken to address those concerns before they pose a risk to the Deposit Insurance Fund. Thus, the Federal banking agencies may
monitor and require action by the U.S. banking organization to
maintain its financial health regardless of the owner of the banking organization.
Q.4. Is there a Bernanke "Put"? Chairman Bernanke, some economists speculate that market participants became willing to take
greater risks because monetary policy under Chairman Greenspan
protected investments by cutting interest rates in response to economic shocks. This phenomenon came to be called the Greenspan
"put"—referring to the financial instrument that guarantees its
owner a certain return if prices fall below a specified level. Now
critics are wondering if there is also a Bernanke put, given the recent significant drop in rates.
How do you respond to these observations? How do you balance
responding to slower economic growth while at the same time allowing the market to follow a normal business cycle?
Do you have any concerns that the 225 basis point drop in interest rates since last August creates moral hazard for market participants?
A.4. In conducting monetary policy, the Federal Reserve is guided
by its statutory mandate to promote maximum employment and
stable prices over time. I do not believe that monetary policy actions aimed at these goals are a significant source of moral hazard.
To be sure, in carrying out its mandate, the Federal Reserve takes
account of a broad range of factors that influence the outlook for
economic growth and inflation, importantly including financial
asset prices, such as the prices of equity shares and houses. Financial asset prices are important for the economic outlook partly because they affect household wealth and thus consumer spending on
goods and services and therefore ultimately influence output, employment, and inflationary pressures. Depending on overall circumstances, declines in asset prices may adversely affect the outlook for aggregate demand, and consequently the stance of monetary policy may need to be eased in order to cushion the effect on
aggregate demand. It is important to recognize that such a response of monetary policy is not designed to support financial asset
prices themselves but to foster overall economic growth and to mitigate the risks of particularly adverse economic outcomes. It is also
worth noting that past Federal Reserve efforts to buoy economic
growth in the face of declining asset prices have not insulated from
substantial losses investors who made poor investment choices.
This point is evidenced by the very large losses suffered by investors in the tech sector early this decade despite considerable monetary policy easing, and by the losses experienced by investors in
many subprime-related mortgage products more recently even as
the stance of monetary policy was eased.
Q.5. Term Auction Facility: Chairman Bernanke, the Federal Reserve created a new Term Auction Facility to help ensure that
American banks have adequate liquidity.
54
What has been the response to the auctions thus far and for how
long will they continue?
What type of collateral are banks posting in these auctions?
What happens if that collateral, particularly AAA-rated mortgage
backed securities, is downgraded?
A.5. The demand for TAF credit from depository institutions has
been ample. All eight auctions conducted to date have been oversubscribed, with resulting interest rates in each case above the
minimum bid rate. The Federal Reserve will continue to conduct
TAF auctions for at least the next 6 months unless evolving market
conditions clearly indicate that such auctions are no longer necessary.
TAF borrowing is collateralized by the same pool of assets as
pledged against other types of discount window loans. For all types
of discount window loans, Federal Reserve Banks will consider accepting as collateral any assets that meet regulatory standards for
sound asset quality. Commonly pledged assets include residential
and commercial real estate loans, consumer loans, business loans,
and a variety of securities. The standards applied to each type of
collateral are available on the Federal Reserve discount window
Web site at www.frbdiscountwindow.erg. Collateral that is downgraded below Federal Reserve eligibility standards is given no
value and must be withdrawn. The likelihood that the downgrade
of a portion of a depository institution's collateral will affect a TAF
loan is reduced by the requirement that, at the time of bidding, the
sum of the aggregate bid amount submitted by a depository institution and the principal amount of TAF advances that the same depository institution may have outstanding cannot exceed 50 percent
of the collateral value of the assets pledged by the depository institution.
Q.6. Value of the Dollar: As you know, the U.S. dollar declined
against most major currencies over the past year. The dollar has
lost 10.4 percent again the Euro and 5.7 percent versus the yen in
2007.
What does it mean for our economy if foreign countries turn
away from holding the dollar as their reserve currency or even if
they diversify, which has already begun?
Are there dangers that we will be more constrained in the actions we are able to take domestically, including selling Treasury
securities, to finance our deficit?
A.6. The dollar's status as a reserve currency reflects investor confidence in the sophistication and liquidity of U.S. financial markets
and the relative stability of our macroeconomic environment. To
date, there is little evidence of a shift in foreign official holdings
away from dollar denominated assets. U.S. data show further
growth in foreign official holdings of U.S. assets. Data reported to
the IMF also show continued growth in dollar assets in foreign official reserves. While the IMF data show a decline in the dollar
share of reported reserves, this decline is entirely attributable to
the depreciation of the dollar, which has raised the dollar value of
the other currencies held in the reserve portfolios. In response to
a private survey conducted by the Royal Bank of Scotland, several
reserve managers indicated they planned to increase the weight of
55
non-dollar assets in future investments, but there was again no
evidence of a general shift out of the dollar on the part of these respondents.
In principle, a shift in foreign appetite away from U.S. securities
toward foreign securities might be expected to lower the value of
the dollar and to raise U.S. interest rates; however, these effects
are difficult to measure and appear to be modest. Furthermore,
while it is true that foreign official institutions hold a significant
fraction of U.S. Treasury securities outstanding, it is important to
note that these holdings represent less than 5 percent of the total
debt outstanding in U.S. credit markets. As such, U.S. credit markets could likely absorb a shift in foreign official allocations away
from dollar assets without undue difficulty. In the event that such
a shift were to occur and put undesired upward pressure on U.S.
interest rates, the Federal Reserve has the capacity to increase
available credit to maintain a level of short-term interest rates consistent with our domestic economic goals. Any effect of reduced foreign demand on the term premium between short-term and longterm interest rates could affect the cost of long-term borrowing by
the Federal Government; however, this impact is likely to be relatively small and is unlikely to materially constrain the U.S. government's ability to finance its deficit.
Q.7. Slow Growth and Rising Inflation: Mr. Chairman, there is
some evidence of contradictory forces at play in the economy right
now. In the middle of the present economic downturn, commodity
and food prices have increased.
What do you judge to be the threat of slow growth continuing,
with inflation remaining above the Federal Reserve's comfort level?
A.7. The FOMC, in the statement released at the conclusion of its
most recent meeting on March 18, noted that the outlook for economic activity has weakened further in recent weeks and that
downside risks to growth remain. At the same time, inflation has
been elevated, uncertainty about the inflation outlook has increased The actions taken by the Federal Reserve since last August, including measures to foster market liquidity, should help to
promote moderate growth over time and to mitigate the risks to
economic activity. However, the Federal Reserve remains attentive
to the risks to the outlook for activity and inflation, and it will act
in a timely manner as needed to promote sustainable economic
growth and price stability.
Q.8. Capital: The ongoing turmoil in our financial markets vividly
demonstrates the wisdom of prudent capital requirements for our
financial institutions. If our financial institutions hold sufficient
capital, they are much more likely to weather the inevitable economic storms that occur as part of the business cycle. Because a
healthy banking system is one of the best defenses against a severe
economic downturn, one of the most important responsibilities of
our financial regulators is ensuring that financial institutions are
adequately capitalized.
Chairman Bernanke, what is your assessment of the current capital levels in our banking system? As part of your answer, would
you explain the steps your agency has taken over the past year to
make sure that our banks are adequately capitalized?
56
A.8. As you how a bank is deemed to be well capitalized under
Prompt Corrective Action rules if it has a tier 1 risk-based capital
ratio of 6 percent or greater, a total risk-based capital ratio of 10
percent or greater, a leverage ratio of 5 percent or greater and is
not subject to any written directive issued by the Federal Reserve
Board. As can be seen in the summary table below, the majority
of U.S. commercial banks have substantial buffers over the well
capitalized requirements (as of year-end 2007), which should prove
helpful during these difficult times. However, capital ratios in
banking organizations can erode rapidly during downturns, depending on the rate of increase and amounts of write-downs and
additions to the allowance for losses and the extent to which these
cannot be offset by the retention of earnings or raising of new capital.
Summary Average Data for Insured Commercial Banks
Ratios
Equity Capital/Assets
Leverage
Tier 1 Ratio (Risk-Based)
Total Ratio (Risk-Based)
% Deemed Well Capitalized
Avg. 1997-2007
2006
2007
9.2
10.2
7.8
8.1
10.2
7.9
9.4
12.2
98.9
9.7
9.8
12.4
12.4
98.3
99.3
Source: Summary Profile Report, Dec. 2007, BS&R, Federal Reserve Board of Governors.
The Federal Reserve Board, together with the other banking
agencies, is currently reviewing several elements of its regulatory
capital requirements to ensure that banking organizations have
sufficient capital levels to weather losses during difficult times and
to ensure a high standard in the quality of capital (i.e., its ability
to absorb losses effectively) being issued by these organizations. In
addition, our ongoing supervisory activities include monitoring
banking organizations' asset quality, market exposures, quality of
earnings, capital management plans, effectiveness and adequacy of
provisioning, and valuation policies, all of which directly impact the
banking organizations' capital standing.
In December 2007, the Federal Reserve Board, together with the
other banking agencies, approved final rules implementing the
Basel II advanced risk-based capital rules—for large, internationally active banking organizations—that more closely align regulatory capital requirements with actual risks and should further
strengthen banking organizations' risk-management practices. The
improvements in risk management under Basel II will be valuable
in promoting the resiliency of the banking and financial systems.
Under the Basel II rules, banking organizations must have rigorous processes for assessing their overall capital adequacy in relation to their total risk profile and publicly disclose information
about their risk profile and capital adequacy. We will continue to
assess the Federal Reserve Board's capital rules to ensure that
banking organizations' capital requirements remain prudent.
Q.9. Role of Credit Rating Agencies for Capital Requirements:
Many financial institutions and pension funds are only permitted
to hold assets with an "investment grade" rating.
Chairman Bernanke, what steps is the Fed taking to ensure that
banks monitor the quality of assets on their balance sheets and
57
that financial institutions are not outsourcing their due diligence
requirements to credit rating agencies?
A.9. Many investors and financial firms relied too heavily on ratings assigned by credit rating agencies in their risk management
activities, particularly with regard to structured credit instruments. The Federal Reserve has long stressed to bankers the importance of proper due diligence and independent analysis in making credit risk assessments. A recent analysis of several global financial institutions by supervisors from the United Kingdom, Germany, France, and the United States—including staff from the
Federal Reserve—demonstrated that principle in the current environment. Those institutions that had developed robust internal
processes for assessing risks of complex subprime-related instruments were able to more quickly identify declines in value and the
heightened risks of these instruments. Accordingly, these institutions were less vulnerable to the underestimates of risk made by
the credit rating agencies on these instruments, less likely to underestimate the volatility of these instruments, and better able to
analyze the effects of changing market conditions on their credit
and liquidity risk profiles.1
We are reminding institutions that they should conduct independent, thorough, and timely credit risk assessments for all exposures, not just those in the loan book. Their processes for producing
credit risk assessments should be subject to periodic internal reviews—through financial analysis, benchmarking and other
means—to ensure that these assessments are objective, accurate
and timely. Supervisors are also redoubling efforts to ensure that
institutions do not rely inappropriately on external ratings. We
continue to emphasize that for any cases in which U.S. banks rely
on third-party assessments of credit risk, these institutions should
conduct their own assessments to ensure that they are sound and
timely and that the level and nature of the due diligence should be
commensurate to the complexity of the risk.
In addition, the Federal Reserve and the other members of the
President's Working Group on Financial Markets (PWG) have recommended a review of existing regulations and supervisory policies
that establish minimum external ratings requirements to ensure
they appropriately take account of the characteristics of securitized
and other structured finance instruments. The PWG also has endorsed plans by the Basel Committee on Banking Supervision and
the International Organization of Securities Commissions to reconsider capital requirements for complex structured securities and
off-balance-sheet instruments that are keyed to ratings provided by
credit rating agencies. The PWG further has recommended changes
in the oversight of credit rating agencies and their required disclosures to improve the comparability and reliability of their ratings,
and expressed support for recent initiatives by the credit rating
agencies to improve their internal controls and ratings for structured finance instruments. 2
1
Senior Supervisors' Group, "Observations on Risk Management Practices During the Recent
Market Turbulence," March 6, 2008.
2
The President's Working group on Financial Markets, "Policy Statement on Financial Market Developments," March 12, 2008.
58
Q.10. HOEPA Rulemaking: During this period of correction in the
housing market, I believe it is incredibly important that we do not
overreact and restrict access to credit to individuals who need it
the most. In December of last year, the Federal Reserve produced
a proposed rule under its Homeownership Equity Protection Act
(HOEPA) authority. That rule is currently out for notice and comment.
Mr. Bernanke, can you comment for the record on some of the
steps that the Fed took to ensure that an appropriate balance was
struck between eliminating many of the mortgage market excesses
that created many of the problems we face today while ensuring
that borrowers have adequate access to credit?
A.10. Our goal in proposing new regulations under the authority
of the Home Ownership and Equity Protection Act (HOEPA) was
to produce clear and comprehensive rules to protect consumers
from unfair practices while maintaining the viability of a market
for responsible mortgage lending. To help us achieve this goal, we
gathered substantial input from the public, including though five
public hearings we held on the home mortgage market in 2006 and
2007. We also focused the proposed protections where the risks are
greatest by applying stricter regulations to higher-priced mortgage
loans, which we have defined broadly so as to cover substantially
all of the subprime market.
As an example of the Board's approach, the rules would prohibit
a lender from engaging in a pattern or practice of making higherpriced loans that the borrower cannot reasonably be expected to
repay from income or from assets other than the house. The proposal is broadly worded to capture different ways that risk can be
layered even as the practices that increase risk may change. It
would not set numerical underwriting requirements, such as a specific ratio of debt to income, but would provide some specific guidance for lenders to follow when assessing a consumer's repayment
ability. For instance, creditors who exhibited a pattern or practice
of not considering consumers' ability to repay a loan at the fullyindexed rate would be presumed to have violated the rule.
Another proposed rule would require lenders to verify the income
or assets they rely on to make credit decisions for higher-priced
loans. Creditors would be able to rely on standard documents to
verify income and assets, such as W-2 forms and tax returns. However, to ensure access to credit for consumers, such as the self-employed, who may not easily be able to provide traditional documentation, the rule would allow creditors to rely on any third-party
documents that provide reasonably reliable evidence of income and
assets. For example, creditors could rely on a series of check cashing receipts to verify a consumer's income.
We believe these proposed rules will help protect mortgage borrowers from unfair and deceptive practices. At the same time, we
did not want to create rules that were so open-ended or costly to
administer that responsible lenders would exit the subprime market. So, our proposal is designed to protect consumers without
shutting off access to responsible credit.
59
Q.ll. Housing Market: Chairman Bernanke, the current downturn
in the housing market is not the first that we've seen, and is unlikely to be the last.
What has been the average length of time from peak to trough
in previous housing market downturns?
How does the current downturn compare to previous ones?
A.11. Although there are considerable differences across episodes
and measures of housing market activity, the trough usually occurs
between 2 and 3 years after the peak. Thus far, the current downturn in residential investment has lasted eight quarters, similar to
the average of previous downturns. As measured by single-family
housing starts, the decline in activity so far in this cycle has been
greater than average, although not quite as large as the contraction that occurred in the late 1970s and early 1980s.
Q.12. Home Prices and Inflation: Chairman Bernanke, a commonly
watched measure of inflation is the core-CPI. Housing constitutes
almost a third of core-CPI.
To what extent has the recent decline in housing prices moderated recent increases in the core-CPI?
What would be the trend in core-CPI if house prices were excluded?
A.12. The CPI for owner-occupied housing is not directly affected
by changes in housing prices. The Bureau of Labor Statistics (BLS)
uses a rental equivalence approach to measure changes in the price
of housing services from owner-occupied units. This approach defies
the implicit rent of an owner-occupied unit as the money that
would be received were it to be rented out (that is, the opportunity
cost of owning, as opposed to renting, the unit). As a result, the
BLS uses observations on tenants' rents (after making adjustments
for landlord-provided utilities) to construct the CPI for owner-occupied housing. It is reasonable to expect that tenants' rents should
be related over time to the affordability of owner-occupied housing,
which would depend in part on home prices. The BLS does not publish an index for the core CPI excluding owners' equivalent rent.
However, one can gain some insight with regard to its limited contribution to core CPI inflation of late from the fact that the CPI
index for all items less food and energy rose 2.3 percent over the
12 months ending in February 2008, while the index for owners'
equivalent rent of primary residence increased 2.6 percent.
Q.13. Housing Wealth: Chairman Bernanke, the recent decline in
home prices in many parts of the country followed several years of
extraordinary home price appreciation.
What has been the overall impact of the housing bubble, and its
burst, on household wealth? Is a family that purchased a home in
2002 or 2003 still better off?
Of those families who purchased homes earlier this decade, and
have seen substantial overall appreciation, how have their spending patterns been affected by the declining market?
A.13. Nationwide, according to the Office of Federal Housing Enterprise Oversight (OFHEO) purchase-only house price index,
house prices peaked in mid-2007 and have since fallen about 3 percent; according to the more volatile S&P/Case-Shiller house price
index, house prices peaked in mid-2006 and have since fallen about
60
10 percent. Both indexes show major regional disparities, with
house prices peaking earlier, and falling more, in California, Nevada, some New England states, and Michigan and Ohio. Indeed,
according to OFHEO's measure, home prices in Michigan have fallen, on net, since 2001. In all other states, families that purchased
their homes in 2003 or earlier continue to have seen a net appreciation in their home's value.
According to the Federal Reserve's flow of funds accounts, housing wealth peaked at $20.3 trillion in 2007:Q3 before falling about
$170 billion in 2007:Q4. Estimates by academic economists of the
direct effect of housing wealth on consumption vary widely, from as
little as 2 cents on the dollar to as high as 7 cents on the dollar.
These effects tend to be spread out over roughly a 3-year period,
so that current spending is still being supported to some extent by
earlier house price gains, and the effects of the current declines
will only be fully felt over the next couple of years.
In addition to directly affecting spending by reducing family
wealth, falling house prices may affect a family's spending indirectly through credit market channels. Borrowing against home equity is often the lowest-cost form of finance available to a household; falling house prices can decrease the collateral value of a
home, forcing borrowers to turn to costlier forms of finance, such
as credit cards. These indirect effects, which are extremely difficult
to quantify, probably are a factor that has increased the size of
some of the larger published estimates of the effect of falling house
prices on consumer spending.
Q.14. Covered Bonds: Chairman Bernanke, recently FDIC Chairman Bair indicated that covered bonds were a "front burner issue"
at the FDIC as they continued to look for ways to improve liquidity
in the mortgage market. I understand that Europe has a mature,
$2 trillion covered bond market.
Do you think there could be a benefit to fostering such a market
in the United States?
What distinctions do you see between the European market and
the status of the U.S. market?
A.14. As long as banks and their counterparties are safe and
sound, efforts to provide more financing opportunities to banks and
bank holding companies, particularly under current market conditions, should be taken seriously. Such actions may make it more
likely that the financial markets will be able to provide the necessary credit to sustain and enhance economic activity. In general,
the European markets appear to be useful additions to their financial markets, successfully providing liquidity and credit for some
assets under most market conditions.
Covered bonds have been available in Europe for many years,
and such programs differ greatly across countries. Much could be
learned by studying the merits of each country's program and applying these lessons to creating a unique program in the United
States. Creating a covered bond market in the United States, however, may be difficult without Congressional discussion and legislation. Covered bonds raise many issues related to the safety net provided to banks in the United States, including issues related to the
bank deposit insurance fund. The legal structure provided for cov-
61
ered bonds in European countries resolves many of these issues.
With regard to creating a covered bond market in the United
States, all parties should seek to distill the best practices from the
European markets and work towards the establishment of a robust
and well-designed covered bond market that includes safeguards to
ensure that the safety net provided banks would not be measurably
extended further.
62
63
Monetary Policy Report
to the Congress
Submitted pursuant to section 2B
of the Federal Reserve Act
February 27,2008
Board of Governors of the Federal Reserve System
64
Letter of Transmittal
BOARD OF GOVERNORS OF THE
FEDERAL RESERVE SYSTEM
Washington, D.C.. February 27, 2008
THE PRESIDENT OF THE SENATE
THE SPEAKER OF THE HOUSE OR REPRESENTATIVES
The Board of Governors is pleased to submit its Monetary Policy- Report to the Congress
pursuant to section I B of the Federal Reserve Act.
Sincerely.
:ti Bemanke. Chairman
65
Contents
Part1
] Overview: Monetary Policy and the Economic Outlook
Part 2
3 Recent Economic mi dFinauci.nl Developments
i The Household Sector
3
Residential Investment and Finance
7
Consumer Spending and HotiselioldFinance
10 The Business Stttoi
10
Fixed
I m ' e
11
Inventory
I m ' e
12
Corporate Profits and Business Finance
14 The Government Sector
14
Federal Government
1(
Slate and Local Government
16 National Saving
17 The External S«lor
17
International Trade
15
The Financial Account
1° TheLaboi Market
IP
Emplopnent and Unemplownetit
20
Productivity and Labor Compensation
21 Prices
23 Financial Markets
23
Market Functioning and Financial Stability
29
Policy Expectations and Interest Rates
30
£j)iM itarteis
30
Debt and Financial Intermediation
32
Hie M2 Monetary Aggregate
32 International Developments
32
International Financial Markets
33
Advanced Foreign Economies
34
Eifietglng-Marker Economies
Part 3
37 Monetary Policy in 2007 and Early 2008
Part 4
41 Summary of Economic Projections
66
Part i
Overview:
Monetary Policy and the Economic Outlook
The U.S. economy ha* weakened considerably since
Itisl July, when tin: Fedcrji Reserve Board submitted it>
previous ^f(tIWf^$n' PtfUcv R^pa>rtU* it,'t* Ctwytrcsx- SubSCSfllial -steams have emerge*! in financial markets here
j n J .ibrc«:.i J, and liuLihii.iL;-n-LiK*J activity lui.-. i:on(i im^d
to contract, AJso, further ilKMMBS in the price1? of etude
oil LuiJ wine other commodities have eroded the real
income?* of U S househo l ds and added to business,
c o s b . Ovotafl economic activity held up reas onably
well into ihe autumn despite tho*e adverse developments, but h decelerated sharply in the fourth quarter,
Moreover, the nutkiDk for 2008 ban become less Favorable since last summer, jnd •consii.kjdN- dmvtrtidc ri-:k.-lo economic activity have emerged, Headline • . > \ r ' i i
price inflation picked up in 201(7 as n result fffi&aMt
increases in energy and food prices, white coiv mentioti (which KnhfiJH the ctirct leffeciv of m&vemcniA in
energy and food pwtjKli WQJ., en balance, a little Itswcjrhan in*00(i. Nonetheless, with tnrlarion expjctatioijs
untiejpnted to remain reasonably well anchored-euarj^y
an J i-tlK'i r-imii'-i-dji)1 prices expected to flatten out, Jild
pic^^urcs on ( n f l O M iikcly lo caw. moneuiry policy
niukors generaUy luvo expected iiwlation tu moderate
scm?whnl in 2tXt*i a » j 20fm, Under those cututnstnnces, tiic Fedenij Reserve has cased the siunco e>f
inonot;IJ v polky •nb>TJ!ili:i!ly >iin:c July.
titie> backed h>itich rftorl|^i^fr&. The loss of confide IK«
reduced invciiors\ivcfall willingik^s to boar nsk and
cattaed them to icnsscss the soundness of the stntcturcb
of other fiitanciul producU. Thai reasse$i.ment was
accompanied by high volatility AND diminished liqjUidity
inn number of tin.mesal cnarkeis lucre*indabroad. The
pressiJiiK in financial niarketfi W0H9 reinforced by bank&*
c o n u m s nbout ucluul und potential credit l a v n In
LidJiuoti. biiiik'i recognized that they miglu need to take
a larj!,e volume of assets onto tlwir balance sheet*—
inducing levctiig^cd loam, some types of mori^uge-J,
a n d a&sefs relitii n
Aflvr midyear, as lasses en Mibprinw mon,gagtf5 ond
relatedstructured invtfsuneut piWutis continued in
mount* unx'siws became iticre-jsingly skcpucut xibout
the likely credit jwfonnanei" of even highly rated « c u -
paper
Initially, ihe spiJI^ r cr from the problems in (he
h o u . ^ i n ^ :NLJ
The turmoil in litmnci^E markets tiiat sincr^cd laM
summer ivai triggered by a> sharp increase in Jclinqucneicsund defaults on iubprimi' morlgag^s. That mcteast
n A a t o U l l ^ unpaired (lie funclionmgcf Ihe seciHidafy
marked for smbprime and nontRdilifiul rtsldtntial
mortgagee which in turn i:h>ntnbtiEed i c o rLLdudioii in
the qv;iilnt>ililyof such mortgageeio hciiKhold-s. Partly
as Q rt'sull of these developments as weU as continuing
concerus about prospect for linDoite prices, (he demand
for hciusing dropped furilier In r^spDiist.' to wvak
d^mnikl und liifh inventories of unsold homo:., hcimcbuildcn; coiumucd to cut the i<•••->- of t-- •• cotusifucticn
•
ni fba amujd half of 2007, pushing the level of single*
family stiuta in ihc fourth q u u r t r more than 50 peirafti
below r he high »aclied in the tirsl quarter of 20i>6.
t o -••.•-!••'!••.! • • ! - • ! • : > . !
program.1;—given iheir rc£i£tin£ commitments to customwns and the irncreased rvsistjnce1 of invtf>iors lo putchasing 1.0-niii securitized products. In response to UIOM
unexpected U UQij baiiks btxsme more conservative
B
in deploy m$ their liquidity and balance sheti capiicit>r.
Icj.fn^' tn lidi-rc-r credit conditions for ionie businesses
LUIJ hot t s ehokte. The combinprion of a more negative
ecanofnic outlook and a reaisc-isnien! of risit by mves [«•>]-: precipitated u ^teep fal] ui Treasury yields n 4ubsujiMnl widening of Kp»ydv on both invesunont-gmde
and speculative-grade corporate bt.tn<bt and A sizable
net decline inequity price*.
f i i u n c i i i l i r u i k d * l o ••>t\\-jY %<.-^ IOL . o f (I>•
economy WAS limited. Indeedb in the third quarter, tedI
. i • • ' domestic product {GDP) rose at an annual rate
ofneatly 5 percent in part because of foiid ^ i n ^ in
consumer spending, busmess investment, and exports
In tlw fourth qiiiarter. however. rv&\ GDP increased only
slightly, and the economy seeim to have entered 200S
with Ijrile momenitim In the labor market* gfowlh in
prr v atf-wctor poyrolls slowed markedly in late *007
and jjciujn' 20UK. The sluggish pace of hiring, .ilon^
with higher vturtgy prices, lower «qtiity prices* and soAening home values, has weighed on CDibumei rfiitiiiiK'iiil
und spending of tote. In addition, indicator* of business
investment have becanic less fovotabk recently Howeverx continued expansion of foreign ccanoniic activiiy and a lower dollur kept U.S. exports on a marked
uptrend through the second ha lf of lust venr. presiding
sonvc offset to the slowing in domestic demand.
Ownill cortaxi iiiee price inftattaii. as nujsurfd by
the price index for personal consumphon expenditures
67
2
Monetary Policy Report to t he Congress • February 200*8
(PCE h stepped up to 3V; percent over & e four quarters
of 2007 because of the sharp increase in energy prices
and the largest rise in food prices in nearly two decades,
Core PCti price inflation picked ^ R m M M in the
second half of last year, but the increase came on ihe
hee ls o f some unusually low readings in ihe first ha lf ;
core PCE price inflat ion over 2007 as a whole averaged
sli ghtly more than 2 percent, a liltLe less than in 2006.
The Fed cm l Reserve has taken a number of steps
since midsummer to address, strains in short-term funding markets and to foster its inacroeconomic objectives of maximum employment and price stability.
With regard to short-term funding markets, the Fedem] Reserve's initial actions when market lurbulence
emerged bl August included unusually large open market operations as well as adjustments to Ihe discount
t e and to procedures for discount window borrowing
and securities lending, As pressures intensified near the
end of the year, the Federal Reserve established a Term
Auction Facility to supply short-term credit to sound
banks against a wide variely of colhieraL mnxMidaB* it
entered ink* currency swap arrangements with two other cenlrat banks to increase the availability oftermdoU
lar funds in their jurisdictions. With regard to monetary
polic y , ih e Federal Open Market Committee (FOMC)
cut the target for the federal funds rate 50 basis points
at its September mccli ng lo address the potential downside risks to the broader economy from ihe ongoing dis-
ruptions in financial markets. The Committee reduced
the target 25 basis pointsat ils October meeling and did
so attain i t the December meeting. In the weeks following lhat meeting, the economic outlookdeteriorated
further, and downside risks to growth intensified: the
FOMC cut an additional 125 basis points from the larget in January—75 basis points on January 22 and
50 basis points al its regularly scheduled meeting on
January1 29-30.
Since the previous Monetary Policy R^porSt ihe
FOMC has announced new communications procedures, which include publishing enhanced economic
projections on a timelier basis. The most recent projections were released with the minutes of ihe January
FOMC meeting and arc reproduced in part 4 ofthis
report. Economic aciivity was expected lo remain soA
in the near lerm but to pick up later this year—supported by monetary and fiscal siHimIus— and to be expanding at a pace around or a bit above ils long-run trend by
2010. Tota l inflation was expected to be lower in 200S
than in 200? and lo edge down further in 2009. However, FOMC participants (Board members and Reserve
Bank presidents! indicated lhat considerable uncertainly
surrounded the outlook for economic giowih and thai
they saw ihe risks around that oulLook as skewed to ihe
downside. In contrast, most participants saw the risks
surrounding the forecasts for inftalion as roughly
balanced.
68
Part 2
Recent Economic and Financial Developments
AUhough the US economy had generally performed
well in the first half of200 7 . the economic landscape
was subsequently reshaped by the emergence of sub-
in the chain-iype price index for personal
mpt ion expe nditures. 2001—07
MamLj] sii;ii[is Jd TiiUiiLizil itmkcls in t i t United Slacks
and abroad. the intensifying down:urn m the housing
market, and higher prices for crude oil and some other
commodities. Rising delinquencies on subprinu' mortgages led lo large losses on related strucluied credil
products, sparking concerns abou! the structures of
other financial products and reducing investors' appetite
for risk. The resulting dislocations generated un a niKip.iied pn-^ujcs on bank balance ^ru.vi>. .and ihosc
pressures combined with uncertainty about the size
and distribution of credit losses lo impair short-tenn
funding markets. Consequently, Ihe Federal Reserve
and I'ENL-I rvnti.il hankN unowned loMippon liquidity
and functioning in those markets. Amid a deteriorating
economic outlook, and with downside risks increasing. Treasury yields declined markedly, and the Federal
Open M nkci Committee cul the federal funds rate SUBstant ially Meanwhile, risk spreads in a wide variety of
etcdil markets increased considerably, and equity prices
tumbled.
The financial turmoil did not appear to leave much
of a mark on overall economic activity in the third
quarter. Real GDProse at an annual roteofnewly
5 percent, as solid gains in consumer spending, business
Changein * a l CDP. 2001-07
j
lilli,
3X|t
^(54
3W5
jit»
awT
rComnrrc. Bwoai of Ecowk Aiul)
1»ftftfti
rf Coar<nxr BUKJU rf Econonk AIUIJYIL.
invcslmera. ande\pons more than offset Ihe continuing
drag from residential investment. In the fourth quarter,
however, economic activity decelerated significantly,
and I I K economy seems to have entered 2WW with linle
I->I A R D momentum. In pan because of lighter credit
conditions for households and businesses, Ihe housing
correction has deepened, and capital spending lias softened. In addition, a number of factors, including steep
increases in energy prices, lower equity prices, and softening home values, have started to weigh on consumer
outlays. In the labor market, private hiring slowed
sharply in late 2007 and January 200K. Tlie increase in
the price index for total personal consumption expenditures(PCE) picked up to 3M percent in 2007 as a result
of sizable increases in food and energy* prices. Core
PCE inflation, though r a v e n over the course of die
year, averaged a bit more than 2 percent during 2007 as
3 whole, a little less than the increase posled in - ^ x -
Tilt1
tial limslmen
iand Finance
Economic activity in the past t wo years lias been
restrained by Ihe ongoing contraction in the housing
sector, and thai restraint intensified m Ihe second half
of 2007. Homesales and prices softened significantly
further, and homebuilderscurtailed new construction
69
4
Monetary Policy Report to the Congress D February 200&
Private housing starts. 19W-2OO7
rates. 2001-08
—
J
—
4
AJ|Mt*krJ»
SoiVt Fvdirri t k o t LOM M n ^ q t CocpwAoa
in response to weak demand and elevated inventories.
In all, die diehnc in residential investtnent reduced nw
annual growth rule of m l GDP in the second half of
2007 by more than I percentage point, and the further
drop in dousing starts around Ihe rum of the year suggeststhat the drag on the growth of real GDP remains
substantial in early 2008.
The downt u r n in housing activity followed a mulliyear period of soaring home sales arid construction and
rapidly esca lating home prices. The earl i e r strength in
housing reflected a number of factors. One was a low
level of global real interest rales. Another was that
Change in prices of existing l e - f j r n i ] ) 1 houses.
198K- 2O07
19»
many hcrnebuyers apparently expecied that home prices
would continue to rise briskly into the indefinite future*
thereby adding a speculative element to the market, tn
addition, tow A rd the end of the boom, housing demand
was supported by an upsurge innonprime mortgage
lending—in many cases fed by bx lending standards.'
By the middle of the decade* house prices had reached
very high levels in many part* of t he United States, and
housing was becoming progressively less affordable.
Declining affordability and waning optimism about
future house price appreciation apparently started to
weigh onthe demand for housing, t hereby causing SALES
to la11 and the supply of unsold homes to ralehel up retalive to the pace of sales. Against this backdrop, prices
began to decelerate, further damping expectations of
future price increases and exacerbatingt he downward
pressure on demand.
House prices decelerated dramatically in 2006 and
softened further in 2007. In many areas of the nation,
existing home prices fell noticeably Usi year. For the
nation as a whole, IhcOFHEO price index declined
in PV second haIf of the year after rising modestly in
the first half; that measure had risen 4 percent in 2006
and about 9'/i percent in each of ihe two years before
that.; In the ma rke t for new homes, ihe cons tant-quality
index of new home prices fell Vk porcent over ihe four
quarters of 2007. Moreover many latge homebuilde
iprttt ^
«»(tb of
IMS
Nun. Ilk iMJ if* 4*iTfc(K Mid r\Md f
•wE^Kft ill n V l < n f h
B*fcB.Lfc
DwpL ^
r high I O I
J UJ near-pnme lo
p
)'k»riJcj ttun
j^t-s. I key nu> •c^nr-c- ImT rwrtr*iino(ul Jitwd i uih^n
r be nud? o
2. 1 be in&n. iiltc ivjaoAilly
i be r ^ c j -tnth *ct\ OCM prm tnda iot -ex. tcltn^
d b b O f I k f F d k H
P
70
Board ofGovernors of the Federaf Rtjunv System 5
reportedly have boon using not only price discounts
but also nonprke incentives ( for example, paying C osL
ing costs and including optional upgrades at no cost)
in an effort to bolster sales of new homes and reduce
IILWHTUCU; i
Inall, the pace of sales of existing homes fell
30 percent between mid-2005 and the fourth quarter of
2007, and sales of new homes dropped by half. Builders
cut production in response to the downshift indemand:
by the fourth quarter of 2007, starts of single-family
homes had fallen to an annual rate of just S26.00Q
units—less than half the quarterly high reached in early
2006. Nonetheless, the ongoing declines in sales prevented builders from nuking much progress in paring
their bloated inventories of homes. In fact, although
the number of unsold new homes has decreased, on
net, since the middle of 2006, inventories haveclimbed
sharply relative to sales. Measured relative lo the
average pace of sates over the three months ending in
December, the months' supply of unsold new homes at
the end of December stood at nine months, more than
mice the upper end of the narrow range thai had prevailed fiom I « 7 to mid-2005.
The contraction in housing demand and construction
was exacerbated in me second half of 2007 by the near
elimination of nonprime mortgage origination's and a
tightening of lending standards on all types of mortgages. Indeed, large fractions of banks that responded
to the Federal Reserved Senior Loan Officer Opinion
Survey on Bank Lending Practices reported that ihey
had tightened lending standards over (his period. Nonetheless, interest rateson prime conforming mortgages
have declined on net: Rates on conforming thirty-year
fixed-iate loans dropped from about 6V* percent last
summer to just above 6 percent at year-end. This year
they dipped as low- as 5 l ; percent but have recently
moved back up to about 6 percent within the range that
prevailed for much of the 2003-05 period . ' Rates on
conforming adjustahte- rate loans have also fallen significantly over the past several months and now i md
at their lowest level since the end of 2005.Offered rates
on ti icd-ialc jumbo Loans* which ran up in the second
half of 2007, b a n recently declined somewhat, on net,J
Even sos spreads between rates offered on these loans
and conforming loans remain unusually wide.
The softness in home prices has played an important
role in the ongoing deterioration in the credit quality
of subprimc mortgages. The deicrioraiic-n was rooted
in poor underwriting standards—and, in some cases,
fraudulent and abusive lending practices—which were
based in part on ihc assumption that house prices would
continue lo rise rapidly for some time to come. Many
borrowers with weak credit histories took out adjustable-rate mortgages (subprime ARMs) with tow initial
rates' of those Inns originated in 2005 and 2006, a
historically large fraction had high loan-to-value ratios,
which were often boosted by the addition of an associated junior lien or"piggyback"mortgage. When house
prices decelerated, borrowers with high loan-to-value
ratios on their loans were unable to build equity in their
homes, making refinancing more difficult, and also
faced the prospect of significantly higher mortgage paymenls after the initial rates on she loam reset.
Mortgage delinquency rate*. 2001-07
BO
w
12
I
J
I
I
I
I
t
L
I
I
A^uttUrnb/ —
J. Coifaminf
nk Mat i l
il
f
f
p
y
c: ihc>- nu4 be t ^ ^ J r r t in mJt io i priTK
h ai w> [KT« I t t«n-to-Ml«c rjtio. tml they < » I H (
ncccd UK c nlorxuif IQJTI tintl. The ECOKVIK SdmtiiArt ol
. MfncJ inio 11* on ftktmr\ \$.t*u-.-*.ii:*l; ui<f J tlr •-• ninf k a i limit for i fwst moiigipc « i i wnf k^fjmS hone in ihc
bgKiui LHiitd SIJ& riocn J41 •?,!>*> lo 125 pcrccif oTlW mrdui
w . with jn wtfiLUjpaf S7?9n75o. Then?* (onforniAf linii ttJlteinvffci i h m f h i r c c n J ^ ^ H ^ .
A. Junbo nortf^gcv jrc thov ihui c^coeJ the nu.vmun iue D T I
i. i>ii«ni ny Eoji, thqr w typiqJI> e uenJnJtohonwen mitfc re btii d > 4n«f credi E t i r i
•
It
I
n-O2
I
2004
I
2 «
I
M
I
200
J
2QK
I I
2<X
Ncm T I * Jjt* art- aodU^ Kof Hitfvuv. pnaf. isd attt-f
a jdt-A pooh, rrfw to V-it r
rito ii Uv pwcool <4 k m * a
71
6
Monetary Policy Report lo the Congress • February 2008
C u m u l a t i v e d e f a u l t s o n 4Ubprlme 2 / 2 8 l o a m ,
often carry adjustable rates—have crept up slightly
by y e a r o f originat i o n ,
from very low levels.
2
0
0
The credit quality of loam that were securiiizcd in
pools marketed as " a l t - A " has declined considerably.
Such LOANS are typically made to higher-quality borrowera but have nonttaditional amortization structures or
other nonstandard features. Some of the loans are eategorized as prime or near prime and others as subprime
The rate of serious delinquency on loans with adjustable
rates in alt-A pools currently stands a t almost 6 percent, far above the rates of less than I percent seen as
recently as early 2006. The rate of serious delinquency
on fixed-rate alt-A loans has also increased in recent
months.
The continued erosion in the quality of mortgage
credit has led lo a rising number o f initial foreclosure
filings; indeed, such filings were made at a record pace
in the third quarter of 2007. Foreclosures averaged
•foe* t q i f*f»b ifcc riwiK4 nf | a » i of if nikhj n He i s f c * * d y ™ tei bad
drfjultod t*v rfcc indh-Jlft] Vnt ipt. kv r u m p l f . pufbfr b tvuntct * f JLI
about 360 * 000 per quarter over the first three quarters of
2007. compared with a rate of about 2J5.0O0 in the cor-
•inr to1} « a r <»«K}-f-w F»>flfti nfcl T V Ud F H K u l u c i l-x rtw H i m
KHI
twtnaf 2C05-JP m tatid 01 BKoaiptaf dab. A 2/3 tan u i
>->*,• 1 ^ »irh J l i t J rj11«rbc Inn t*o s«J» «hl«adjwttMf 1 4
™
k A
r r
r f
SOLTCE: Stilcakil
ddi
Co
c
Futi
AIMK
responding quarters of 2006. As was the case in 2 0 0 6 ,
more than half of (he foreclosure filings in 2007 were
subprinn? mortgages despite the relatively smaller
share of such loans in total mortgages outstanding, I n
some cases, falling prices may have tempted more-
Subprimc A R M s account for about 7 percent of aII
speculative buyers with little or no equity to walk away
first - lien mort£&gc£ outstanding. Delinquency rates
from their properties. Foreclosures have risen most in
on subprimc A R M s bogan to incrcas? in 2006, and by
areas wrhere home prices have been falling aftera period
December 2007, more than on e -fi ft h o f i h c ^f loans
«
of rapid increase: foreclosures also have mounted in
•ACK seriously delinquent (that is, ninety days or more
gome regions where economic growth has been below
delinquent or in foreclosure). Moreover, an increasing
the national average.
Avoiding foreclosure—even if il involves granting
fraction of subprime AElMs in the paat few years have
become seriously delinquent SOON after they m m i>ngi-
concessions to the borrower—can be an important t e n -
nated ond often well before the iniiial rale was due to
mitigation strategy for financial institutions. To limit
reset' For subpriinc A R M s originated in 2006, about
the number of delinquencies and foreclosures, financial
10 percent had defaulted in the first twelve months,
institutions can usea variety of approaches, including
more than double the fraction for mortgages originated
renegotiating the liming and size of rate resets. A e o m -
in earlier years. Furthermore, the path of the default rate
pltcation in implementing sgch approaches is that the
for subprime A R M s originated in 200? has run even
loans have often been packaged and sold in securitized
higher. Forsubprime mortgages with fixed interest rates,
pools that are owned by a dispersed group of investors,
delinquency rates have moved up signihcjnlly in recent
which makes the task of coordinating renegotiation
months, to the upper end of their historical range.
among all affected parties difficult - In pan lo address
For mortgages made to higher-quality borrowers
the challenges in modifying securitized loans, coun-
(prime and near-prime mortgages), performance weak-
selors, servjecrs. investors, and other mortgage market
ened somewhat in 2007 b but it generally remains fairly
participants joined in a collaborative effort, called the
solid. Although the rate o f serious delinquency en A R M s
Hope N o w Alliance, to facilitate cross-industry solu-
has moved uph lhat on fixed-rate loans has stayed low.
tions to the problem.* Separatehy*the Federal Reserve
Serious delinquencies on jumbo mortgages—which
has directly responded in a number of ways to the problems with mortgage credit quality ( described in the box
& TbcintluJ L-M-ralc px^i-xJ fc* raort MbfxHncARKU<ripidod
iitKc penal from 2005 (DJOO1? w u Iwntiyrfournorthi Rixj£hK
I' J million Aifcftrinc ARM* UK %chcJukJ \o undcrv^ tbdc fim nic
revt in Z1 HIM E^cnuiU^tbc Kccnt Joclinrh in nuii^t iatcrnt raits, J
rtoitb4cfrurtjonof tb<rKHtbfHmc ARM*areKW^UIH¥>re*ct b a
hif bet infcfcH rjlc.
A
T h e M o p e N o * Alliance(www.fct i *
n en and to ptjy J "
i i » n-ilc in Ufc^nlini •$ ihc PUKC*1* f>f rcHunciif and nviJih in
iubfriro* ARM*. The Alliance * i l l
A
d h
H
Board of Gowrnors ofike Federal
entitled "The Federal Reserve's Responses to the Subprime Mortgage Crisis ")
Most commercial banks responding to the Federal
Reserve's January 2008 Senior Loan Officer Opinion
Survey indicated (hat loan-by-loan modifications based
on individual borrowers"circ umstances were an important part of I the ir loss-mit iga t ion strategic*. Almost twothirds of respondents indicated lhat [hey wonid consider
refinancing the loons of their troubled borrowers into
other mortgage products at their banks. About onethird ofrespondentssaid that streamlined modifications
of the sort proposed by the Hope Now AlHate a m
important to their strategies for limiting losses.
A]1 of the factors d iscussed above—ihe drop in home
sales, softer home prices, and lighter lending standards
|especially for subpnme and alternative mortgage
products)—combined lo reduce the growth of household mortgage debt to an annual rate of about
IVi percent over the first three quarters of 2OQ7H
down from 11l/* percent in 2006,Growth likely
slowed further in Ihe fourthquarter.
Con Uifttiw Sifwttdittf;
and tti>n\i-h(fU FlBOTTI
Consumer spending held up reasonably well in the
second half of 2007, though it moderated some in the
fourth quarter. Spending continued to be buoyed by
solid gains in aggregate wages and salaries as well
as by the lagged effects of tile increases in household
wealth in 2005 and 2006 However, other influences
on spending have become less favorable. Job gains
IflJ- M
(Hfi.tO
IJ" •
— 110
i:v. • -
—
I**- •
m
•
<••'.
er
I
Han
i
i
v*n.
1
i
1 1 1 1 1 1 1 1
L*J6 LM^JL ^ L l J ;oce
1>
— 100
—
1 1
1 1
x u ^M6
1 1
MS
«
1
O^HKV B*MJ J l l i I H naarit Mil
" ' * * «»«*J * J . .j,..in.-.jir,,
If U*l*M S«
bout
have slowed lately, household wealth has been damped
by the softening in home prices a& well as by recent
declines in equity values* and consumers* purchasing
power has been sapped by sharply higher energy prices.
Moreover* eonsumer sentiment has fallen appreciably,
and aIthough consumer credit has remained availabLe
to most borrowers, credit standards for many types of
loans have been tightened.
Real personal consumption expenditures (PC E)
increased at an annual rate of 2% perccnt in the third
quarter, a little above the average pace during the first
half of the year: in the fourth quarter. PCE growth
sloped to _ percent. With the notable eiceptton of
ttitiinf ru [Kful ncttrafc n CCUKI bondmen and refer ihtmtopv>
Change in real income and consumption. 20OI-O7
— 5
— 4
I
I I I I I I I t I I I t I I I 1 I I I M I I I I I
IW?
IWI
1W*
19»
XDS
JOtlJ
Nan. Th( HitL «f g«J«ie(1ir M J &H*3
tUf W H < ef C
Bunnof Ecfltwmt AWTJ^
far****** ** f i
9*t<*$b JBTyt Tb* *+Jl
8
Monetary Policy Report lo the Congress • February 2008
The Federal Reserve's Responses to the Subprirrra Mortgage Crisis
The sharp Incraass*in iubprim& mortgage
In VIM ((dlllXjLHIK H-\ ,)l:.| fora I' '.!•'".. DIM l l f
past year have created personal, economic,
and social distress for many homeowners and
communities. The F&deral Reserve has laken a
number of actions that directly respond to these
problems. Some of Uw efforts are intended to
help distressed subprime bOCTPWBW and limit
preventable foreclosures, and others are aInwd
at reducing the likelihood of wjch problem; in
Ihe future.
Home Iraws t r o u g h foreclosure canbe
reduced if financial instiiutions work with borrowers who are having difficulty meeting their
mortgage payment odlgahom. foreclosure
cannot always be avoided, but in many caies
prudent loss-mltlgallon techniques thai preserve
homeownership are less coaly lo lenders than
foreclosure In 2007, the Federal Reserve and
other banking agencies encouraged mortgage
lenders and mortgage servicerelo pursue prudent loan workouts ihrough suc h measure as
modification of loans deferral of payments,
extension of toan maturities, capitalization of
delinquent amount*, and conversion of adjustable-rate mortgages (ARMs) into fixed-rate mortgages or fully indexed, fully amortizing ARMs. 1
The Federal Reserve hasal so collaborated
with community groups to help homeowners
avoid forectosure. Staff members throughoL* ihe
Federal Reserve System are working lo identify
localities that are likely lo experience the highest rales of foreclosure: Ihe resulting information is helping local groups to better locus their
borrower outreach efforts. In addition, the Federal Reserve actively support. NeighborWorta
America, a national nonprofit organization that
has been helping ihousandi of mortgage boricw« n facing current or potential distress. Federal
Reserve staff members have worked closely
with this organization and its tocal affiliates on
an array oF foreclosure prevention efforts, and
a member of the Federal Reserve Board serves
on its board of directors Other contributions
include efforts by Reserve Banks to convene
wor kshops for uafceho Iders to deve lop co mmunity-based solutions to mortgage delinquencies
in their areas.
The Federal Reserve has taken Important
ste ps aimed at avoiding future problems insubpfime mortgage marked while still preserving
responsible subpr ime lending and sustainable
homeownershiip. In coordination wrlhether
federal supervisory agencies and the Conference of Stale Bank Supervisors, the Federal
Reserve issued principles-based guidance on
subprime mortgages last summer.-1 The guidance
is designed lo heIp ensure thai borrowers ob(aIn
I. Bura«GovtmonotT*FHITMR*wntSymm
I2CC'J1. "WxthgwWi HoflgageBofrowwi,' UMibior
i f i O J * (Apf» " j . W "SuttfW* en LMJ W
tf Y i e e f i of RtiWendal Mcrtqajei.
7 • I t |S#fc*mter &|
(200Tp. "Suwntn en Sixp im* Monpgt LffMmg," Dtvtucn
or fiwUig Supffvhtjn vtf fiojuWtrv SopwvhUxi and ft*ju\a\on l « « SBOMS M 21
outlays for new M^hi m*>tL>r n d i s h i ( t j r s . •ipott-utjlitv1
tivity. For example,, average hourly e a r n i n g 5 measure
vehicles, and p k k u p trucks)—-which were well main-
o f w a g « for production or nonsupcrvisory workers,
[;LHWJ through year-end—thedeceleration inspending
increased only V: percent over the four quarters of 2007
in the fourth quartet was widespread. PCE appears to
after accounting for the rise in the overall PCE price
ha\"e entered 2008 on a weak trajectory, as sales of light
indei. Moreover, for some workers, real wages actually
vehicles sagged in. January and spending on. olhcr goods
declined: Real avenge hourly earnings in manufactur-
was soft.
ing edged down about V* percent last year* while for
Growth in real disposable personal income—that is.
retail trade—an industry that typically pays relatively
aft a r-tax income adjusted for inflation—was sluggish in
low wages—this measure of real wages fell about
the second half o f 2007. Although aggregate w a g « and
2 percent.
salaries rose fairly briskly in nominal terms over that
O n the whole, household balance sheets remained
period, the purchasing power o f the- nominal gainwas
in good shape in 2007, although they weakened late
eroded by Ihe energy-driven upturn in consumer price
in the year. The aggregate net worth of households
inflation in the fall Indeed, for many workers, increases
rose modestly through the third quaricr. as increases in
in real Tft-ages over 2007 as a whole were modest* once
equity values more than offset ihe effect of softening
again falling short of the rise in aggregate Labor produc-
home prices. However preliminary data suggest that
74
Boani af Goventurs of the Federal Jtaarw System
9
g pf«*di
adjust ab l e -ra te mortgages that they c;3n afford
to repay and can refinance without prepayment
penally For a reasonable period before the- first
interest rate reset. The federal Reserve issued
similar guidance on nontraditional mortgages in
2006.*
The Federal Reterw is work ing to help safeguard borrowers in their interactions with mortgage lenders. In support of this effort, in December 2007 t he Federal Reserve used its authority
under the Home Ownership and Equity Protection A d of 1994 to propose new ru les that
address unfair or deceptive mortgage lending
practice*. ThIs proposalI addresses a b u m rotated to prepayment penalties failure to escrow for
taxes and Insurance, problems, related to statedincome and low-documentation lending, and
failure to gh/e adequate tonskieration to a borrower's ability to repay. The proposal includes
other protect ion s as well, such « rules designed
tocurtail deceptive mortgage advertising and to
ensure that consumers receive mortgage disclosures at a lime when the Informat ion is likely TO
be the mow uwful to them.
The Federal Re-serw is also currently undertaking a broad and rigorous review oft he Truth
in Lending Act, including extensive consumer
testing of Ioan d i s dosure documents. After a
similar comprehensive analysis of disclosures
related to credit card and other revolving credit
arrangements, the Board issued a proposal in
May 2007 to require
such disclosures to be
clearer and easier to understand. Like the credit
card review, the review of mortgage disc losures
will be lengthy given t he critical need for field
lesiing but the process should ultimately l»1p
more consumers make appropriate choices
when financing their homes.
Finally, strong uniform oversight of all mortgage lenders is critical to avoiding future problems in mortgage markets. Regulatory oversight
of Uw mortgage industry has become morechallengingasthe breadth and depth of the market
has grown over the pJ3 docadaandas the rote
of nonbank mortgage lenders, particularly in the
subprime market, has increased. In response,
the Federal Reserve, together with other federal
and state agencIES, launched a pilot program
last summer focused on selected nondeposiLory tenders with significant subprlrrw mortgage
operations.J The program will review compliancewith consumer protection regulations and
impose corrective or enforcement actions as
warranted.
4. Th* «h*t A 4 C H4 M
OA
tM C4ftl*«tftt+41 $ u t Gtn
nd Ht&Juuan Uow y ! 06-t4 (Odctw 10).
FVrsonaJ u v i n | raic. I9S4-2007
(ho vdluc o f hou<-t?l»lJ wo-jlth loll miEio I'ounh ^turd.1!
and a^ A re sult the ratio of Iwu&cliolJ wealth t o d i s p o i
abk? incoinio—a key influence on eosisumcr spending—
ended t he year well be low its level a t the end of 2006.
Nonetheless, because changes in net worth tend lo influ<?mx cOiVmmplion wuh ;i Lig. the incrcniiev in viv^hh
during 2005 and 2006 likely helped suMiuis spending in
2007. In the fourth quarter, Ac personal saving rale was
just a shade above zero, about in line with itA average
value
SINCE
2005.
Overall household debl increased at an annual rale
of aboul 7W percent through the ihird quarter of
0
2
07,
9 notable deceleration from the I O'/4 percent pace in
I I I I I I I I I L I I J ]
Hon. Tb* tLu 4** qu* u I > J*J *il**J ihrujch "DO7.Q*.
2006; household dcbi hkely slowed Further in Ihe founh
quarter. Because; t he growth of household debt :ibom
matched the £rowlh in nominal di^po^able personal
75
10
Monetary Policy Report lo ihc Congress O February 2008
Household financial obligations ratio. 1992-2007
I
»J
I I I I t I I I I I I I
l « * I W tW* M01 XflJ MM
Delinquency nfinon consumer Eoans. 19Q&— 2O07
I
1 1
I I
M T
O
!•'•-
i
i
»T
O1
1
1
1 1
I
|
|
Km 1
n*utft*
o***r'# u m c f . tod pfoprrty U H L *• divided by dsponMt [vnoul
iaooAf.
SAia R4»ltow*B n .
od
P-Qi T>ta
nh •
t i l Ei
R«poArfGondboc ud Inrorar f Cil Hrpxt).
ID..II.I . * i | . - !xi ad
rupicy law implemented in late 2005, the bankruptcy
niiv rose modestly over the first nine months of 2007.
income through Ihc third quarter, and nci changes in
interest rates on mortgage debt TO (lut point were; small*
The issuance of asset -backed securities (ABS) tied to
Ihe RATIO offinanc i A l obligationsto disposable personal
credit cord loan s and auto loans {consumer loan A B S |
iiitromc wJS ;iboul H.n.
has remained robust Spreads ofyields on consumer
Consumer ( n o n m o n p ^ | borrowing picked up a bit
loan A B S over comparable-maturity swap ra(e> have
in 2007 i&$'.i percent, ptrhjpn fcflecurtg ^orne sub^iim*
moved up considerably n a July, the rise pushed
lion nKiHisiiiiKT credit for monkUi^i? Jobt. Tho p t f a y
spreads on two-year BBB-nited consumer loan ABS
in consumer debt I H mostly attributableio faster
to almost double their p n v k x n peaks in late 2002.
tro\Mh III I L V O I V I I ] ^ CILJ][. .I p:itli-rt LOEISLSI^IU with tilte
Opinion Survey, Banks, on net. reporled easing lend
Spreads on two-year AAA-rated consumer loan ABS
jumped to be[ween 60basis points and 100 basis pomIs
results of the Federal Rcscni 1s Senior Loan Officer
-
ING S tand A rds on credit cards over the first half of 2007
and reported Little change in those standardson net over
iifier iLLLving been near zero for most o f the decade,
|Vrh:ips in p:irt LIS :I result o f investor*' jjjeilifml tv;i--sL's>ment of the nsk in structured credit products.
I he j w o n d hiilf of ibe year In tontru.^. sL^tntitMnt ff^cIions o f respon dents, in the second h a l f o f 2007 reported
ihat I!KV h^J lik^htcneJ sinjid;irJs and lemi% on olher
consumer loon*. ;i i-limi^c ib^l may b»\x comribntcJ io
j slowing in the growth of nonrevolving loans over the
I ho HlJ\llUaHS Svctcir
Fixt'd Investment
final monthsof 2007, Average intercM mtcson credit
cards generally moved down in the second h a l f o f t h e
Real busmen tk^-d nUcsUih:nl I (It'll rose JII :m aiuui.il
year, but by less than the short-tunn nurket interest
rate of 8'/i percent in the •second half of 2007. largely
rates on whichthey o n often bused. Inleresl mte?: on
new auto JI.MII-. si KitiiL;, :niJ .it auto liitiiice conipstiiei
because of a double-digit rise in expenditureson nonJ'.'MiJ.lUkll k.-Oll^[riX'llOll \\1\ : itil 1U111 UL-.'I.|IIJ|'J1J-.I|L ^lllil
have also declined some in recent months.
software ( E & S h which hud accounted for virtually all
indKalor^of the credit <|iolily of coi;stiiner Urhin\
of the growth in real BFI from 2003 to 2005. has been
-.ii^^.'-.c [||Ln it li.r. v.*.,iL.-JiL J but kit-ni:r:iIK ruiitLiii)s
erra lic since early 2006 but* on balance, has decelerated
sound, Oier thc second h a l f o f t h e y e a r, delinquency
i i ' i u . . , .\\i\\
rates on consiinKT In^ni ateonimcTfial I-JIA^ IIK-E^.I^^I,
conditions lli.n influence capilai spending were f a irly
but from relatively moderate recent levels. Meanwhile,
favorable in mid-2007, but they subsequently worsened
dehiK)uency rates at captive auto finance companies
as the outlook for sales tmd profits soured tmd ?s credit
increased somewhat but are well below previous high*
conditions forsome borrowers U^hiened A bright spot,
Although household bankruptcy filings remained lovv
however, is that man)1 H m s s l l have ample cash on
u
rebtiv e to the level* seen before the changes in bunk*
hand to fund potential projects.
*• »n Mii. v\ 11• • I..-_ I J I L •. •. ^ i n - n m . .• 11-.11 tj111•.-_ i_iI
76
Board of Governors of the Federal Reserve System
11
Meanwhile, real outlays on nonresidcntta! construc-
Change inrealbusiness fined investment, 2001-07
lion remained on a strong uptrend Some o f ihe rcccm
strength likely represents a catch-up from i HC prolonged
weakness in this sec lof in I he lir>t ]i.i|f nfthc- decade
With the nolablc exception of die non-office commercial w c t o i v A m n
pending has been about flat since
mid-2007—all major lypes of buildmg continued to
exhibit considerable vigor in the second half. In genERAI. the non financial fundame ntals affeeIing DMmsiJo nl i.i I c on.^ntci ion rcnuin favoubk?. Vacancy rales for
office and industrial buildings have fallen appreciably
over ihc pjsl k'\\ yC'ir^ dcApile the oddmon of a ]£OoJ
dc.il of avaliable space: and. jllhou^h t l v vacancy rate
for retail buildingshas moved up somewhat o f late, it
remains wclI below i1$ cyclical highs in 1991 and 2003.
However, funding has reportedly become more difficult to obtain in recent months especially lor specula(IH.H_- projecls. ,niJ the slowing jn aj^fro^atf outpul and
employment is likely to limn
the demand for nonresi-
dcntial space in coming quartern Meanwhile, real out law's for drilling a d i n i n g structures have continued
nm
Although inv e ntory imbalances had cropped up in
DtfHrtml rf
I ol Ectonv Autyw.
a number o f industries in late 2006, overhangs were
largelyeliminatcd in ihe first half o f 2007, a nd firms
On nverageh real outlays on E & S roseat an annual
rate o f 5 percent in ihc second half of 2007; in ihe finJ
half, these outlays h d r isen just 2
a
H
pefcent, in part
generally continued TO keep a tight r e i non slocks in the
i
^eonJ half. In I ho inmoi wliKk- &ector+ manunictunfrs
pursued &n aggressive slratcgy o f production adjust'
k i l l l <• . . . t ' . i ^ ^ l . l l j ^ J i . ^ M l - . ' - M I I J IN u l l t l IV S " I I I C L . . k l
menls E keep dealer slocks reasonably well aligned
o
vehicles, 7 Real investment in high - technology per-
with sales. En December 2007* days1 supply of light
I'ufnivJ well in the second half, with further i n c r e a s
vehicles stood al 3 comfortable sifcty-four dap—though
in all major components (computers, communications
1 licked up m Jamuary beca use of the drop in sales
t
equipment, and software). Real outlays on equipment
o t h e r l h a n h i g h - t e c h a n d i n m ^ p t ^ r m i i m ( u broadcat- Cagbsnn1
hnlusetrnenive
ir ie o
a 2
s
i0
.
C h a n g e in real businessinvento
^ inventories. 2001-07
egory thai accounlsior nearly half o f mvohncnt in
E & S when measured
n nominal lerms) posted a solid
i
gain in thethird quarter Howe v er, i h o v outlays edged
down in the fourth quarter, and ihe relatively d o * pace
of orders, along withthe downbeat lone in recent surveys o f busi ness conditionv suggests that the softness
in spending hasextended into early 2003.
7.
in bniocu o
c tuge Uuc la.
y h>nu h*J i «
l ntabf ^
m the fir
Mo tf*C« al (he Hut cf 3007.
t « of wxh U»cki info 200^
IJK) ikui ±TOB) #K hi^h>rtH^^jfI n u x ; u t t j thill i k
i n » l « vriiKlei c** modtcdy. ot act, in (he
-m-end kitf of the yat.
I
1 1 1 — 30
j
U
77
12
Monetary Policy Report to ibe Congress O February 2008
noted M z t i K Apart from motor vehicles, re;il nonlarm
ed lo have been negative, primarily because o f
uivcnlory investment was a modes! SlO billion {annual
asset writedowns: m contrast, earnings pershare of
rate) m the fin>l h a l f o f 2007; it slaved around ( hat rate
I he nonfinancial firms appear to have increased about
in the third quarter and appears Io have rcmuincd M O D -
13 pcrcenl.
est in I he fourth quarter as manufacturing firms adjusted
Nonfinancial business debt is estimalcd lo have
production proniplly in response to signsofsoftening
grown nboul 11 percent in 2OO7h buoyed by robust
..!-III.!LI.| Wilh only a few exceptions—mostly related to
merger and acquisition activity. Net corporate bond
the ongoing weakness in construction and molor vehicle production—book-value inventory-sales ratios in
December seemed in line with historical trend* Moreover, businesses surveyed in January by the Institute for
Supply Management reported that their cuslomer* were
general ly satisfied with their current level of slocks
• • • 0 0 1 was .strong throughout the year, although highyield issuance declined after midyear, as yields on such
bonds increased and spreadsover yields on Treasury
securities of comparable maturity widened lo k v e U not
^een since laic 2002- The amount of outstanding nontbanc ialI commercial paper was aboul flLiU on net. o w t
2007, held down mostly by runoffs of lower-tier paper
in ihe second half of ( he year a£ ihc market forsuch
Corpttrato Profits and Business Finance
paper came under pressure. After an unprecedented
amount of issuance of leveraged syndicated loans over
Four-quarter growth in economic profits for all U.S.
I he first h a l f o f 2007 h issuance declined considerably
corporations came in at about 2 percent in the ihird
in ihe second half of the yearh when demand by non-
quarter of 2007. valh the entire gain attributable to a
bink inveslors for I I H ^ L ]n;ins 1LII • • tV. L o n B M B n l
large menxtso in receipts from foreign Mibsidiarics. The
and m d u s i n ^ ( C e l t ) loans at banks expanded briskly
share o f profils in ihe G D P o f I he nonfinaneial sec tor
in 2007 as underlying demand for hank-intermediated
peaked in tlw third quarter of 2006. ne;ir Ms previous
business credii seeuvd to remain solid a n d bank*, look
highreached in I997 X and has SINCE receded- F o r S & P
onto iheir balance sheets loans thai KAJ been intended
500 firms, o perating earnings per share i I he ihird
for syndication. In the Senior LOAN Officer Opinion
quaricr came in about 6 percent below year-earlier
Surveys taken in October 2007 and January 2008. con-
levels. * Daly front about SO pcrccm of t hose firm* and
siderablc ncl fractions of banks reported charging Wider
analysts' estimates for the rest indicate thai operating
spreads on C & [ loans—the Eoan rate less ihe bank's
earnings, per share in (he fourth quarter fell more (han
cost of funds—(he first such lighlemng in several years.
20 percent from the fourth quarter o f 2006. Earnings
Large fractions o f banks also indicated t hat they had
per share among the group's financial firms are estimat. IKc diffe icnce between e<M*«tiic
tbc ctleublHi bfecotdrnk ptafrt but *n iKluJcd » t n c v w c in
m n ^ ptrrfwieof £ H K » I Amu.
i l y 1
Before-lax profits o f nonfinancial corporations
u a percent o f M c k x GDP, 1979-2007
Selected components of act financing fornonfinancial
corporate bininesv s. 2003-07
U E > M Ltln. Mid ntr
— u
— 12
— 10
—
K
I . . . I I
i
o f C o n m H X * . BurccoofEcvacnJcAmil
Tb* dstiforMW QJ * f H
SCAICI. F*ihrjl VMtm DoofAflowrff
78
Board of' Governors ofthe Federal Reserve System13
eon outstanding corpora* bonds. 1992-2003
S'i I •,V,i. ', .;l.-.v..- i'1 J- • 11K -\ IL l\L-lk^ (L^lTi J 1 n J •
1
jnJ inoiv^iinf spre:*l\ m commercial ;mJ InJuslrLj
loan*to large JTKI mcJtumMJxJ borrower*. 1992-2003
I I I
i l l
t
i
i
i
i
i
i
i
i
i
I
San: Tlv diki Mt nomkh J*J tiknl A n ^ JJMUR M S T b r
Kent: TW djti nt ilrm-o Tron A v n n j<t*fral) coodKirdfcur(
In. rtl j
*nul iilo'<
Sfflirt Lno Ofliotf OpWoo Sw**y <»
Alesser fraction- about one-fourth—cited concerns
about the liquidity or capital position o f their own banks
• t m B i fortightening.
Gross equity issuance picked up in 2007 on an
UK-IL-LIM: in UK- paCti ur^fd.^Jihrtl OJTvfuljp. NHJIKTIdvkr>\,
record ^ l u i n e s of share rvpiifcki^cs jihJ ta-J>fin;ii>ceJ
ding standards- MOST o f the banks that
mex^en und requisitions pushed net equity retirement
tightened lerms and slandards indicated that they had
done so in response to 3 less favorable ormotv uncerbun economic oullook and a reduced tolerance for risk-
even hig h e r in :"<•" Ihun in 2006.
The credit quality ofnonfinancial corporations
remained strong. The six-monih trailing bond default
rale stayed near zero through January 2008. The delin-
Financing gap and NET equity retirement
a ncnfiniuicial mrporauon s.1992-2007
quency rate on C & f loans at commercial banks at the
end o f 2007 remained near t he bottom o f its historical
Uiwrilibn
raxi£ch but it trended higher ovof thf ycm. t'hac^;^-olT\
on C & l loans at ban k a lso increased in 2007 . particu s
-.P.
larly in the fourth quarter. Rating downgrades o f corporale bonds, were modest ihrough the fourth quarter, and
o v « tho \ v a r i h c fraelion ot'dobt thit vyj.% down^r^d^J
:ip.
roughly equaled the fraction that was upgraded. For
HI'
public firms, balance sheet liquidity remained at a. high
:•••
i
ii
t.c i . i , t ; [j|>
'
level through THE third quarter of2007*
and leverage
siayed very low despite robust borrowing and surging
rehrenienlst of equLt\.
Commerciul red ctcatcdcbi continued to npvnd
briskly in 2007. reflecting in part strong investment in
1
nonresidential structures, but the o v e n 1l pace tapered
o f f some in the second half o f the year. A * noted above,
TheHIAIVCisHiItkctiv«va
i TTK li*i*ai$r pip n E
p
d iriiruU} fttrXd tmt&i. tdjuslrd for mni*Y)
Mrt «|i(IV rrinfxrt b t k iTr<nK« tvMrni cquh rrtircd AK
ol" l : S.
•cinrdtuA. -donx-rik cufc-rLuacAJ n c i j f l \ cf lonigi
linu mdtqiity tuud h> docH-vtx" ti.m^-inii'-1. in pabk
iiock option frocradj.
readings on some market fundamentals for existing
structures—for example* vacancy rites and renl>—
remained solid. Similarly, the latest data for commercial mortgages held by life insumnce companies or
b j ' issuers of commercial mortgage-backed securities
( C M B S ) — m o r t g a g e s that mostly financeexisting strue-
79
M
Monetary Policy Repot to the Congress • February 20GS
N e tinterest paymenls o f noafinanc Lal corporations
as a percent o f cash flow * 1975-2007
sp
f ten -year investment-grade commercial morigagebacked securitie s over swaps, by securities rating * 1997-2008
I I
I I I
I I I
I I
The Ji|i«f irttl) NkJ
BJcomt
Hires—show lilile change in delinquency rates in recent
In contrasui hc delinquency rate on commercial
mortgages he ld by b;inks about doubled over the course
of 2007* reaching almost 23/* percent. The loan performance problems were the most sinking forconstruction
anJ land development loans—especially for iho;,e that
ttn^rtce re^idcfliiil d^velopmcnl—but^ome irKrcvMf in
ikUn^uency nte.\ «?*!• J I 1 ^ jppuent for Loan* booked
by nonfarm* nonresidentlat properties and multifaintly
properties. In ihe most recent Senior Loan Officer Opinion Survey, large fractions of banks reported having
lightened .i.iml.nJ^ -uuj ILMN-. on coniniercul JL-JI c^Ule
Delinquency ratesoncommercial real a tiale
loans at banks, 1991-2007
MM
MM
21
\
—
—
ShfciJi
^ - ^ ( H f vr nonttHikilul
H
i:
pnjwtt.
—
\V^
1 . . , MLlPl,..*J
|N
loans. Among the most common reasons cited by ihose
that n^htcivd credit conditions were a less favorable or
more uncertain economic outlook, a worsening of commercial real estate market conditions inthe areas where
the banks operate, and a reduced tolerance for nsk.
Moreove r despite llic generally solid performance o f
commercial morig^c* m secuntizcd pools, spreads of
yields on BBB-rated CMBS m e comparable-maturity
swap rates soared,, and spreads on A A A-rated I r anche s
of those securities rose to unprecedented levels. The
widening of spreads reportedly reflected heightened
concerns rc^ardjm; me underwriting slondards for con>mercial mortgages over t he past few years AND likely
LILso investors' general wariness of structured tinanee
product:
Issuance of CMBS in 2007 topped the pace of 2006.
1t WU fueled by leveraged buyouts of re a l estate investment trusts in (he firs) half of ihe year, butissuance
slowed to a trickle over (he final four monthsof (he
year cm tighter undcrunlm^ standards and (he hijjltcr
required >-ields. Nonclhctcss I IK still-sicady growth
of commerc ia l real estate dcbl indicated lhaU thus far,
borrowers hive found altcmalivc runding source* for
—
-^
(Governnu'tit Svciiir
1III11 1 1 1 1 1 1 1
1 « 1 1 W 1V>J IV)'
" >
Federal (ittt'er/titn'tif
1 1 1 11
i msH
:Piit
>JOJ 3007
Son: 1>K JJ< J M^ ijuiiii i1
i f a t dfct « u t vci
xio* Council. Co*uli(
IL H. j]jJu.(V»1l
The deficit in the federal unified budget stood al
M<C billion m BscaJ year 2007. roughly S250 billion
below the recent high reached m fiscal 2004 and equal
to|ust I 1--*percent of nominal GDP. However,, growth
Bimti nf Gamvon of Ike Fali'itil &Bmna Sy.iirm I $
J efcptndilbi^, IQ8J-3J
Ctanga is real govakniGni ^qK^diuav
OS L'iiiMiinplii.iil and InvefiLnienI, 2601 -1)
Q ItJrral
P
S i n Tbrs«L-ipl*QHiiL'ipemWi>iviaii.i dvirn < iini rini-hu.t£n twsi* pml
MKIV rmrnl j v » » ICWlntirF lliiT*(h V | H r h « * n . 0111' > rw »r»c li -Inr q irr*
«
dntJmj III Q.V
SilAil I mice nl Mwwgenwi* .H)J nu.Sg«_
ill revenues has stewed since last summer, ami gnwili
in outlays HAS quickened Given IboK developments.
lie deficit dsitus fc» 1'ir^i lour montiis affiscul 200S
(October 21107 la l.iiiu n i 2m is i was l.u LIT than it hud
been during the comparable period o r fiscal 2(107 Over
Ihe remainder of fiscal 2 0 08. a slow pace of economic
Mth iiy and ibe revenue loss ussot'inleil vMlh Ihc t c o nomit Slimlilus Act of^OOS ure Otp<K»d la bdOfl tinikiicil.
Nominnl federal iveeipis hove dcraleraiMi s
siiitv |Kwling ilouble-digit tdvanoes iti fiscal yean 2005
LIIIJ f l 0 & Nity rose less than 7 petueiit in liscal JIHI7
mid Imvt: flowed subslanlially Turlhcr llius far in fiscal
2CM)S. The dtfcclcralii.in has tven mnsl nrennunced in
<:rirpk>ratc rcccipti, which batvly increased in fiscal 2<K)7
•Set Iliree years ofexcept!mmI growth and hnve follen
well below year-earlier levels so far in fiscal 2006: Ilie
ito w nlum has reflected the rutcnl softness in corptjriitc
prntitfi. In addition, growth in individual income \a\
icccipu; has moderated from Iht rapid rates seen nmttiut
i he rim I ilk- of the d n a d s N'oneilieless. ujial receipls
gn:« faster than nominal OOP for die Unrd year in a
row in fiscal 20t>7 and reached IDS pcrtcni nl'GDP,
•.lijliily abovt the average of t!ie past forty yiiari.
Nninnral federal outlays rose less lhan 3 percenl in
BtMl 2I.HJ7 oner having risen obnui 7H pereenl in each
of the twa preceding yean, In large pan, the slowing
in 2OU7 retleeleJ a number ofiransilnry fiictors—roosi
notahly. the tapering olTofexpenditures for flood insurance and disaster relief relalei lto Ilie 2005 Gulf Coa.il
hurricanes, which had produced a noliceabk hnkv in
jpeoiing in risen! 2006 - So far in fiscal 2U0S. sharp
intrcases in uutlay.s for defense and IK-1 inlercsl liave
llclpcd push spending 8 percent above its year-earlier
level.
-nrn
SM »< i
an:
in))
:IJCH
21m
sm
J»T
OvTs.iiiikati ^ C k n a a o n Butwii ai BeooAnle AMQAfe
As measured in the national income and product
accounts (NIPAh real federal espendittu'cs on eonsuinption and gross mvesuncni—the pan of federal spending
thai is a direct componentofGDP -rose at an annual
rale of 3'j percent, on average, in the second half of
calendar 2007 after having been unchanged in Ihe first
Iwl f. Ihe step-up was concentrated in real defense
spending, which tends to be crmlk from quarter tu
quarter and rose At an annual rale Of 4!r4 percent in the
second half, somewhat above its average pace over Ihe
pust three years.
Federal debt rose at an annual rate of almost 5 percent over Ihe fnur quarters of calendar year 2007, a bit
taster than the roughly A percenl increase in 200i> , Tile
ralio of federal debt held by the public to nominal GDP
remained in ihe narrow range around 36*j percent seen
Federal government M l IKU hy Ik- puhlii;,
m Tte cLua Its M* im&al
Moi-e&L [IK i4»L'ivaiu^i tut VMTJ ll
ir. Xttc eonapantfiv MIHH W ti\H' wt \<r* 0 1 J IDI VBSA r
l ». nmili
16
Monetary Policy Kepon 10 the Congress i l;cfcntary 2 J
(K
H
in rc£imtycar*L The Trmury's decision in May tndisrarriiaueractionnonhree-year nominal ticrncs clieiled
•iMl., reacturn i n in ••i.-n n i a r k t i s . I i_- i r e a s i i T y .! •
t n i i nin'd s o m e LLUCMOFI gffids TOT a u~>*. u i b e r • •• >}•• >u
sccurtiie* over the first t h w quanores of the y^u- as ft*
narrower dtficii reduced borrmving needs. Dhuta suggest
[inn iiit fux)|.wrtH]ii L>rnciiiKuil Btwpon Mjeurittets purchased ;» Treasury auciions by fbri'ign oifieial ssislittitinm* edged ilrwn over rhc second hnlf af 2007. bill Ihe
proportion ha* changed little, on net, iincc miii-241115.
State and Local Government
n»c riM\«l i nudHum of mate and local governments
appeal* to have hwi BOSK htsicr in - M 7 after improvn i d 2IKJ6. Indeed, for the sltlc ;ind luc.il suvtor O Q
S
v^liuL1. nvi saviiij! as meanured in line NH^A, which
is broadly simiLur lotiw surplus
in a o e mting buttnp
E£d. tell Iroim a receni I-.I-:I c>rs2? biilitm
roughly zero, on average, Uuring the firsl ihrcc q
or' 21(07. The downshift occiLnvd: us revenue i
tailed: nrT.irtL-r ;i perniJ nl'licrty jsiins and n* noinlsad
t:\rKiudiiijres cspLtmlly O encryy and henllh care—
R
row -h-Lipi\ i'...•..-,. in mi,111,1.1111.11 t'roiti niiiivlnhtul --.MI«,••-.
o . i lo J gtHid deal of tincveniwss in turrcnt budget
i—csptvLpllyi [lime irt grieulregions—continue ki enjoy
M"n .ftsCalipii-.iv. ••>. OUscri. Imwcvtir, iirt? rtpL^rting
tiii^iihlc shortfalls in revenues, in pud httiisiw s&to) lux
s arc being hit tmn1 by the wcsknE** in p»ies ol'linusinu.-relii^d flcms. In ificsc cin:urn:sLanccs,
c states Frtay have t t cm spondliag or raise BUOS io
t mquireivumn. Alt
Slant attd bod pneotraan us sating i*)B7-2i
k v d i prmpeny tax receipts apparently were tolBlcrcil
m 21K17 by Ihe ejirlicr n»i-»p in KJII eslutc VAIUBS, tun
ihc JL Lateral ion in house prfca will likely sfmv ihe nse
in ta$d t$Vtatt*93 dn-unrtu: m;id. Moreover, many stale
tnul Irttfil governments expett to fate ^g/llftc«tt *iiuciiji'al nnlxilanccM in (heir hudgidts in naming yeafh ai> a
rwnli of the niifiomr pressures Irotn Mcdtcaid fed tibe
need ti> provide pcraamu and healfli care lo ihcir tutlwJ
employees.
\ccordine to 'htf NIPA, real exptrdiHircs mi cdniumptiLHt and yrais investment by SEBIL! iind lot^l govertiments cmiHrnscd iu expand briskly in Hie seamd
haU uf2007, Much of the strength was in construe!ion
sptnrfiTiji, which picked up ipmd curly last year lifter
having been WWJltiaUy Hal bctweeti 2W2 and 2{HKi,
MLiinwhale, real tuitlays fbreunrcnt opcralJLins remained
on the nnhJer.nc uptrend that lius been, evident AHWH
fioosicd by Nptrnding oin rdutation and nnlnsiri.il aid,
hUTTO^inji, for new mpiUil expend)turcs by stale nnd
tncol governmontii wus vefji *!rni]^ in 20f]7. ltet\j.ndiiny^
in idvaBHuf rciirtinents were brisk m the(SJtly |\in
OIISIL- \\-,u Ay, \-.-,s\\ i:\-~. Uukol in k»w HUL'^SI ITIIC*, bm
rchsndings *iiibimicd in lhcs«ond half as n result
oThiyher vnnlatilrly and ruthieeil liqurdrly in Ihe municsjuril h»»nj market- By cnnlrast, slwn-icrm horrnwinji
picked Up J hit during rht sectfnd half ufihe ycarH possibly beeuu*e of wine deterioniFicm in untc and local
budgets.
Municipal ISSIIIERS arc htfiwtiLing from lower iniercsi
rates, as bond yIfIds have dec lined *ome since nudyetir.
However* investors reportedly Imvu beeorntr increasingly comHOHd about Hit wraktr llscal ouilooks for
niimy stale and local gamnmeols and Ihc condition
orninnicipyi Ixtnd insurers. Partly as a result of lt)P>e
developments.fltCniliu 6faU index ohmumtipal hood
yield*- lo ihe yield on eampurahle-niaiuriiy Irvusunei
has trlinibed foflw top end flf ift historical ningc.
Some ittiiicfiiors of credit quality m the munitipal
bond BSe&T h&vg begtan pcsiniiny to greater we
in tueem muniIii. Rating! up^rudc.^ hn\e tilowed u lukdoy^ngradci have risen- A snbstanETuI nujvthcr of revenue haa&i far pfqJK&l in&urcd by a subsidiary of a
major invi-stmciu bank were downgratted in October
In January another group of bonds was d
because of ihc itowngrudu of their insurtT,
Toifll nt't national saving—thni is. llw saving
l>t>lds, bu5inew.es iind govurnmento excluding deprv
cfatiuiTi cliargtr* nm$ equal to jhout I 1 - percenr of
P, on tivenigc, during ihe tirsi three
82
Baanl f Gweruorx of the Fithrat fteiserw System
IW7
mg
IBB
!OI1
V ' t i ' I he si«ik m '^intily '<lht CMcmd iliHtugli 3J07.OJ. wi
•BflQ <» Ifcr «
t" [wnwul nirul n*T AHMINU »ilfi.it **l the (nil m
life imi hunt Ysmmtett*
S»JtLT PupHlillllli i-l Q H M H I KMDIHI M
7, T he drum an national sin-ing from the federal
delieil Vf& smaller lliiin tl liiut k.vn L ffe* years
L
irller. 1 lowcver, rwl business saving receded somewhat
from tho relatively high levels of the preceding Few
years, etd nmunal saving was v<rry low for ihc •' >
•
*>L-L i:.nsi-.M-..ii saving Tell !|<i'iL'(.-c'.i-h. as a su-i'. ::m IJL6fQOP bdWMn tliv Ink1 IWOfi anJ the early part of ihit
dctfldt; ifiai ntfO ftiU changed titllu SIIKV 2lHJi2 (a^J^
from Ihf Ihird quuner of 2005. which «'AS nlartied by
sizable hurrioiiw-nilHtcd prupotly losses). IT mil boosltil over ihe longer ran. pefwitell low levch of n a tional
saving ^vill hj ji^socinled ^ uh etlbcr slower capital
fomuiiofl or coffflaued hotvy borwwtng ivom ibtcad
ijiihtr afwhich would reuird the nsu i» ihu sumda
living oT U.S. rcsktenis uvcr lime imd hamper Oic
ly Dfrtffi tiiHtoti tofflflo)the rcMircmeni nw^lsiifjm
porntlahon.
i of
17
sizable increases lorulltomohik-s, ugriLrtillnral
and capital goods, especially aircraftG s p n r t s o f sa- ••
vices rose rn MB? bu tal a slower pace than in the previous year. The value »r e \ f « i s to China, India, Russia.
South Anietioi, and the members of OPEL rose quite
suhstDnijaEiv, and gains forcxpon^ lii Canada and westem Lurupe were also sizable, t x p m t t |o Mexico and
Jiipmi Inerniseu at a Mmewttut slower pucs.
A slowd own >i in real imports was also a factor in the
posilive contribution of so! espans lo the growth of
real C1DI1 last year, I lie growth of real imports ofgoods
•nJ wrviues decreased to about i K percent in 2007.
down from a 3 a percent nsi in 2(W, in part tecauM
ofa slowdowni n U,S. domestic demand and the depreciation of fte dollar. Although real imparts oTeapilal
goods a m strong, ihe growth of most other major CATegories dec lined. Despite Ihc moderation in the growth
ofimports uvcralL ihe vidue ofgoods Iexcluding oil !
imported from western burope. China, and M«ico still
rose atsolid rales.
Given those movements in exports and imports.
along with somewhat higher nei investment
Income,
the U.S. curren tnccouni deficii appears likely to hove
shrunk in 2on on mn nnual basis lor ihe lirtt lime
i
since 2001 f, The current account deficit nnmiwcU fr*«m
SSI I billionin200fttoanaverage»rS753 bill ion at
an annual rale, or around Si* pcivenl of nominal GDP,
in [lie firs'i llaec qLnqrters of 260? (the lulesiavpibble
datnj. However,, its largesl component, Ihc trade delimit, uideiiixi in ihe fourth qmtttflj ftfewae o f a a a q i
increase in tilt? price of im|»orted oil.
The priLC ofcrude oiF BQwed on world markets
in 2007 Trie spot price of West Texas t ntenneiiiale
inereasen from around Son perbnircl ai Ihe cm! oi J i M
K) aboul S i (K> al present. The strong demand for oil
Change m real import** and tsjwrt."; of gwxLs. ami ^T1". EOfit,
TM KiU'rnal Sectnr
The exja i kai Bcol of I>I'i>v Wed sign i Rcsnl i uppoft M
L.-ctinomic jetivuy in the second half uf last yfiir. Nei
cxiwrts jiifdcd •Imofl I perceiUu^e poinl to U.S. C!DP
growth ilnring thai period. tRording to the lotest CiRP
release Tram the Eluraitt of UcunpiTlic Analysis, hut dnu
epoeived since iiicn iq^psi u wmcwh* larger t»ssiivc
coiurihudon, The c>«nitihiihh»n of'nei L'\fnnts wn:. Mjpportixl by a rubusi expansion-— ahDjt 11 percent A ian
umuil nrio—ofrsa] c^poriii of gtioJs and serribei thru
waa litlpvtl by stillrgofid gmwlh o r f o m s n eeanomies
Bw lite elTecit al'lhc pic I dL'preciat[t>n of the Jolkir.
ad
The bruad-bii^tfd rise in real exports uf goods includcii
..Illl
I.I
ami
II-MH-- LVlhlllfip^iliil f
am?
18
Monetary Policy Report to Uw Congress
Februaiy 2(108
U.S. irulrunitciincrnd
I K 4«ianert> l\it the intJs jL-.-miiii. '\tc ikiin i d o ^
5DVKI
«V3t pQWBQil by the continued cx[unsiDM aftfae world
economy through 2007, ggpecmlfy in Lhc (Jc\eEop»>^
countries. In addituiTs, d number a factua] and poJential
disnjplions to supply have contributed Eo the surge in
oil prices. QPF.C members announced cuu* to oiE proUULLIOII in late 20f)6. Decile refill ftgOtfWISflg ihat
haVEreversedst>me of these LUIS, OPKC production
remains, rcstiaincd. Tin; growth af produciioi> has also
been liampefeil by SOME gDvemments' moves to iuktconti-ol of oil resources or raise their share of rev enues.
Geopolitical tensions in the Middle hast and instability
in Nigeria have contributed to concerns nhottt oil supply
as well. The price of liic FAR-DATED NYMEX oil finurcs
(cuircntly for delivery in 211Id) now has risen
Price* 01 tild
ei tmfisol o
la nearlj S*5 per barrel and likely rellects a belief h}
at] markei parEteipiints itii.ii the balance oE supply and
demandwill tfiiniin ughi lor some limi1lo come.
Brood indexes of non-oil eomimxlilics prices reoiaio
elevnied, Althmigh ihcy fell back slightly over the
second half of last year, prices hnve again risen since
liie slart o£ 200S. Prices of a number of inelttls. which
surged ID the spring on strong ylobal demand, relrealwl
somehwhni during ibe latter half of 2007 as prodLittion
increased and as users substituted into other nittlcriols.
lowcver. more recently ihc prices of copper and aluminum have moved buck up. Prices for food coramwlilics
continue to rise steeply. Poor harvests in Ausrralis as
well as in pans of i-urope ttnd Asia led to higher wheat
prices. Tlte price af soybeans also has risen sharply
because acrtagu lias heen shilled lo com production, in
part In produce biofuel, in uddition. the soybean harvest
in (.'hina was down sharply from last year.
Import price inflation increased in 2007, with live
depreciation of Ilie dollar providing an unpmUni impetus; liiglier ufi and FOOD prices also contributed. Prices
uf imported gomJs rose about K* pereenl tn linn, inn
;-v. udiiig food, oil, and nmuial gas. such prices rose
2V> percent: both rates were somewhat higher iltan in
The tmanviat A cemtiii
Allhulteh the current account ddicil appears to have
narrowed during 2007, it rvmains sizable and conlinuusi
UJ require ii sienilicanl influx oflinriuciiijj Iram jbio[id.
As in Env past, foe tidicil wus larjit'Sy tjnnnccd b>' foruien net LKqui-sitions of U.S. sec unlies
1'hc global lin;.irK-iiil lurrmiil th»I began m ih*_- -ummer left an imprint un the componentsof the U.S.
U.S iwt rinnnriul i
MI,,
m
ft. 2003-07
„
vm
[ten : lit' >ui,i mi- mnubly. OK- I H A u r I
•>•• in- all pA^ •
jvtrwpn fin iVhnntry I (linnii];li F-cltfimry 2\, 3iftK TW r f ' « " ! « »
L.-MnkuJtHL". « U'ltdi (Jtlttfljjl JuiiLidry l » i n . the JII I jTicd it We vf«4 |H l t
Wi>i T M M bflmfnedtint cnifc «'ii i iu- pflHso] iioiifltd wttmuwSiiei
•r..:.'. ui i, rQ fhv |TMLi,iry^Mnn»JiJHj jinirV*.
Sl«-IQ-- R»r tiki, llh' i"LiiniiMnl)t> RcH^in.1!! Mun'ioiF. I in noulu !
H a i f a . iiiimwin<ii «i M « w y > F-"niw)
I l k dfiui w c|?uwicrly r>i«0<:MfIH! ilin
ra btpHttftf e Cwaneree,
T
84
Board of Gmvniors <ty' ihv Fettvrul Reserve Systtfti
S
V-i private foreign purchases oflong-term Usce.
.,eus
it
r
2003-07
19
securities, and a notable pickup in acquisitions of both
corporate equities and corporate debt securitiesNet purchases of foreign securities by U.S, residents,
which represent a financial outflow, were maintained at
I brisk pace for 2007 H I uhole. Outflows associated
wilh U.S. direct investment abroad remained strong.
The Labor Market
Employment and Unemployment
SIITI: TW diu ttt quantity ind * wad ihrough i
Sennet: DVpoflmnri rffw
financial account. After acquiring record amounts of
U.S. securities in the first half of 20G7, foreign private
investors sold a sizable net amount ol mm-T rsasury
I >. securities in the third quarter the first quarterly
net sale of such securities in more than fifteen YEARS.
In c o ntra s l, foreign private demand for U.S. Treasury
securities picked up sharply in ihe third quarter as
global investors shifted into less-risky positions. On
balance, flows out of non-Treasuries and into U.S. Treasuries nearly offset one another, and toial foreign private acquisitions of U.S. securities recorded an unusually small net inflow lor the third quarter. Preliminary
data for the fourth quarter indicate renewed foreign
acquisitions of U.S. corporate securities, although at a
notably weaker pace than in ihc hrsi half of the year.
Foreign private demand for US, Treasury securities has
remained strong.
As issuers of asset-backed commercial paper around
the globe began to encounter diffic ulties over ihe summer ,tionbank enlities that had issued commercial paper
in the United States and lent the proceeds to foreign
parents sharply curtailed those activities. As a result,
those enlities reduced their claims on foreign parents, and net financial inflows from nonbank entities
thus were sizable in the ihird quarter. Foreign inflows
through direct invesfment into ihe United Slates surged
in the third quarter, as foreign parents injected addi tional equity capital inlo their U.S. affiliates.
Foreign official inflows slowed in ihe third quarter,
as Asian central banks acquired debt securities issued
by government-sponsored enterprises (GSRs) but on net
sold U.S. Treasury securities. Official inflows appear
to have strengthened again in. the fourth quarter, with a
return lo moderate purchases of U.S, Treasury securities, continued strong purchases of GSE-issued debt
1he demand for labor decelerated early last year and
has slowed further of laic The average monthly gain
in private nonfami payroll employment, which slid
from about 160,000 in 2006 to 80,000 over ihe hrsi len
months of 2007, was only 50,000 in Novcmher and
December, and private employment was nearly flat in
January 200&. The civilian unemployment rate, which
had hovered around 4 1 ; percent in the early part of
2007, drifted up about lA percentage point from May lo
November: it rose another W percentage point, on net,
ever the following two months and stood at 4.9 percent
in January.
Employment in residential construction has been
falling for about two years and now stands 375,000
hclow the luyl ivcwdwd in early JiVMi Jobs in related
financial industries have also decreased lately. Payrolls
in ihe manufacturing sector, which have been on a
downtrend for more lhan a quarter-century, have continued to shrink. Meanwhile, some service-producing
industries have maintained solid gains. In particular,
hiring by health and education institutions and by food
services and drinking establishments has remained
strong* and job uains at businesses providing profes-
Nel change in privale payrulI cmploymerit, 200 1 -08
3002
300*
300^ 3HH
MOfr
300? 3WS
IT. riW J J J Jir nhinthN JOJ «xJcAl thri-uph
20
Muneiury Policy Report TO the
February 2(HJB
Civilian unemployment oie.
IIMIT>; it i-.:- cluM^i-'ti liitle, un net, UVLTIIIC pa^i couplc
of yean after fulling appreciably aver the lirsi half t>f
ilhe decide.
Most other recent mdkfilors. also poinl lo some
sottenirtizallabor murkc-t conditions. Initial claictis Ibr
I I I . I i i n l « '•• n M.'ii* l i - i i i . - i i . - - . - . ••• I n I I . n l i : m r t i n e d
'^:l I-
tively lovt ihrouuli ihe fall, moved up soinewhiH In ihe
clLoiiiy niotuli^ (>r2<M)7; t1n>Ligh eirciiic fnaim week To
wtMJkT ITICJ jippe-jr tt> liuve nsun Further in curly 2£H)H.
MeiinwhiLv private surveys mj^^csi Uiai Jirma havtcul
b,n.-k i m pluMb. far lurrny in Hit- nc;ir k-im. MOLINCIVOMS
bsvoa^ffl beeome les» upkieai about the pro.npccls for
the latwnismkcJ in ihe year ahead.
("•IK
2imK
Productivity ttttd Labttr Compensation
IkfinHri
StOtt&l *inJ uvlinicaf SCfVhKS have been slznhlc &> well.
F The Increase in Joblessness since Ihe spring o f 200"?
b«M been widespread across major demographic groups.
In January I?00Kr unemployment rates for ITUJII and
women au,nd 25 years iind nkkr were bath about W perccniagc point ubswe the levels uTIasl «prinj*. and aa
lyjnculty occurs—rsics for teenag&rs jmd yoitfi^ adata
showed Iflrgei' increjscs Anmnji the tnajof racial and
cfisne yrotips, uncniploynicni rates lor btackfi nod UNpanics rase sfiTTiL'Vihfli D M lhan dkl nn^niployrniint
X B
mlcs I.OF whiU's. a dinVn:nu:i1 ulyo lypiuw] ol'r»Lhniids
1
MIKTI l.ihor nijitki'i CtirulllioiiH suttcn. Ajt kltCFMSC n«
Tlic number of unemployed who Iwd lost i hcir IEUI jobs
(as mppo&ed to ihose who had voluntariiv left their jobs
Or were new entranls lo tlie labuf fijrie) accounted tor
jihtiul luEfnf (he rise in live uvemll jublessmic Iwiween
tl>e spring of 2!>07 und Jjinwiry 2IK>f(. The [nlwr foree
participation nitc stotnl stipJiily nbcivc 66 percent in JAII-
Output per hour in the nonfarm business ,sector rose
t% pereeni in 2U07 aflei1 averjgmgjuiit ] W percent per
ycar ostr Ihe prccedinj! ihivt years Althoujih esitinnnle?!
ofthe underlying pace of productivity jirr^vih are o . t i
Lij.'ri..iiFi. Ihu pickup m measured productsit\ growlh
in 2007 suggests Elmt ihe tundiinii'ninl Ibrccs Mippnrlmy a ^ulid kiuderlyin^ (rend rtmuiu in pluee. T I K W
linn"- include ihc mpiJ prtce of tcclinologjcul ch^n^e-fls
well n& ihe ongoing efforts by firms io me information
technology lo improve User ef)icient:y ofthyir flpera'
tions. Increases in the umotmi LOFcapital pur worker
O^Hi ,ipric5rto be prtividing ;m impetus k^pruductivily
growth.
lltHirtv cojnfjensfltionr t w c a t a relatively moderwW rate in 2OU7 despite a pickup in overall consumer
price iniljLion: i conlinued advnnct in labor productivity ami generally light labor murkefc. TheemployCrum^c in i>ut|iiii (vr hour. l^JS 2iJfJ7
p;.uiPt'ir»aiiott raic.
llll
11 * 1 j. 1 1 1 J
1
1
I.JJ.I.J i 4 1 i |
|M
i 1 t_li 1 . | 1 >
N i-
[TB (tau .we \u\*w\A; and RMHIJ ITI»IMUII
I
J^pttOM^-imil U l * - , HHI^S.
lUbM
1
i .n \.Hiunn iputJow KSfVK, Uinnpr hv ax
u*c;y,maJ |& iln- luunn sfMm at Ue firul jcu. ..f i|w
>
y p
l>cpnHliHnll nl LJuif IIUT
«m Ik Mfiti
Botii-d of Ginvrtmrs of the Fet&itil Reserve System
Fchange in hourly Kimpe
l l w7- J(K)7
21
Chwigc in anil tohur a M IK I ( Wft-3
*
a
20GB
2lB.ll
-ctmr The .'hnniM Nw l
f f c il>i4 * v mwrinif mft rtml lfmni|Eli
liiin. ilijutv u mi.:i tnur qiiiuwn, In
qj
Midi1*. (fDCfr. t l
••: i-OTWM l * * h < RHmbt i''ii1lihj.p in I k ' l*ii
M
R c .loniJ.in hid)m> OCM* #trfMla fam iu
k
I: i- ik- uxu- n« (|M B rH W XIMIIV^ IBQIVriin IW^Ilfll
Wf T
Ml
v » i o MM RSDdMoed (or Jsi* | | t<l JBOUI* "W Itfi
i i L M t . . UN-ftanntcm ..I La h i t . llur-L-aii «i
iticjit cost index (ECU for private industry workers.
^|bh^cl^ measures bolh WBge»afld the coM orbenchts,
incrta&cti S perwiil in mmnnnJ terms B V B ihc twelve
ii \ : L i»f 2fHl7. aboui m lint.1 with ils pate in 2U0S and
2IJ06. Within Hie ECl, wage* und saluritii inoeawsd
V/4 percent in 2(M)7. tJie emna as in 2006 bui ^ pertcntagL" \witH above Oie incrctLStis in 21WH .nm
Mtratiwlnlc, mcrcdMis in tht coisi u
have flowed iiiLnkt-dly lit rcccnE ysan, in pari b^nuftc
njnipjiiyurtunlributiuns for health i
0 .Ikui
I In. 1 JITCrL'iJMJ i « b t m h i - . •-•.-.!. L;I ' U N " 1 i
imOntttod (o jusi 2W percent, was also held down by
u drop in anploy£rctmtnbulii)n:s kxJclincil-b^nt'rn
rttincmtnl plans in the firsl 4UAITCI. The lower contributions appear lo have been fciciliiiUcd hy sevetsJ Hiuiors.
inciufjhig i liigli level of employer cuiilrihufMHt over
\
lhe preceding few years and Ihe strong perrisnnance of
(he alock market in .'•u• <
According to prentninan1 14cte, nditinml uhtTnipcnsalion ptr hour in ihe nonOtrm btisin^s sector--dn dlkTimiivc measure o l honrly coitipensution derived from
(lie compensation dutu mtlieNlE ] A iTise V.-'i pnaecd
in 21)1)7, Korticwhatfaslerthan the ECI, In 2tMt6, the
miiifatm business measure had risen 5 percent, wilh
an iip[):nvni h i s i from a high level of bonuses dnd
sl(H;k oplion ejiercijtes. which do w$j reem lo have bven
repealled in 2tK)7/'lhe modemlion in this meijsure last
vL^ir. nbng with Ihc slcp-np m measured prothiciivhy
n
getTW'th. held Ihe intresse in irnil labor costs in 2(KP to
'*. tncuiiK receivftl Uc»n ibe tfxvrcisc or*<tg«ti o^nifin* M i
I ifH BKHSt efhsorlf v*m(wift!inon m iiic munrnnii, hiiitn'h-. mem
] pcrccni. Unit labw cosla roscatniut 2 ^ perceal jwr
year, tin average front 2DW to 2(>06 dllei having been
nearly flat over this preceding three years.
Prices
Headline consumer price inflation sl
in die ihird t)imtier tif 2007, when energy prices hit a
lull after their first-half surge, but it moved back up in
the fourth qtiarfcr as energy pntL« el irnhed again. Over
the yesr j s a whole, the ovendl K ' l ; chuin-typc price
index nvsQ 3VV percent, t \ pefet-ntiige: points more than
in 2tMjft, tore pnee in flation excludes the direct cfTecls
ofincreases in food and enerj^y prices; ihtrse increases
were sharp Insl year. Like headline innation, eore PCh
in fbium was ticitveo from qunrtcr to quarter in 2t)(l7;
overrhe four quEirters of llur>trat, itavcrayect a i l more
b
than 2 percent. In 2iV}bM tl>e e r index nwe VA pereentoe
Alilio«nrh dala for PCE prices in January 200S tire noi
\vi availfiblc. inlurmalion Irom the eonanmer price
'Mil -. \( I'ti
Ill'l .'Ili.-i
L
i M : l u " . -Ili-^'v:^:- lIlLU I'l'lM ..il.ll
and core inflalion rcrnaincd on the high side early this
ycaraflcr having finned IN ihc fourth quarter ol 20lt7.
The FCT price inrfex Un energy mas nearly 2U percent over the four quarters of 2007 after hav ing lhlksn
B3od£flt£y in 20llfs, The rvlaii price ofgasoline was up
about 10 percent OVER [t& ycar ai a whole, driven higher
b> UH1 upsurjic in ihe cosl ofcrude ail, In 200R, gasoline
prices through mid-February were around (he high lev•J\: • LCII laic last year. Pritej: ofrtaluralgas rose shnrpiy
Inn iu.il in ibC BD
klBBim nccovtNl rmra nwwt iy|»K »rhointrfi n
87
21
Monetary Policy Report to ihe Congress
February 24)1
in early 21*17, bin ihe_vrecededover the second half of
the year as inventories reached their highest levels si n e
c
the early 1990s, £e Tar in SdQfti natumi gas. pnees htfW
d$QI notnbly a? inventories bjffvfl luSlen back mln line
with seasonal nunns, Consumer pitas for electricity
rose sharply last rail, likely retains nflast year's higher
prices of fossil fuel inputs to electricity generation.
Last year's increase in the PCE price iniics for Ibod
and bevemjps, .11 * H pcrccni, was ihe largest In nearly
two decades, foiKl prices accelerated in response m
slnmg world demandu n i t high demand forcom for the
production ofethanol- Taken together, prices lor meals,
poultry, fish, and ejjgs row 5M percent, unj prices of
dairy pruducts were tip a! double-digit rates. Prices
for purchased mesh ani lbeverages, which typically
art influenced more by labor anil other business unsls
than by i'arm price*, also recorded a sizable increase
last year. In eomitiudily markets, grain prices wared lo
near-record levels in late 2007 us strong global demand
outstripped available aitfpfy, and they have moved
somewhat higher since tlw inm of the year. Meanwhile, spot prices oI' livestock linve declined of late;
the ilei-rasc ttluilld pruvidc seme otTscI to the llpWilrd
pressure from grain prices and thus help limn increases
in consumer food price* in corning months.
The pattern of core PC F inflation was uneven during 2007. In ihc tim half of llie year, ewe inflation « f
damped significantly by unusually sort prices for apparel, prescription drags, anct nonmarkci items (especially
financial services provided by banks without cipUcii
charge I, all of Lhese developments proved Ininshory and
were reversed later in tile jtiir will liltle act etreet on
eyre inflation over the year us a wiiole. Meanwhile,
the rate of increase in thecoreCPI dropped from
2Vi percent in 2006 to i'A percent in 204)7; Ihii main
rcasun lor the nhtipa dccderalioii in the ewe CP1 than
in the core PCI price nuk* is tliat housing tntis, vihtch
rose less rapidly in 2UII7 than Ihey hart in 2006. carry
much grenlcr weight in ihe a m i ' f l .
More fundjinientally, Ihe behavior of core inflation in
2IKJ7 was shaped by many of Ihe same forces (hat were
at work hi 2Wlft, The December jump in unemployment
noiwitbsianding, resource utilization in labor and pB>ducl marked reniaincd tinrk high last yearT and increases
111 prices hbr energy aid other industrial commodities
contiiuied 10 aiW lo Ihe cost of producing a wide variety of goods and ier\ ices. Higher price* For nnn-tMl
imports also likely put some upward pressure on core
inflation. Meanwhile, the news on inClalnm e.vpeclaliiins
has been mi.Ved. Probably reflecting ihe higher rate of
actual heudlinc nUaiiun. the median expectation lor
year-ahead Inflation in the Iteutcrs/Universily of Michigan SurV'eyB oFConsun>CTS moved up from 3 percent
ill cailj 2007 to between 3Vu peicenl and J 'n percent
^t- in GOffi COItUinKt priiicv
•
•
Mntf [Witt irnk-i
1 i..,ni.ni- p t m iHdU i..r.<
rI
ir urn; Cifli*umi:r}ifiFi:imti. rVpniimmi ul I^
^; apun from ;i dOWBW«t| hIsp m Itic
im
11 rcmaiuiuj there ihrouyli Jjnuar>' HVlR «nd spurtisl 10
y.'» percent in the preliminary estimate for February. In
cunifssi, BUHl in^catow isu^gfsi rbat HKpecJatioCii for
longer-run inflation kivc remstJtied rcusonably well CONtained .Ihe preliminary Febriia^ i^sull for median fiveto ten-year inflaiion expectations in the Reutcrs'lJniversity ofMicjiigan survey, al 5.0 percent, wns around the
mitlillo oftbfl nurrow rnn^c (hilt 1ms prevjilU'd for ihc
past few years. And according H Hie Survey of Professionut ranjicuTiicr?;, caiiiJutii-'d hy (lie Federal Histrvc
Gunk of l]1i iIVuUphill, %xpWtJ8$Qtt8 uf CPt hiflaliun
SHI ilK1 BBX1 ic» ycui^ have wmaimd jrniund 2'^ petceflti ii lo'.-l ihm \\&s been C
1'jyK, Mcjinwhite. tcn-ycai i
Bteasund by I|IL- uprCiieU ui yields on tionninaJ Treasury
svcurilies over those ontheir inlialton-pRiieciLid cunntfrpiirt^. 11.:-. • ii:uL:L. • I link', on biituTicc, staSE mid_
2007.
Lstsi year's sharp rise in energy prices also left an
imprint on the price index for GDP, which rose a
link' inorc than 214 (wnriint for Lhc . J . V I . I year tit a
I B % '• EUfitudiflB food snd energy prices, Ibe tocna&B
in QDPpcicQs shnvetl fiwrn 3 pereeni in 2ft06 us
> ; percent in 2007: significantly smnllcr increases
in constnieETon prices accounted for mKli of the
decelcnuiun
Hi T I KflFTccir«f Cltflgy prk'Cs VH Or>l* pikTs M M mild *mi*HVT
wii IIMII on K T p»w«t T^w rcawn i i Ehm UMICII OFTIB en •• • • ,-> u ••
ie iiiis*: w*ii iilin hyiuhjd ^ |lli< luiiliti piU-Vm umioti^d ml, irvhu'h is
: IL u nml pun ci| sdmiL-
Btxmi o/ GmvmarN of the Federal tteurvs Syrtem 23
MleiTOIIw measures urpncc d u n c e JOOI 07
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L'niwuBiCT i«nce i
rsfl.lUMI^Jw^
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Sffl H I
f i " thmMype M U M UfpOASH »if CtanrfkBBb IWr«u nF
I_V>K fat fi>*i-w*lj|hi mtswirc*. llqurn.i, 1
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Financial Markers
Dumcsiii: arid Eii!cmjtu»nj| fiiuintial niarkcts ttKfWriciictd iuhstnnicil siniins ami voljitiliiy in 2*107 ii\ai \Wtfl
.sparkL-d bj1 die on^ti ing duleriuratiort Pflh^subpnnit
itttingagt sKLhu1 and lamciging worrits abcuji I|ILI noirleilii DUthwk lor U.S. tieniiomic growth. SuK^ianiiaf
lossts nfi strijL'iu rLhd products Felii^ to *iiihpnirtir
muiiu3g.es caused irsarkci p;irttcipants to reassras the
risks asswiatett wnJi :i wide range of Otter s'trucimred
tirmrii-'inl MiisiniiMciH-1*., "1'hc result was ^ drying up of
inurkcfr lor subprinu1 and nomniUilmriiil mon^ngc
|M"oJutl> as well as a siutnlk-ani Hvipninmcnt of I lie mnrkcti Tor Hbsel-bEick£d oaninicrciiil paper flnJ leveragtid
syndicaltd KMIIS riktsc dlbkx'utums ^-ncriUcd unexpected Inland" sheet prcssiirei at H*rTte inmur financiul
in^lilulionb. and Ihu pressure* in turn c<mlnhnk-d lo
sOVcR" sltiiins -in i-liuil-lt'rm hunk luniling mnrkflv Tlic
l-jilciul Ruiicrvc ri!sp(mjfd Lo 1hLL linari.ri4jf Litrmnil .ITILI
iht risks to Ihc bmadtr L'conomy aloii^ tWa iTackis; II
iihA (i series efagtfOnfi (o support murk-v'L lu]nnlii\ and
Innctioiiing (pantv in cmirdtnEtiion with Itirvign ccnlnt)
batiks), and il castd nmnciary policy in pursuil of its
macTflccontintic oh]eciivcs. AH a nanlH ol'ihc dowflwanl
rCV ia i oci to ilw economic ouilook and strained fiBeneia! tundilams, vieldais n Treasury wcuniies fell, risk
spreads widened aignificBfUly. eqitity prices dropped,
aiuj volatility in nmnv Hnancinl markets irwrea»ci
Murker
Functuming
mat I inant ial
Stability
The •-•••;:-- •!•>•• crijsion in lh*.H credit ^tmliiy olsuhprimc
rcsidcniiaJ modtingcs. padicularlv mljualsblC'ralc
mortgagee hascxpofiod weaknesses in <nhcr tinancisl
markets and posrd chull^nges t« BnancioJ insiitniioiisOvw ihe first halfof 2007. probletns were moatly iso(latod wiiiiin Ihe sunpriinc mortgage market*. HMVVVLT.
around mady^r, us crcdil quuJily in ilwt SL'ci
ucd to worsen and leasn mttunkiJ, investors (n:gan to
rcirttH from slruclurcd urfdit producis and from m k y
iiBsyiB man:' generally. Strains began lo WPffl^cs m ijic
leveraged synttieuttd loan marktl in laic Juot: and then
siirliited in the issyt-backijd SOflVitBftSJ pa|>i?raiid
ii:nn hank fundmji gn;irki?t& in August Alter a respite m
late SL-ptemiwr Lind f>ctohcr, r^vtliiliiins of larger-lhunl several financra! finns. and a vveufcer
t tt,n>iribuiL'd ki year-end pressures in
g iarkets lhas caurtfirtJaWd financial
^(raias and heightened market volatility, Finanuinl rmvrk d s remained volatile through nuid-Fehmary, in \yan
owing lu a fitnher downgrading of the economic outlook and prubtems al some firuineinl guaramuis.
Sijrns of investor norvouiTics* about the mortgage
iilUiiiion first uppewu'd in DtMJtnber 200G 4ind Thefl
inU'ntilfed in btc Febniarj 2(H17H ai a time when sofkrIhnn-cvpLxted L;.S. ccunomii.' data wem mliltrrjf lo riiEtrkct unLLTlainly. O\yr lli is period, mortgage companies
speuiah/iny in subpriniL" product* bek!,an to L'\peri'
trnce considerable Llimltng pressures. Jint! man> lailed.
hecanse rising ilciinqucnck's on recently originated
stihpnme mortgage}: required Ihovc nnns lo reptjrehaise
ifie bad loans from sccurifired pools. Financial inurket;*
t
i April, however, and liquiilily in mrytir marpofs remained jUTiple. In June, ratiny uyencics downign£?l at p»[ under review for possible downgrade the
trrcdil ratings of u large number a ( securities rucked by
ngagt s . Shortly iheicaftcv, n lew hedge
nttduiu-\-d serious difTicullies 3$ a resuh of
Pnctt of indexes of credit dL'iauJi swaps on rest<Jenliul nmngugL'-backcd stturiiics backed by s
iortgugcs- which hud alfL-ndy weakened over ilu* first
halfof2CP»7 lor *B tower-rated irunchcii -druppud
siLt'ptv in July for botfi lowtir-mtti
minchen. Suhsi'qiumUy, investor demand for
hackLtl by suhprimc mid alL-A inongage potils dwinilLJ, and iliL- ^curiiizutiLVii rnarkct for tho^.-1
li1.. -•.
viduslly .shui down. Tfapse deVfltopfSfiQta ampli fied
credit and funding pressures on mortgage eompanies
specializing m snbnrimei nongages; with no buyers for
the mortgage* ihey originated, more of those linns wen:
forced to dose or drastically reduce their operutituns,
JI el subprimecrtfijTStiDB*Mowed to u crawl. OripnBtions ofa lt-A mortgftgi-s- vvhich Und held up over the
iirst halfofthe year —stlsu dropped sharply begtmring in
July, Ink-re^t rules on jtinibci loans hwafeawt hill instii.iinii.- rli.ii had die opucity tu li.tUl-ui.lt testSOd iheii
balance &l£t8& continued to \u\\ku them iivatiuble to
prime borrowers. In conlrasih ihe markfi ior conl'omiinu
mortgages for prime borrowers was afFccted relatively
little. Indeed, the issuance of securities carrying gUBIBti-
89
Munelary Policy Report in the Congress
Fcbnnuy 21108
i ce s wJexes of credit de limit swap EM
ptOTM TV- J^.i .in.- .taily i n K - j e m l HifiiufJi Fulwii.*n 31, JiMlH. Th,-«
lees from Fannie Mac or Freddie Mac m « snmewhui in
Ihc m'ttnd hfllf of Ihc year.
The unprecedented decline in the value o f highly
rated tranches of mortgage-related secufdlioa led investors lo doiibl their own ability, and ihtii o f ! he rating
agenda, lo evaluate many other typiss of sltuc'lured
in.«li umL'nr*. TI>L» Inss ofcDnfidoncc was njflcciL'J in
sigmficiuiUy hrgncr spreads LMI the debt o r col latemli /ecJ
li ii3i> obligations U 1.(Isj, .nn] Ehe i^Liaitee of ^uch debt
weakened mitiee^My wver the summer- Because CLOs
hud heen Tin.- 1;iF^M purchasers of leveraged syniticateit
loans, the drop in issuance contributed to the dectinje
in leveraged lending. In (he secondary market fortucli
loans. ULuJing velmnw we« rcponedly lor^c, but bidajiktid steads widened tilurply and prices, wWeh luui
twen high in ihe first hiilf of HW, deelined inurkodly.
fmpiicd spreads on yn index ofltwvonjy crwlii dcJbult
KwupsfLCDXi ipiki.'d in July and re\n\unctiriavatadin
August, Unable to distribute many levelled syndicated
foflfl* ihj[ fe»y had rflpOftefly undcrwritttn- -a problem
appurcnUy iiiftttinjj Btottt S250 billion of such toms
in the Uiiiied Stales a Lone- hanks faced flie pinsptit:!
of hringinj; Ihosi: loans onto their balance sheetsJ L, I | ]
under!yinu dea ls elost*UAtthe end t>f July, Enrppeuni assct-baukcd tomiin.- -. •.!i paper (ABCI 1 ) and short-term funding matkels
were miled by warnings of heavy losses associated
wills commerciaf paper programs backed by VS. subprin>e mortgftg'Ss. On August 9. a nmjor European bmik
anniitinced ituiT M bad frozen redemptions for lltrce of
IRS invcsmicm funds, citing Us inability to value some of
the mortgage-rriated securities held by the KUHfc. AHer
thai Ltrtnuuncwnem, liquidity prubleimand short-ttriTi
tunilint; prc^HORS intend lied in Kuriip*.1 and cmcrjicd in
U.S. money rmrkds, Partly in r^wnde totifiXftCdPi^tnpnwnls. the Ft'dtrrbi Reserve and other central hunks
took slt-pit lu foslcr sTiMH>thuT funL'tionin^ of short-lcnti
fn:dii niiifkcis (refer to i hc box auuk-il "The Fcdtrnil
ReserveTs Responses nn Financial Straios")h
Spreads oh U.S. ADCP widened ton^idcrabty m
ntid-Augusi. j i i d the uiluine of ABCP LHitsiLtm 1 in^>
bfu.ni] Q precipitous dctiiK- sis jnv^ten balked at rowing over papxt Fur more tharii a Ctw dayt. OuiKiandinji
Europuiiai ABCPulau dticilntcd subsiajtiiahy, ami ihc
tnaikcl fee Canadian A B C f no ^rx^iNored by bankA
tiiiisv is^ttuncc of Atturitic1
am
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kvi.-lil.lnJ h ' l l i ; SOTBI (• "K:il vl> in<\U\if U
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in M t «ecn(Kkir> nurtiU hir
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OiiL--munlti Libifl" minus OIS rale 2DUT-4HI
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NOT 1' Hit «b!E 3(t »CEi.1^ IIElf I L-HnuJ Llnnuijh C-LATIIJJ) JK IHft,
Ofll .L.Iiulifl£* ii«c ^.m.iHllv iulji«ieij Fur i\A-nwixt 4«n!i-lr*-JiftL ^[tre*( ur\
Jav JUI^IJIKC, b sMt fcA l i i u
I. .»Vf AA Miimijinniwl (nlc
virtually C L lapsed." structured investment vehicles
O
ISIVs) a i siiiglc-aellcr ABCP sonduits thai wen; heavm
ily eX|m«d lo securities backed by subprimc inortguiiw
cupcriiticed Ihe grcaiest difficullics. Unlike traditional
ABCP prngrams, SIVs IML very lillle explich llquitliiy support thim their sponsors. AsaresuJl.invcsiots
became particularly concerned iiboul the ability of
SIVs—even itiose with little or no exposure M vtsitleiiliitl mongages- M make timely pitymenu, and demand
Mr A l i i ? issued h> SIVs IL-II sharply. Over ihe nost
few vveeks, some U.S. issuers inv oked their right to
extend tbt n^ilurity of their p:iper. Others lemrKlrunly
drew on iheir bant-provided backup credpi lines, and u
few issuers defaulted. The general uncertainty and lack
Of liquidity also led to sonic decrease in demand lor
I..1...M.Ilei- unsecured nL>nnnanciui conmiLLreial paper
especially al kinger maturilies and spreads in that
segment oHrie niarkel widened markedly in August i :
well. Issuers of high-grade unsecured commercial paper
were largely unafteeled by tlie turmoil and cspcrijnceJ
little disruption.
At Ihe same time, term tnlerbank Euuding markets
in Ihe United Stales and Europe came tujder pressure.
Banks recognized thai Ihe dinkuhiL** in Ilie murker
fur ntQlgsgcs. syndicaltd loans, ajld commercial paper
liould lead 10 subsmntiully larger-lhan-anlicipgled calls
f
n (ninhuok \GCP InJo liin
I., an imjf* lit dnll> 'ndnli^M rajc%, ^ULII JS <EiiI eilKIJUS lcik>*-,ik IIJIKI'. KML
Al lr*iunl>, I * " [s,nn-. o u t e
h. I M - I
e >•.•• -.1
DEIWUHII [iwiUrtcrj.'ntc M t ^ t i ^ i mitit^i »:crui*l ill lln- «i\fU mh-'
1 mhinrvi
:ktrw^LOJ«Luni;>i Ue",HEhf..• j.ci-it;n'L 1 nl rlw fliinliny. ut "iiifc*. rtle.
SbtWK B f l l I ln.it.)1*l(^i B B H I E W A—n' w.tvr Itie OIS ink 1 .IVrNm
nn their funding capacity. Moreover, creditors found
they Ltuild mil reliably delenninc the size oflheir cotlnterpart Its' potemlal exposures to those market-., and
concerns abom vuluution practice satUed to ihe oterall
uneeriLiinty k i a result, banks beemne much less willing lo provide funding lo others, including other banks,
especially lor terms of more than a fen day*. Spreads
offirm federal funds rates and tern Ltbor over rales
on uonirarable-maturily overnight index swaps widened appreciably, and Ilie liquidity in Ihese markets
diminished (for the definition «f OVWntghl index swaps,
refer lo ihe Hccoinnnnying figure). European banks
also waght to seeitre term funding in Iheir domeslic
currencies, md similar spreads were seen in term euro
and sterling Libra1 mart;els. Liquidity in the foreign
escltBnge swap market was poor over this period, and
European RfmS found il more difficult and cosily to use
the I'nreign esehange swap niarkel lo swap term funds
denominated in euros W olher currenciei lor funds
denominated in dollars- Temi funding markets in Ihe
Japanese yen and Australian dollar also cnine under
pressure as foreign insiiliilions atiempled lo borrow
in those currencies and swap the funds into dollars or
SU1TJS-
Against thai backdrop, investors fled lo ihe relative
safety of Treasurv securities, particularly Treasury hills
during mid-Augusl. For example, inflows inio money
market mutual funds investing only in Treasury and
agency securities jumped in August. Surges of salehaven demand caused Treasury bill rates lo plunge at
91
Monetary Polity Report to the Congress . Februa
The Federal Reserve's Responses to Financial Strains
In response ro the serious financial strains thai
August, me Federal Reserve has
en a number of measures lo foster Iho
normal funciniHmg Of Hn&TKftl inrirkels rinr)
thereby promote ili dual object ives ot uuiKimum
employment and price stability.
In mi d- AUGU st, the Federal Reserve, as wall
o> sever al foreign central har>ks. irx* actions
rjsifgrved to provide liquidity and help y oblige
markets. On August 9. the European Central
Bank (ECB) tiontjijctwl Ein uniichietlijletl i«ntiEr opuc;]LJijn in naiionm lo ihofply <:Ffiv*ifr;(J
ariran it rcpoiitrcti WVETJI more tinins lr> 5tJtJ'
*et|Lnsrtl wpelv^. On Augnsi 10. •sinnluf strei«i
umcjqorl in LP.S mnmey mjrkeiy ana Otc F(fderal R«fjrvb rtrJrjfrtJ tubM^nriak rewrves 10 meet
heujfueiitjcj cJenwiKJ for Fur-Kts Proin hanks.
ShnrtLorni rnuTkcl^ inFTisincrt under ctinsulrf
<iU1« preii-ufF! ovei subsequent tfayb rje^pilf Lbf
provision oT^nipto ^qi'ldlty pn ovcrmgN funrling
mockers J?y rnc Fetihfrai Rewfvt. the ECB. and Th
Cdnirai bdnte orcrth^r nvijor inrJusumlirtd countries On Augusl 17, the Fetidral Reserve Board
.inriraiiiced a narrowing oftut spread betwutn
inu Ftfjuriil fund^i rate dnrt I he dlhcoiint rate Trnm
100 l/jin. ijom^ ic 50 birti* prjiTit^ ijpkch ciTdnged
fJi^couFit WJnriow Ending prflcncr*i ro JHOW ibc
provision of lerm financing tor as lomj as tturty
dayy fsrmwublH by Itie tjorrower. To ante p>eiSLut^ in HIM Trtaiujrv iTiafVei. [hu Fijtj^ral Restffvr?
Bank, of New Vori tannouncer) on August 21
Mnv? temporary changes to the term* and conditions of me System Open Market Account
(£OMA) securities lending pratrram.
Tim Federal Reserve ' Rtrtiru aiihiHued some
oftna desired ff:MJhs The provision of increased
llt|Lirrfiiv gftnefally ^ucccttJiEd in kcapmg Thn
ted&M furKfs rriio liorti FitkKj anuvi.' >ft mlt-ndisl
IL-VEI. (InrJcpd, de*pitr> hciijtiicmxt rjciFTi-inri for
iif|UKMy. tiifflrfecuue r^der^i lunds >ote ^ a i
somewhat helowIhpl,srgal lor a tlirw In August
nnj KJTly J>cp[pmb?T, ris Gffnrt&tn Ji*?£rp ihe rrilt?
near the [argti wnrs Fmmf>i*rE?cJ by ificttflteaJ FLi^lori urTd fkUhCW in^iket vcil^lHity] Afltfr ttw
Sqpu?ml?pr meeting of tile Ftidoral Open Market
CarnrTTHtBe. cunrjilhant m uvermqhl Punijmq
rflerk?(5 trnfiroverJ furthef. The Julurne of loans
todepository Institutions madet hrough the
(!•-.':(i^jnl WlndUW iHciK*snl Hi (irr»js I N L I I N fiF tui'm loyn^ tr) a re1fliivt»ly siriall iminhEir of
invltUlHifw. but il mnitimed rj^ncraUy nndeiL
ate. Institutions may have been rnkinurn to use
(ht thy.'SurFt window, imbuy* rtdrirtg inaithBit
horrnwlng woutd noccmo known j m l would be
soar by creditors and eaunleiparties as a sign of
'in.trn.jjil wHriknc^i—IF* ^u-calFmj *ilr[jrtiij |jrobIcm. NonclherE55. coMtitnral pJarcd riy tj-inki
dl the discount window in anticipation ot possihirj hrflrnwinrj rose uli.ifply during Atrgusi and
5c]3lernbor. whic'i ?ugg«i*?cf lhar sonne twnki
viewed the discounl window a ta pniontlally
Pressures In (tnandal marke
time in tne fall but rosrs again Inl^F r'n the yaw
On Novembei
26, theTederal Reserve Sank Of
New York announced some additional modest,
(f>rri[i[>f;jry thiincjeii lothe SOMA secuMiitt tending program that wera dtBlgrte uto runner relax
Wit llmQdtlMU on htKiowiny IMIIHUJJ TrfMSiuv
seairities anb to imprtjv^ Nm functianinij of
the TiwtsLiry mflrttMi M ^ciclHrort. 1hR New Vbrk
Reserve Bank SfUBH Wai the Open Morket Trsiding Desk planned TO conduct A series ofterm
npuechme *|feem^rni tliui wourd fix^jnti wvt
ti.:< IT en id ^nd thbit H WOLIILT [MOVI;!^ sufFlmcnt
reserves to resist upward pressures on the federal
funds rate around year-end. Dun on Derajmber
92
i at ii
/ Reserve System
<0WM tn iU** Innurhry nnd f »?btunry BUCIfOni
Tht? lower ^yc.wj dpptwfrnriy rtjfiectntj somy
iniprovcniBnl in bonks' accea to tRrm fujining
•iNi.i me him of Eha y w Anrnjugn i^r>irmng
itm Impact of Bw TAF on Financial markOi ti
not easy, a declirw in spreads in term Funding
markets since early December pro^idm collie
tividi?m:[> thiit iMo TAF may have had ftfflftftclnl
eFfocls on Financial markets. The initial expsriUF>I.O v^itn Uic IAI iuggcM^ThaT il mjy WGM be
•! LisififLih «orn[>l[!niynt \o irw discount wuKlnw in
sonvdfGbnwancBt, ond (he Ferja^i R^str^r:
(SNB). which provided dollar funds that Those
Dt^rd will coniidflf rriciking ii a pcrmanotn .EdiCOnirril UarikliCOiJlfJ lend m thOn-J<jrlKJiCLiQ«15
tion to the FnrtcTjjl fieiicrvn'^ avoklnblu tn^lru1
At Ihr1 yirntr tirrnr, [Tin ftjinh c]T FnqlFwid iinrt Ihc
ments lor providine liquidity to Ihe banking
Bflnk of Canada announced plans to conduct
•£EtSfn
airTiiitK tarn Tijnci^ operairjr^ in Ihtir own
The swap ama ngornonts with Forsign central
brinks a l lawccl For up tG %2tl b i llion in currency
auttiutts HUB tar, iwo of S20 uill ion in Decemswaus wiih the ECB AND up to S4 Billion with
ber, iwo ul S 3 0 6lliion in Ipnuary. and Iwo of
tin? SNB Drawing upon those lines, tha ECB
HO C'IIIQIH m February, ^hf riuchtrns iiiirr>r:(Dd a
cJuctJcmRO $1t) billion in drill or 'UPKIS O» l^ccemi^rgej numtwr &i lt\iiti&$ Tht* r^titi nt the dollar
bcr 17 rintl ynothfif 11(1 Million an DtH^fntMr
value or bids TO Ihe amount oFfeiod (the bid-to20 in coordination with Ihe Federal Reserve's
cover ratio] atthe1wo auction s InDecember
TAF duL^JOrft. ThMj SMH aufiUoriod $i bllllcm in
Was HUDtil 3. The auctions In Jnnuary and FebruftJnrj^ 0(1 December 1 ?. Thtj rjidtD-covrjr FHHOS
ary wwtr iciTinwnol 'ewovcif^i.ibH".r»htfd. with
at ths ECB and SNB auctions in December
hkd-TD-tCVtr fdUDSO* roughly 2 on January M
rjngc-d between 1% and 4%• the actions WORE
Fetnuary 11. and February 25 and oT TK on tan>
considered successful in helping togive foreign
ouTy 2G Th'? lo**3 bftj-tO'CcrvOF niOos »n iruw;
ffndnCriei instttutlont acvcsMu Additipn^r ctotlai
akXiTitint irwy huvt* u$feevxi improved liq^idiiy
Funding. The Dfi^omtwr loans were renewed by
in lad rn Firtidiriy iiuaitteb. r' •• - I a • • • • n .MI/UMI sl/tj. the ECO find !>N6 at lU.r.hnrr. in I.mum v witJi
•
and. For lhi.J January 28 auction. KRTA unterMmbld-to-cover ratios ranging from 1TA to 2Vt The
ty about ihfi monetary policy action dmt would
ECB and SNB have not conducted BUOtBq in
be laken at the January 29-30 FOMC: mooting.
February: ECB officials have indicated tbal consideration would be given la reactivating, dollar
\he ipresd of llie inlwoM rjtc for thL- auc.merums nr ounrjiticit^ ctppeur UwvCStf U h
Htmed Tunds ovrjr Itiu itiinimuin t i d ndB 0• "•• J
•vL-rn ig IH -l ndex- swap rate correspondinq to
12. the FptJwfjj* fti^t'»/•.'< niij SBVtfBl Uinjign
Dflncral bank* dnnounnert ;• cmvdJnijyid cfrtwi
to Inornate A return in more-narmiti pricingand
Purn;liunmvj in lorn hnvUmi ffiarkoi'j As pflrl of
UiJJi effort The Ferfffrjji Rcr*rvt flnncKjr»c«l the
creation or a temporary Term Auction Facility
|TAF) TO pTovldo wcurtd term 1uncling to eligible
c1f.h|jraLl[ory iriitjiuttons ihroiKjh an mi! umi
rm?ihiiini*i'Ti buqinnirHj in Tnid-DtrctrJiibcr TIir:
Federal Reserve also established •iwup Nnei
with me FCB and ih« SvHn National Bank
:;•!•
i • -1
iv
i..lHn
hi
i n - H.I i . i..-i
' i . if... 111 •,-,•• i .
abuut S(l hiTsiii fK]inti In Dcjcurtilnfl bin was
27
etary Policy Repor tlo the Congress
February KIDS
tFiiii'v unit I he MH^nL'nihlt' volalility in lluit in.jrfcvi i u s
all-A mon^n^e incite t> remain t:\M.'nh:iJly shullereJ.
likely c.sacerbated in September by a seasonal reduction
i."(}iidi[iHjnv tn ihc marfci'l for Icveru^ed syndicaled \oant-
in bill MifTb r"Jid-;i>ked .spreads in tin.Ircisiirv bill
htVd v L>rvt"iif J. and ilic fV»n^iirJ vnk'iuLir *.if <H.Him>itlcil
murkei w]deik\l MibsliinliLilly >n ibis period
dmls uin.
rinanciiil condition* a.p|vn**d in iwprott: somc^h^i
in UH« SiipicmbiT und Ottorvr LIULT Hn- Idr^cMhan-
^ibsUiohnr Ki>k %r>Fi:odji oi> ctirpi^mkL
Kviils wuLiiwii ^iyoilicinily u\ Jjinury. •md eu.Uiiy
prices dropped. VU'si rc»:ciilU, deii^md Uus eiaptiraieJ
txpccttvi reduction n\ 5(1 basis pumt-f m lite ledcra]
IL-IT .HJvlioJi-r.iiL «CUllliiM — llllljMcm) drftl {ntUCh n!
funds i,iu- J I ihe Scpiejnbcr H ) \ 1 t " tuccim^ .md .s luw,
uhtcli » mutucirul bonds>Awin Houim^ itilerbi rjies
ciiirouragi tin rc|KMis on economic :Kliv}ly Spreads in
lhat :IIV icscl Jt friM^ntrnl, rc^uJai .uiettuns
nu[i\
tmposetf higher rules on ii-iULT* ami minccil liqutrlity
^ I H ' I M I ' I M I funding in.nkt'lN pariiatly n/wc-ed
Jiul incrrvhy
ihi'i? AiimLitl run-up V UiJ-iisked spreroh in llu* mler-
si'i •=11TT..'PIi holdtrv
dcaler market fur Treainry hills werea hit l e s selevated
ihuH (hoy hutfbeen in A o g ^ i . lt<ji ifceTtMMU}! hill
ci.sl ^ii.ir^inTiiirN niten^iliud us rctiiny iiy^icic-- ;md mv^s-
m.irku m r i p e i ] tJun. Lir'.si w U > v n
roj> bnidoie more kJOiKcmcd diat ^uanutloTa' espttsilnc*
i a l d i i k .ii
m m
In Jninitin =inJ rcbnuirv pn^kfii^ al K V W l linjin-
lii Uie synd^utirtl lo^ui [u.irk^t. mipEicd L CDX ^[lu.nk
t^ that hold asset-hacked
p;inJv K V W M l their suinnnr jcurgc. .iiul BMBC rinilnbii-
lioa- backed hy subprime rest-
lion-ilol|nrdiMls were succt's^ftjMy pluct'd I;I tlif m:it V-ci.
\k"hn:il :nn]iL|.j^L>i had uitpcf iL'd ihe jiu:imniorv" AAA
However, unde rwriting banks I C R forced to take siz -
T.ninu^ liulfCi], llic r.niHu .iuL"rivie•* (imvn^rLideil J lev
abk*difi'ounls trum ptir v;ifhf 1u iinlli-cir in^CAliirs h>
liniincial jiunmnlon: iinii pul v i m : linns on Watch Icr
purcrVjx: Iht- loanv. Jhd <hc> recoiu-d ^i^nifitant^
1
possible do^ngnules: 1m»ni:ral jiU*ranli»rs'etjuily pntcs
liirtcr-ilnm-mk-iidvd poriknb ofUmlsoii ihctrown bnl-
declined, iiod^redii Jefaoll ^w>tp -j-iv.nl^ m u ; i . i . . l A
ahkic ^1IL'^1> I tit.1 hmpnivciiifnls in in^rV^l funtUnnifiti
nunrhcr *>f ^ujranlors iire undertaking cfTorts to ^flViff
jirtHftl IB i v ^tiort [ncJ. in pan HL-CJUSC o f f fimhcr
0BB linnmujJ ritrcn^th.
L\oisv?inti: in ihc uulliKilt l^i t\w inutMtiu sct'lor^nd
-
L
F ni.ilKiHit tU,lfjnlors lij|^-c pLiyi.-il ;m lin|ioiT.ml TOlC
L
J.WK-i a leti LLTHL CI ii n ulnnrt ^t^ihlcr^nii.s:is an hii:nu. inl
in EhL' nuiikijis lor mumei|iiul S>mU .unl fot some %tiucr-
insliCuEions and ihc ctoiuuiis.
I n r LM.1 linanee proditets by pjvsnlmu nixinmee a^iiin^L
default. Jlune fnarkctshavcalrvaily felt Jn'mi? c.fleets
The btnnns in hri.rui.tl m-tiV^i^ <rHun>t1ii."il during
Novcmht-r jinJ D t v t i n K t . Ilk- -jsndkMtal lir^ii mar-
liruni ihe <\rv^ til Ihe linantial ^our.mtors ;mJ could I v
kci htjjiim ground <o :i luili_ iind spreads- on ihc I C\>X
more substiniiiiilly sffecied hy uny ttuure downgrsdes.
1
HLJL^L ^ moved up. Tim hoi^litoin^l uiKvnuinfi^s jnd
The ilireci ovpuMucs nFL>\S- baflk^ ^.^ l o i * » (TOH>
onpumti financial lumioil, jlunj; toilh ihc d ^ m ot
d^win^mdes of ^uajunuirs'
L
l
reiir^s
through bJiik-i'
fin>;int ifll itHiLiuiioiu i*>sho» s.)k Ltud ^i|itid u » t f * oti
lK>h)in^.s ol niim iciptti \t* ••ml • JIKJ cre^n proiecuon on
>
tUuii ycar^nd HWnimiTtL ^L:ripened ^i^intig.ini yen-
sinicmrcd products
end prtrshiircs in slmrt'lrmi hindinj? murals for the
Ihc banVh1 iiipiial. LJni J-.IHIIC lut^c hanks aiul broker
h m tinif HI srtcfii] years. Spn.Mil> on WK'-monlh Lihur
dealers cotild experience signilicanl E'nmlrng pressures
,ip;vcjif lobe niod^rjite reljn^e lo
and Lerni lcdcr.il Rimly>li^l up m liUc N y ^ m k - r whin
from structured produels lied lo municipal bondsthat
ihcir mnluriiics k-ros>t-d yc4ir-cntl. Similarly. spruMnl--
rni^ht return luihvir KITAHCC stBCTf ilLi:njrHirnor%aiv
doHn^nidfd tal<vu ipct:hfit:d ihrvsh^ldvor if invc*toft chdostr UT ui>^ind their invc^inid^is m ddvjrvcc of
her over the penod Simhg demand tor
s over year-enddrove yieldson shufi-^Cfl
I;^i-iL:JV hilN iiLiUitin^ m cnrly ZiHK ut Juu- kvcis. ,niil
Ahlioujjk I S
HiNiiUviJil in.!ik-.'i?i LMUI inMilutKms
hati? eneoumenrdeon^idcnihk' ilrflKiilhcs over itic pj^l
liqnuliLy in lluil muricl uj-i mipitired Jt (nnf%.
several months, the linancial system entered thai period
In mid-Duccinhtr, Ihc l'cdcral Rescnc nnnounL'Al
nvnlinulcd M\\un vyi\b ;i MlMIlllff OfOrtMf fWliltl ^iirsk^
niiili soitw Jistintl ?i<Fk"iiL[(Ii*. In (Kuiieuhir. inosl Lirj^e
liniiihrinl itisliULU0Fi^1ihii}slrt>ii^ Hipilul posiiionn. j n J
lo hdp liictlitLik- a rvMm to nu>nf-iivfnul pncinif JIHI
L
tuiK'liumny H li^mi funilio^ m^rkebi- The lilTntTl^ i>f UIL
>
ihc fiiinintini infm>lrueiurc v^ji rnhu^t AtlVtotjuti R U N
cirnlral hui^k^ u^nbjnt.ti with Ihc piL<isufc of ycar-trnJ.
Ijrye I[n,iin::JI Misiuuiions haxv e\j»ei k-»ted ^i/able
jppvdiMil io Iwlp siCddy sluirt-tcnn hi^ncidl nurt^is
|OSH% (he sector generally remains healthy. A number
in caHy 200K- So Tar ihis >v:u, ctHnnu<xi;il puptt
of ihc (inns iliiii btiic rcporicd si/jhlc unie-douns of
spreads-
asuLi ta\c been able lo mtsc aitilthonat tapiial. MnrtttM
[\tpcr
both lor A B C I ' and for lower-ncr unsecured
JIHI Lcnn hjinL riiiKliuc sprcjds have dmpped.
jhhnii;h ific> rvniinn nbove the IC^H_-|> ihnl p r o f i l e d
before Inst Au^itfl. In n»nlm>l. Ii^uii1il> in ihc Treasury
hill market ii • Ivcn incon^isicni Ilicsuhpnme oi>d
inlitiMciiHitii" ILIr cleann^ and vellkmciiL perlunncd
well over the year, even when volatility spiked and tr a d>u^ % olome$ WWI vtf y hir^c.
Mnr^weTT noi all ftwket* eKpcncncod
94
t iovvrtmrs t*( fhf I'vtk-nst Hcsvn-c M:\tcm
t. For instance. lh« invc.stmtnl-,gradc corpoviiie bond :rnarfcei reportedly lunciiontrd well over rnosi
of ihe period. nm\ (IK unsaMiivd lugh-gratk* commercial I
paper rrtarkci appeared Mitle affected by (he dilTkultics encountered in oilier short-term funding rnnrktMs.
The
n of consumer Uwis and conforming
residermal &afigtg-l£fi w u rubitsi. Despite a lew nn table
failures, hedge liimls overall seenied ly hold up fairly
well, jnd eounlcrpttriies of failing hedge 1'UIKI: did (lOI
sustain materin) LOSSE
29
T l P S - h n w d intloiinn compegaaiiOT. 2l H I • i Itg
•
Policy Expevtaifons ami htwrest Rate*
turrcaii luryict fnr the federal Kinds rate, 3 percent
MlK ht-l^w the lev«l tliut inviUiiiori expected
ut the end Of Jims 2007. Judging from iururcs quotes
at that OfflGi nturiffil pur!ie(panK en;pceied the FOMf
ici shave al mosi 25 basis points troin Ihc fedora! funds
niu by Fisbiuary 2U0K rytHier thuii Hie 225 basis pflitUB
that lia>> been nialiifed. Invesiurs currenlty e.\peci
ah,jut 100 bjMH |>cinLs of additaonai casing by the
tfnd oI' 200S, UntWrttHIty about the path ofp(ilit:y bad
been, VL*ry tow during tlier first hail'oft h e yual, bill u
increased appreciably over Hie summer and generally
has remained unjiirid Its king-run hs^ioi'ical average
since then.
Miln'U^li lu-miii^l Treasury ).\vkh ri*w somewhat
over iht (Irs-t half oFlasl vcar. rales subsequenlly FCH
sharply us the outiotvk for the economy dim med mnd as
market panicipants revised ilicir ejq&GtAfQtiS Jor m««netary policy accordingly. Treasury bill yields declined
lo particuliirly low levels ai liimcs l>ccuu*eol'inciTasctl
demand fi>r sa fe and liquid assets. On net, (wo-yc«r
yield* fell rOlJfihi) I8U basis poihttin ihesecomJ half
j
M
W
H
y
21. JWW. P # « l c q
,1 <.tUiipntiMXii ut rik- jiL-lil curve IMP (IL-IVJIK tillUl«.in-rm«ltacvl «<<i.ur1|gtr»
T
1
P
3
i
l
U
T
^M
i I r-fJcra.IK.wv.: B
nf tbt year, and Ira-yem yields shed ahiwt K M) hsisia
points, rreasury yields fell signilicanily more in early
200K, CSJ^CIJMV forshorteMenri sccuntics. as policy
t'xpeclationa shifted down in response to sigjts of further weakness in Ihc economic oudmtk. As uf February
2IH ihc Iwtt-ycjir yield was abam 2 pirrcenl, ani JiW kLnycar yield WH ubtiul 3 Hi pcrttnt.
Yields on inflation-indexed TnJitsiiry BfiCQPties nhu
declined considerably in LIIL- second lutlf of2007 and
inio 200H. TIIL' diffcrtntt; between thu five-year nominal Treasury yield and the live-year in(I^EIion-indexed
I rv;i>nry yield - five-year in Mat ion uouipcnsutittn - -
Spread".1* n!" em [Mriilc huHJ yltiliih *^t*i
T
yields, hy stfurittn rating IWS-2flfffi
[steceri t&a m wltttcd Tir;ts«rjp
am
:
MB
am
1,
1
UT
..! ltir.i..i;|.t".-;fi. r, ••..
an
dlnwn H * fk: !(1dA .«i kn.v^r hiwd* t
P
i
IKIIVIAI I
I
95
epun in Nit { \
R:bn(nr\ 2
ed^i'd ildwn (HtT Ehal [vrnsi. ML'.in^hik1. I hi: [en-yejr
inflation curapensatuui ISILM^HTV •• 11in^cd lilllc, As im^il
_
earlier, sun cy-hu»:d merlins t*r*hurMenn infl.uiwi
fs[Hvi.nri'rT. rose u)mewhnl in 2'nl7 and emly ifhjw.
prmtmnbly bccmuc <<f the tucrmic in IKMIIIHU- iiitta(ii.»ti. Snrvt\ w Lin i ires ofl^n^'Menm Fi;f)mion i^vi-fri*
lions changed oilty slightfy.
Yield* itu ttirputtic hoikls tinned J b>i i>vcr the lbs)
k»U »t'?<HJ"\ uiiil spreads o h hose yields over yu-JJ^oii
eompjiable-iuttfunty Treasury sectuilia dumped Iml-.-.
im net. Sin4:f JtniLhr yi^tds cm AA-rjtcJ Lrorp^rjU' IKIIKIS
\i.\\\- dccrciiscil MiinvTM'halr on nci u-hiV I h n ^ on Hhhrakd hands incteuscd stitjhlly: sprc;uh tm AA-naLtfJ und
RHm-rdtiJ bond* lu\c nstitabcul *M| and l.iOhu^s
ivmus a-spcdixcly. Murvi'vcr. yitkli ui^ ipwtiUl^cL^nidk- sccuriito Itj^c incTCd&cd snbsranlidily o^tr rhc
BOQB p^fimi. and their snnrart> Un\c shO< up altiuvu
Equity Markets
Urn iHui equity indeu.** lodged increases of around
10 percent over the lirst IfcilFof^tfl? hut then fan
gmund over the second hull", they ended the \ LL,<r unli
yjins<*f .1 percent ti>(» pcrccui. The intrrczsc reilecticd
tors. pjrttk.Lul:n*ly jnerjss, TWMC innioulv. jnd iccttnoiogv. By onllHt, •Zocftl indc^ci fin ihc fiitjiwi^i Kcctoi
M l iihtnil H\ percent in ."UMi"1 H iiniMms rejclird io ill
lalinul It^cn the problems in the vith|prinkn unTtiiiijii1
sector. So liar in ZOlW. ^nn^mi! corttfiiis iibtiut the ret
fifnnif oiiMi»k. alonp with aniU'iintcrnentb ofddditi^ri
subslanltnt K»s^Ci at Mime lirge rtiuintml linn*-, luiuprecipitaled a widespiiad drop IN equiiy prices (hat l i
pushed hrimJ intii?\c<t i t i ^ n uhoul W nchccnl.
ilk- iidniinuoJ uttLvnuimy surruundin,^ the ulnnuiu
bin:;iti(.1 di;itnbutifin ofljsscs from ^ubprin^-rfLitcd
and oiht'r invcstnicm pfinlui'tii. us w^ll n> iht? poi^niuil
trffevis of tli L' HiuLficuil luminil on ilic hin:nk'[ cirVtnniny.
cnniribuicd \o Inyhcr volatiliiv in cqmiy m.irt.ijr- und
A siwider equity premium. The implied volatility (if Ihe
S&P 3lK>4rti-ctlcniiiti-J thwii options prices KB* tiflflffi•:.irnl> in ihe >etund JMII ••! .IIHT and r.Tii.im- •*•[.,•. ii.;.j
rite ml in ort^ol^o-month-rMrwiird i:\pvcioil enrnmgi
to equity priceiLft>rS&.P SfMi fifnn bVRB0d9VtrdK
-,-,.• 11.1 hrifof2007 nod iota -<"i.v while uu- t n g - i a n
real Treasury yield decreased. Ilk- dittertnce belween
inesc nvij xjlueti ;i nicuiurconhe premium lii.ji
invcihtuns revutre Im liol^iri^ cumtj slvta, lus
rc--iLLhcd ijit:>»^ii end of its onge DVS ihc pusi tnenty
n*iH> into trquil) ntnlusl funtls wen: hcivy early
in Z001 bill slimed Mic^i;intinlt> LITXLT IIIC rirsl qiurtLrr
fmlectl. eguil> lutids iliiil Utciih.il *<n dtmicsiTC holding
CApencnLvd ^on^i^lcni net onMk<u4 hc^nmnii: in Ihe
ipiing. fl> contrast, inflow•* into foreign equm lunj^
HLM up Through the end of3007 ik^pire die ^eakfie^s
in many foreign slock markets in the Iciiirth quarter,
estic and fore ign equity fands experienced
K mMftnnc w JmiuHry n e^uuv fincv% imnhled
ti1« kiv. run f1ou<v^ppcitrtn Imu1 *i.LhLli/v(l in
Debt and t'watti'iaf Inlfrmtriliafifirt
Km nx i
n i t nnjl debt of the domctfic rhinim^ne^d scdon
uppc^rstn luivii cxpuded JIVUII K percent iti 20^7. 4
slightly dower riiic of gnmrlh ih;m in ^(HM>. [lie *|ow-
96
Board irf Oiiwrnitn ttf the Fmttntt Rex&w System
Clwilg? til M I I ) dnmostfc minliniiHLiiiJ *fcht, IQ*»l-2(Hr7
-
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i |
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3«Ji
n Mi^
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BSfl
P » (frfa »iv Mil hIMl =1h.l mHM«««ath iViv ofileaiwil l!.,-.s
<
• tinii in 'Ik- mmtniK \m, v * | w iur:
N 4 Kit j» m i i»> nw k
SMM
I ledtMl Ke«rw hU-ml. ll^i, m ftah AH
ingrellecitrt!a deceleration ofl umsehold debt that w n
a
only partially olfscl liy a etinsideniblc step-up in borrowing by h uM nesses and governments.
Commvrcin] bank credit && Hlli pirrtvnt kiai war.
ii piukup from the '^< pfivL'nt •; • i• • in 2(N)o,17 The
accdcmlron of hank Ltcdil. 0S well as the diflVrcnccit
tn growth rd(fs ft(9tea hank a^SL-t clLtwci. reflect U\ p^ti
ife edfBOB of the financial inarkcl distress. As already
motet), commercial y]>J industrial (nans surgfll in 2(HI7
because of ^Ktrem^lj1 rapit] yrowih in ifie vcirtuwj half
of ihe year that HI pan resulted from Ihc inability L
M
banks tu syndicjitc leveriiyt'd loans. At various limus
over the second hutf of the yt;arh banks' balance jtlwm
were t)(xns.[L'(J by cMcnstotts of credit to lumbank IIULLMCKII itislJEutions. ii category iliiir intlinks ki:ins ut AHt'P
programs Ilial were no longer able to inaue commertiol
paper. I hiou«h the ilnrct ^tiartpr ol'2CJ07, ihc ^rnwlh
inl'rcsidciilijil mortgages {including wvoiving home
equity loans) was "lairly robusL Nil the ^aluc nl"such
ImnS on hanks' books cuniiTiu;l(.*d tn (he loiirth quarter
The ivvcnjal Ilkclj slimmed from a 5tcppcit-np pace of
H'CUM i i/iii i<un of con funn ing mortgLi^cs stud n ^
of new orignvudon*! in response to the weaker
ynd ilie lighlemnti of lending siandards reponed in One
SenifH" Loan Ofliftir Opinifm Surveys covering the
MKomJ lialfof 2OEJ7. Tfie growtli of revolving lioine
equity loan>> pickthd up in 2WF. i^niculurly laic in the
year; bcciiLi^c i nk--; mi such lozin.s are generally lied to
ithttrMenm nmrkci rales, which declined over i\K si-htoud
halror20()7 1 ihn fomi ortiniincing may have bcwimir
relatively more attractive. Bank consumer Umns grew
mwo fasLor in 2007 than in 2HW\ which is w n c hl
i with StntM SuMtlruttOa of nurmnrlgajie crt-dil
lor mortgage credit. To land THE rapid cxpiinsion of
ihelr biiltiiwc >hocK coinincrciul banks nmmly LiLnud
iii a Viiricty of oianiigcd Mobilities, Inctuding large lime
dK^OShs anil advances Ir-oni f:L<d^ra3 Home Laao Bank^i.
I): jiiJi. . a,t\ti ,IJ _I'L i,•= of litivign bank-s ulsn tapped
ihcirpartnl instil un'ofis lor funds. The growth of bank
croMi slowed in January 2(KJKh «s dtdinca in iu>I(iiJighi
ofnecuriliesand rcsitk'niiiil! nn>rigajies |»yrlly affaei coninuivil L'TO^LJI in moKi other kxin categohet1;.
IlinL profltj declined Aignilkiuilly in 2W? as- faliom
frum (he stibprime mortgnye crisis and rebied finantrijil dismtptions caused tr&diny income la plunge and
\o& provisions to rnoir ihnn double from ihf previpus ye-jr, OVCT the SfiOOdd hall "of 2007, thu reliim on
$£&&& and (hi; rcliim on uquily btnlh dropped to lewis
mil se^n since lite tEirly L99Q& Weak pFoltl^ or oitlriglit
losses, along wiili significant balance iheet growth.
aha pui pre^suiv on napiiyl Mtros JI Kane O f t e largc-St
y number of bunk ing
HK^unLs OfQSW capital
in tiw Kcccind halfnf 3KT? and early 2CH1S. Loan dclinqucrtcy rates rose ooticreybly for many loan c
but especially i'nr rc^idenMul moFiga^Cji, ctin
lion ami kind devdopmcni lojuts Hn.iiteing res^k-nlinl
projects, and other constinciion ami land development
loans,
(Hher types ofnnancinl iiistitmiions nl«i fatvJ subsuiniial cliLillenjie*! in 2tX)7. As a resull Dffl&$K]$ttf£fi (6
sniibpnmt: Incins sunn.* IhriJl instiluiions liad signilk-nn<
losscb, S^venil of the maior invcstmcnl banks und their
fttiihnio booked lO88£$ on morlgage-rcFalfd products
ctnd olher exposures that weie large enough to lead
some nf them \o raise aiidiliortal equity cofjitalIn Uie thirtl quarter Fannie Mac and Freddie Mac
CoimiKTuijil burin profilabihty.
I'n; Mill
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n L'-lmner. and a^s i T-UII»I IS:1-, und SS
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fur somt slulfcs ofasMU u
31
I 1 I .
1992
-
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J i .] - I 1 It .
1WB X»t 3IM-
1
aur?
% jILJ m a.nnuul unJ tiLriiJ |JI<HU[II 'JH* ?
,Tni i fannR] iii«iiuim»^> fiaBaimNM1 Joao It, Q M M W ...M
H'.-|--ii ill i HI, I.I|M>
| Illunin' •'< '.I I I'..;
97
nT
Monetary. Policy Report to the Congress
i Kebruary 2 0
fciuiiy indexes i n MrlcfEeit wtvmicec) Gscfga cumatnilra.
M 2 grimth rale. I
IJQ
IOT i..KM gnu j w i a w :uii7
- The Jirj tK inmtnl on n fiMBih-quancr nwir fiiuni(i-i|Hrt»iL'<
n»i»i.M'tufreik'j, imvflir'tetBiK JcnmiiJtlepotia. inii*i Lfa
y 'Mi"fnjj**k'poili»( Iniiibdlni moiicit i i m M *ltfpo«ti wtv-oihilti
cnch c^ptncncL'il si/;ihki losses on iht;ir morlgagt.'
portfolios and on crcdil gicnraniitrt!*;. In responsef
Hrms raiscj .nM'inuul equity. The firms ntsn tighltnctt
Liiikk'nvriting slandards slightly anil intrciisa! flu- lets
ihitl ihty churyf to purchase som^ upui ul' UuiTii. All
nisi? eqimf. ihcse chai^iis wuukl bt1 cxptrtitd in iiKTCwe
borrower ccwtM fpr contormmg loans.
The M2 Monetary Aggregate
M2 grew ill a SUIILI ru(L\ on '*i>\\ MILL1, in 2007 and ihi.'
early part (iiL20fl&. Orowlh Wiis snpp<)rtt?<J by Ucclincsi in
[he opponiintly TOST uf holding munty rclnlivu Eo olhcr
finuEiciiil ^SSffls, The ciin«idcrabl£ growth of Hwni-y
pnarktl innlLiul IbmLs gtso buiitslcd Vf2 a^ invi-slor^
-"""tifii the rcblivi: sjslc-ty ul ihust- MijLiid ssflO amid
the volatiltiy in vtirioui linaiittal murkcls. Tlie currency
toimponciH ofM2 dcceleratid rurshtr in 2EMJ7 from lite
already ttpid p i i « in 2lMlft it dciuallv coiVtracTi;d troin
Npvenibcr Uirougli January 200M, probably btcauii of
reduceJ detnund from forcijin SQUcefc&,
H*. t i c lJuIll LKIl! M'L'L'klV. hit; lj?l lJ«-_'l%l*l,lf1H till i w h *<ni."S
slowingj irowth weighed tin investor scnlunem, mmkol volatility ruse isubsiuntiiilly1 and oil »ti mosi major
foreign stock mnrkel^ fell. Despite Ehc rocky end lo me
year, rnosi majoi' equity indexes in the advsinccd foreign
OBBttttnaeSt with the exception of Japfin, linisheti bi&hcr
on MI in lociil-cmTcney icrms coimpmred with die heginntn^ of 21KI7. However indexes ot the stock prices o f
niuMiriiil firms MI Iho^e QBBntiRM declined Hj pcrcettl
iu Mi percent1 he firi3inti;sli turbulence had less clTed
on ctjutiy prices in emerging marked, and MAST major
I:t|ii'iy ind
T^irn;- in.,irkri L
-
-
r
/
ittternaihttal Fititmvial Markets
Global i is,. HI . ;l mariicts were calm DVtJ Ihc lirsi halt
of 2007 except lor a. bnefpeuod in lute Ecbruarv when
Ci]uiE> marfceis were roik-d in p.irt by worries abpm U.S.
-subprimc mortgage lenders, After niidyt'flr, ,AS ihe gldbai
financial inrmoil began in faffiCSl nnd [he po^ibilily of
.ihi
al
a
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^
International Developnitnts
m
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^ ^ L ^. t b c liW *»h*urvdiM.it |iV GaVtl «tne> ^ l|*f
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niL
incfaicf ft if Mirtiur, IK il.inm id RAnwy -1 SHH I -i ii..- 1 .inn A
.mil .1.1. [ f\t\\f ha'*n'< iii»nip1-. i-Muli (MUHHIJ 1 mil.'* «¥iV*» i< itv muKei
| D | ii.HieLKUi Amctwiui « • tfitrilitu
L4]hLhllJjl i
B
IIJIC i>t Ilk- 1
r
iu>' APIL'< UlliJ. Urii'«l Hulk'. .
IV™ The fi npiyiiij*
.-, jre pOM, llnHa, liiLilailcMii M i l ijsfe Mds alL blv
Aaiali CL
1 » Np|
s -VIHIII K'wr-ii I'jiik* ,llt, IIKI 1 ILJIII"M(
*uj,ii Suntij t *\<\U<
'•, WK1 1- 1 .'HI A run it i•lk.1 O n £ 0 H | Amu MlD
Ini.in.iu. '. .1 ".V: ; 1 i-i.:. •- >i4 riiuiii siiMivhui i :.in,|h..il. in
.„,
98
ttuttttt ufiftmrmtrx of tin'
System
33
tl.S.diillur t&fihaage niie j ^ u
scJeocd nmjar'eurrenciaf. 2Ot
ivliti. on benchmark government bonds in iefcclrd
^ LUK-UJ l o r d tin ppmwutfws 2UD4-04}
M a
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^- ri.r mm
TiieJiil.it. ii
!i-.i.
*y
I
> II, aw,
emery ing-market stock indtprea oLirneri'omnetl ihcir
cunnlerpnrts in I M mlranecd economies. So for in
stuclt mnrkcis in both advanced and emergiitgeconomy art; flown Further us wncerns .annul glohnl
grmvlh have increased,
Lnng-lenn hirad vislds in the advanced foreign eeiinomitrs mwi ivcr Ihc firsl hall'ol'2tK)7 but Iften reversed
courst: as invesKM-s rcnctctl to signs in many countries
oFdMtrforatfOg niirxici.il condition a, e SD!woiBgoe&.
nomic outlook, and e^ffiettljoi© for a tawcr future
•••"!
•••-.- i i iv policy rates. A l l l o l d . iliu >iei changes
were tiol iHrgc; ttiu^-tcrtu rates in Canudu, the Uniied
U.S. diitlnr nuniianJ c\c1niiige rait', hroail ind^s. 2OU4-0R
ii*'rekonJiiiuJii*'
v and Jupan ended ihc year 20 to 30 basis
owcr4 wn n d . while they wore ahuil 10 basis
points litgher in the euro ares than «( ihc siari uf the
year. Yields on inflaiion-|>rolecicd long-lerm securities
followed utiinilitrpmuem; inflation compensation (he
difference beiween yk'ldi on nominal securiliei m<\
in Cannda and rosi! slightly in ih t;cum area. Since Ihc
. - j i M I L 1 or 200ST yields on nominal seL-uriliw in mosi
tconnmici hflvc declined; yields un indexed securilits
have liillcn in [he euro area but have risen in Canada.
IIIL' •mk-d Kingdom, and Japan.
The Kedcral Reserve's broadest measure ol'lht noniinal iradu-wcighted fqrcjgn tJSchange valiu: of th* dollar
has declined blbtnil 8 percent nn nei since the hei:iniiiu
oI Q f f l . Overthe same periods the major currencies
index of 'lhf dollar has moved down a bil mure than
10 percenL Tin? dollar has depreciated ahciui 9V5 percenl
against [he yen and slightly more Elian ID percent
versus (he euro. The dollar Kas depreciated roughly
33! J ptFcenl iigainsl lite C'anttJijin dollar and in Novein
her brielty Luuehed iis lowest kvel in decades against
thai currency. The dollar lias declined &A pereenl
iigainst the Chinese renminbi siii L i tiIhe hejiinnirnji pf
20f>7, and the puce tif ilepreeiiitum accelemleiJ lute lusl
year.
Ailvuittcii Foreign Evmtotnies
P T W t i n for t-mh « W O i - " ' - . • • -•• « •;• i'T lYhmiirif Ifl ihrcmuli.
•
) I t , 33GR H K M b d luik-t la ^ v,4j|u1ih.i1 W ( d ^ i<i Ik- IHIV*L>I>
< n ^ l n n) llw UJS akilbtr Ngninn Ilk1 IW7CH&I n( n b r i p jrnij)iiiJ
lunnmiaiit I t J . llsJ|i|£ |HiHn£n 1 lie tittle1* VtV.'ii{lllt\, Klimh d u i ^
K «fLL 4fltwd Run u.v f i i m ikim aid Itatn U S, j n j fore*int
Kconumic activity in Ihe inu.ior udviiiieiMJ. ffn^ign economics postoU rebnvely sirong grcvwlh &V& the firsl three
qiiajlfiK Of 2DQ7, and labor markets, tightened. However, evidence .--!'.• slo\vdo\vn has ijccumuimed since me
99
34
Mnnclary Pulicj Report to <lw CongTCff
febniary JOUft
-uinmtT ] JH.UVI.I! nurU'1 strains iippeur lu I K W^-I^IMUJ
on jmmih m ihc nuym rrnnnffiiir SurvayaaffeNhn
have revcnlcd ;i tighieninj: of credit suiniiiifds fnrhaih
households" nnd businoscv Uulh consumer jriit hiisihn&conlklcrK-c have >lrtl>inceAti£ti*l. 4ind rculirui^
from surveys ofeconomic activity have declined. Retail
vik'\ hum A n v d . and housing n wrists in a number of
ceuiirues iliui untili rtenlly had bten robust- including
IrvL-iiiiL S^iani, ;iti(J ittc L'tiiitfJ Kingdom- liavc SLOIV
cricil According lo mil in! rek'JiM'v real ClDP^rnvrlh
tor (lit fourth quarter vhwed m ;i number of counlticv
A)lh0llllll fi-irt l!i ill J.ip.m i u-l- •I.HILI*.'L1 HI UK- Untnli
f>Etii.-i^lfr tjt^cu'd 1 1 11 x ntfp in Mrl
1 1 . 1i
'
ipcnJin^ hous^Imld spending huv been rtlaiisrcly
weak, und ilie *.j<>n^imuimti nctH h;is tven dqw^scd
by Lli:siijif*. ki it^tiliinims cbjt hii^c it-'.itlk'ii in Ivitik-necks m reviewing building plans.
Ik-adlinc rak-h ul inllitioti lute c<vihnuctl lo rist in
nind LrncriiV pnecs. Hici^chv-monlh uhnn^c in ton*
•*:IIHLT ppdtt iri i^ic eun> Jifca wcttdtd 3 jvrctrm m
Jjiiiuiry up fmiri Ic^s limn ^ pcrt/cni jiisi ;i f t n niinufi-.
cjrlk'r: aorc infLilion i^ IHLII excludes ilu1 L-ltjnu^s in
'f^ ft 'L'IHTJIN <iniJ mi pn VL1 s"»otl l'(H*t1t lui4- im^cd
up J clf. CannJi;in mfl^uivn climbed ITX>FI> 1O* itian
I percent laic in 2fMX> {•> jh*>ui 2U ptTtvnt in ihe 96CumJ hultof 2IXIV: however, corv inHjiioti has rioiictl >n
rvcciU mnntlti. parily hccdiist; ofihccooiiuucJMnrnjjiih
i>l'lhe t ansidun {lipllur. Alrfiough inlijnon in Jjpjn v,a\
close lu /em fur nw&t nf^LKV?. Mn* rale picked up la
roughly >r* pt-ivi-nl =it flic i-ml^Tlnc soar, u^ain ni;nnlv A
result or the rise in cner&y prices.
Faced with aweakeroLitU-k for growth bui W J t t
. Ik" v^ll HP.XW.I nK; jr*L t
whai higher infljiMii r major lorci^n cenira.! hjnk^
either have cm adtciul policy i'atfsor have rctmnuied
on hold since f:ne ,(Wi7 a cli;iii^c ir^m tdrhcrmirkci
e\pc^tiilioiiH t^l fiirlher nmr mcreaiers. The hank olt'an,nl.i MI til (he Bank of l-.n^kwd Ifiwcjvd their lurycts lor
tlk-irfnpcchscovcmi^lit rjti-s<. I h e iiuwpcjfi C'tiilrui
Bank mid iln- Bank of Japan have kept their policy rat&
.i4 J rvrvi-iiE ^nd 0.5 pcnvni n>y*«ti^i;U (Rirtlur Ji>cosMon t>f actionii by foreign centnil banks is in the boh
vnmled '*The Ix-ilenl Rcsent*s (tcifptwisc* ii> financial
Slnnns."!
I:/ttt?ty»itif!-,\ftirlntt Ec
•
v
^bjwed m the teCQftd half of 2I.K17 but was
slronj£. In China, yoicmnicm pt^icy H-.C.IMU..bclpcd nwKknj^ the ^rovvih mic of rtal GDP m Uw second half. Todpmp loan un>\nih. the government in 2(K>7
ivpcaledly miscd the rvscrve rvqnirvment r.iiiu .unl ihc
henchnufk rale at tsliH.li bnuka can lemJ lo Ihcirtuv
[ontcrs. In iidilihoM. ihe ^Ltiemnicni iticteittl hnnks \u
iVtv/c iliL-m bevfl) of lendJng over ihc limiL twumomhd
of2IXIi7di ihc October level CIHIKM: jutiioniie* als*^
allowed I lie m i n ) n h i \ m i c of jppn.\iaiion ii> Mcp up
in Luc ^IK>". JTI(1 the People's Hjnk o f t lima lU'lcd in
i(s monvlur^ pulic) rerK>ri ui November lhal il ^tmld bv
using the emchange rate as n (00] to light infintion.
M itrtvliiTC m emer^iny AMU, gmmli ni^pcars l^havc
stepped down to R more tempered pace in -icveral COITI]ines MI the M>:OIH1 h-M of ihc yt'at. iho^i^h generally
100
UottrtS fV inventors of the tedervi ttrwrve Snta*
In nn \ c t y MThTrtfr tat f h in ihc (\r>\ half. One foclM Suppfr\<iitftji gri>ulh HI ilh-St ^ipuri 'ikpcndcni ^canomiti
.ip^nir-n fi>\H i t o i V
i: • -J" 1 m MSOl IfiUviU ..i Uk1
1
mi of HK-wiirltl.
In Moxkn r nioipni grcittih WK rruktratt in 2007
<tnd rtiMowtl mi^hly (ho binic pultem A^ in ihv t'nKeJ
Si-ii^ H k ^rrnvth^ro^onoinic JctiMlv excfAlAl
? ptirccnl diiniifj the llnrii t)iuuifr Nil ^IktHnl In } perccirt in ihc ti.>Lwi1i h|turlor In Brazil •iiMlottur l.,alin
American LT>unlri«. j i i m t h u *> m t i w i •
IptTiilM^ in the p T K « u f ffKK) JWl flKlCHfirifbLHrtl
to JI n v i n connMTkT nritc infljinw MI nwnytmergingmarket n x f l i h u n ^ F Y K V f f c J i h i c i n k ami gom* HCH.L
anil dairy pnea t w t A o i M m i c d t i LnnMiuipi^i
irf ilna*: p<IJKJUCIS in ik'i tUipifl]f LOitiuriirNiu* ^ D ^ H
rjpiillv and at Uw p t i t t of i n i n u l feed nio*tl> t j o i
tub r i v n tnfUlhvi row during Zflti1™ m huny fnk.*rK
•\*J4fl cconmnics. including Chhu, ulwnrthc hnlLili
ralo fr* Hie HACIW month* ending in Juniury R a t h d
inlXiihHi w n ihc WL'ftthtliaH ut'lhv \CM MI
luiJLCIiik. MCMCO. J*H1 VcnvzucEu- ThcnK i
m Vcnczucb i*a> compounded by Aimnlaihc
35
101
Part 3
Monetary Policy in 2007 and Early 2008
i the first half (>r2(Hj7. the available infor-
anil credit conditions hud become somewhatti
fbfiCOM htuis^holiiH ynd btaisetsu. ^inicipnnis in
rn,ii.uvi |>omiL\t U* 'A ijairriiHy favorable economic
cmtlunk dt&pnc Iht: b>nyoii^ WBPBWfan i n [ h t hoLi^n>Li
c
r O M t " niL'-cnDLL^ iHn.ird inttUlwn j n d ROSRVB Rank
market ,Indi ators o f consumer and business spend-
pivsidents) imlLiI t a. l i n - i i i k i i t s in the housing sector
h iu
ira^r v/ett -.-ii - --.^:i-:- uneven, bul iheir ^ j u i i ^ N y pusilive
hnd ihc poletiEFsit to prove deeper and more prolonged
traiFkrl-nrit?s sujyscsird ih-n ifiu MfiiiMHL1 ntartitM develop-
MniEi bad S B M d likely curlier in llie yunr. LLIILI J iVirlhei
OH S
1
ments were, as yet, having l i n k ' c f l c d (in thu h i n d e r
11?iLI_• 1 -L"11 •."-u 1 111 I L in the huu^ini; are^i reprcnvntcd ft BIJI1
1 . . 1_ "
'
ecoafiny. Net (GfpQift, spurred b) pun by u Mlhuji JDIIUT.
HI 11•-.-_iiii dnungidi: rink U> Uic economic outlook, \ I H K - -
wOnt ptiiv i(li fjjj support to uton^miL jirovviti, Outside oT
(huliss. iuctyrnin^ ilLita indicated tirM econonuc gruwih
I hc subprime mortgage i a f a r ,financial conditions In
bntl itrcniiilieneJ in EITI? .second ijuyner. its JI fUffl)(<T
^i L ntr L il WQQ ( i i r l yfeCtiUfffltiodMiVfeT h f Fc-J^rul Open
i\itt- ofbostiKSS Npcitdmjj olVsvt a JIOW^OWH in opn-
Market t p j i i n n t i t t c x p t c t f d ctirc intljition if> modfidM
RQIMr DUthyB. PUtiCipttQM t v h f w d 1 ml I In." cccnnmy
1
irorii die i p u t w b i l ctcviiiu^ hvcj i l u i Imd- prevailed A
r.Lrn.-iiikLil Likely to exnurid JII :i uunkTuU' p.t-.v in HMMJI1.-
' I . , skin -ii iii-: -,• ii. bul i i r J . nuwiCfl ulili^utik>n IILICJ
qitmicrk. suprK>rled in ptirt l>y coritnmetJ jjniuih in busi-
(he rnncnlifll io nutatti u p ^ ^ r d pnssune oi> inflation. A i
ness ntvcstntcnl and J n.iinisi gkthjl AQOWRHy, AJtlnm^h
u DCdQht during ihc H I M l u l i o l i h t ' year, (hi; CoQUfllOce
core inflation had moved lower since the siart of the
'. • 11 -1 -1 •• 1 1 - u- ••r L1.1 in its -I^I^IMLMI ihat its prtdciminunl
1
_ 11
yoflft fwriicipjtlts ^erc ^lill concerned about s o CM I
pofcy cooBcra was thai infl a tion wonkl fnH io m o d e r a
H 1 . r 1 r >—inn hiding a tonlinncil iii^h level ot'rtsiJLiT-ee
; 1 1
"
as cvpccicd. Hosvcvurh in r;i:i ewlog lo a&ctikaru
iHiMAiiiLfM
of
I tint ccuild OLi^int'nl inHalum f>rcsMirc>.
n i c r i M ^ i ^ wctiknirss in ihe liouving « c i t T . Hie Cnminii-
I l v \ I>_• 1 u• i d Muil J MKt.mui! in.'LII.MIIUH in IIMKL1
1 ..
'
t M L-iii|>liii>i/L'd in il'.- IWifinteRH issuc-d at ik-.- GPIfelo
pressures had yet to be convincingly demonstrated.
situs nfitM Mctr-ch, Mjiy r nnct Jinn: mciiHii^s lli:tl ils
A^ Li EVaiK, Hie FOMC dttided (t> lenve the k:r^fl fur
fuiurc poEicy Hctiopa uouliJ Jepcnd mi i!> • evohittQfl
I he r i • 1 ij ra I lund^ rnti? LinL'h^n^cd at S'1* percent nnd,
1
.
despile SOME W HAI greater downside risks to yrowlh.
• •j
i i . / .'I
i l l . ' I
Jtir
• . ' i l - -.1 I i . I r . . . i i j J l d
.. .."
•
growlh.
i t e r u l e d lhat the predominant policy concent
rtnuin^d the? rmlt linn mfiiition UL^i,itJ i\\.i\ io
W'liL'ii llkr (.Viflniiucc oiL'l on Ait^usl 7. hi^ncltil
niiirkus htid b f t n unusLLtlly VUIJIIIL- I b r u ii. L ^ nceks.
w i r*wv3OQ5-CW
MIL^ llnl.l i'Pi' ll.H-ll .IIILI CT^L'lul lLlP|
H^ ex peeled.
102
38
Mondury IMtky Report lo the Congress
February 20OS
lit Ihi! Jays following the August 7 FOMC meeting.
financial conditions deteriorated rapidly as market parlicipante Ivt.inK' LL^LUFIIL'J ahvul dunlerpuru credit
risk and ihcmiecc1* lo liquidity. After an FOMC conference cult on Aiky.Mii Ml to review \%<irII.JuiL-J ^it.un-.
in nioircy .nni cmbi markfis, ihc Coininhtce lssiuda
slatcmcnE inilkntlin^ lluil the I cxlerut KCSA.T\C would
pr<mdc R n V a as neves^un mnutuh open markd
opcrahons C promote trailing in the federal funds marO
ket at rates close lo tile FOMC* target rate of 5' * pertLi>i As conditions deicriomicd further, (lie Cnmnriiicc
mel ,I;_.!.II i MII \:j.-jij^i lo by conference call n> iji-.oi^Ihe potential usefulness of various policy responses.
The foltou-mp duy. ihc Z-'cikml Reserve mimikiiKcd
changes in discount w nidnH- policies to l.ialii.nc I htr
tifJcrl> funciionin^ (i| slian (enn credit irLnkci1- FurIhcrmorc, Ihc I'OMC K-IUISCIJ A ^Icmcnl nuiit.HMij:
lh«l iW Jo^nsttk i\*X\ \<> umwdi hud increased appivciuhly nihl that HiL-t'n.niniM(<.-*.- ^ . i - pn'pjrvd in ,ILI US
d 1L> r II I t I J I I I k snKcf-.\.n rll^T-h n"i ihc cc^Tinniy.
.
xrt cnutlkSl "The J'cdLtal Kt"scr\c's R«|hniM-.'i
u) I "iitaiic^i I Mtjms" |m>M tk'* jdilitioiul dcu»l nti die
milCOfnct uf ihLW LtJolirrtfTuri! tJilts untl olhci measures
taken h> ihc l-ctlcrul Hc/wrvc \o liicihljitc the imlcrty
fuhcliimiriji of financial murkclb uvcr Ihc sctvnd hjil1'i>r
ttie year, mcluillng atordinalcJ aciiom uiih "ihw otftAt the lime ofIhe September FOMC OKXHUS^
Fiiuncitil mu/k^ls rcn^iin^d •-i^mL- I kumlns in sht<rticrm LinJuiL! markets MW M|:nilkdiUl> iihpuircd jmid
fJV111nciLf^ mvcxior iinc;iMf uboui cxixv^ure^ n» n b pnriiv mtvtiptjrct jitid lo Mmchirtd credit pnHlvris more
hffjcidly, f TL'I.III .VIILT.I]!1! rcmatned ,w Jilnl^i.1 fnrnidsL
bun nesses and hmi!iehold&. bul ihc i. nmnudCh: Doled
Itul Ific MdiU-r LFWIH iMntlillun?- forulher imunOWOTi
had the potential lo restrain economic growth. INCOM" l y k-L^fiMinit diiia hciv mixed: CotOVM ^pt.LMilirig
J u* hn\-e sirei^ihefkcd Tnim iia. -;uhdkied scu^Klbu< a lunlinr nitcnMiicaiiLiii ol ihc htniMm^
ii weaker evtmtunie uiiLfdnli. Kmk'ipjnts nott'J lhai
incoming dala on core influiion continued lo iv favor*
nHc jnd ihjit (he iln^nw;irJK fcMscd rtuhumk- DUttMlt
implied ^ m e {e^M>nm^ ofprotfireson mounccv. bui
ifiey r?mai nvd t-^HHvmcd ;iboul possiMe Li|i^nl: n-.i, •,
In infkilion. To forestall some of theadverse Macro•'••Mimin:-. eJTecis Hut ini:'Ni oihcr*use an>*e From the
LiiMrtij>tiLi-n.v m luuiiei^l rivLrket> Ami to prmn[>tc intnJefule ttnuwth DWf tune, ilie Jrl>\it tinkered I he Uir^el fur
ifiL' kdunii funds rule ^> HJISIS pornls, DD4H pcrtcrH
TheCommittee also nnled that recent developments
hud n^n-.iseJ I he Miicertamtv Mirr^innJrni; TIK cv^momik:
LMiif.KhV .ind staled th,it "n u.i U IJ ;^i M ncx-ilAl ii - f
price itabiliiy and suvUHtthk cvtMU>rnic jjrro^
Al Ihe lime of Ihe October F OMC mealing, Hie dala
huliciiled Ihsil economic jen^vth liml hcon >v]n\ rn Ihc
ilwrJ quartLT. \ pieViii{t in efinsmntfr speiidint and dm*
tinued expansion of business invesunenl suggiKled Ihai
-spiilitvm frotti the turmoil m in? lumMiiji LMHI fiiM.i,-i.ii
itiarkci> hud been Mmiicd M di:ii |vunt Ahhon^li ^c-r.ini-i
iti Ii»iinijt.i1 MLi;LLLI". tidid LLJNC{I sinner hill r>n hjlaiun:r
lighter credil eiindilions WCfB LhtHi^rlrt hkel) K^slow
Ihe pace ofeconomic expansion over coming quarters.
rurthenrKiTc. Ihc dituiitum m rx->idenUul conbtruction
h:iJ ktce]tcnekl nrvd a^dilnhle nuliLjim>. p. unit'. L IO t
(urtlhr -.l.nvi 'IL:J m hoosin^ UkTtivity MI the near term.
FOMC meeting participantsnoted that readingson core
iiiH.ii inn lud tmproi cU MHIIOI lut over Kic ye;ii mid
iiiticipjiml ihiii >omc t>f Ih^ nnHkraEton likely ^i-siki be
smlanieil. Nmiclhckm, pidirtip.m^ expressed concern
abuul Ihe upside risks lo the outlook lormflj^ioni, MOnIHing in i^in from (he elTfc*> of recent increa^e> m eonmodity pricesand Ihe sijmilieani d^vline m the toreisin
exchange value ofthe dollar. Against that backdrop, the
Commitiee decided lo lower the m r ^ i for ihe federal
fumk rflte :.S it&tAx pomiH, i^4'> pervcnL Jiid judged
lh:il ificr upside iidk^ lo inllihon toii^hly h:bl:inci\l tlic
[luwnsuJc hskh togrowth.
ALSOAL the Oetohcr meeting, IheCommittee continued ilh JIM: unions nrga/Jin^ commumc^liun wiih Ihe
public. Parti CI pan ts reached a consensus nn increasing
•he lrL\|Ucoc> and c\fv;inding ihccoMtcnl of iheir peniniit (COnonia projcviiiOi*- l-nikf ihc ftsfw prnvtr*uirc.
which TAJS Luintrunced oil \itvtrrtbct 14* tiic FOMf'
iiiuipili^ ,]mj nrled^esthc prt>jcciLonsiiude hy ihe
r-^k-Mt Kcscnc Governors mid Rtwrvc Bank pr«iUems tour limes each year JE jippmviumicH' qiLrinerly
itik'niiU. ralnerihan t^viee canh \ci\r. as had been ihc
practice since 1^7**. In LiJihn(>n4 ihc projeclioii horizon hdf been c\tciidc^l from twoyc^r> to lurev yarn.
t'OMt" nwdHrts particijKiutv provide prLTjeviion* r"Of
Ittc iii\fc ( iH : in ihe pnuc intkx lor Ml<d pcr^oiul con^utiiption cxpendilom (PCEjus ivcH a* ptoictiioiii
for real UDP growIII, ihe unemploy ment rate,and core
t'O. puce mflaiion. S LIITIUI.IT ics ot'Lhe pEi>jceiioim4ind
an accompanying narrative arc published along with
ihe nimnlcj of ihc I-ONU" meclmu a\ ulilch ihcy ivere
Jistiti*ed. rle^inmn^ w+lti the prvsenl rvporl+ Ihe pmjectifri-t made in Jiu>uan' are utrlwk'd JII ihe f^brujiry
\tf»wlan P**lUv finfHtrt httftf (iHigvca*, Jnd ihe pn>jcciiofis iTiatJc in Juiicdiv intluikd m Die July rupon
In a uonlfrtiHjc tL:ill on Dccenibcr <T, E^Mtrd menitters
,\nt\ He.terve Dunk ^re^idents re^ieu-L\l eondihous in
domestic and foreign linancial markets anddiscussed
Iwo proposals a nticd a I inlpmvin|: ni:irkcl liincE;onin]:.
The HI ••i prop^tfHil Htf J"i ihc e^.tbli^hiiieiii of a temix^
rary Term Auction Facility (TAF ), which w u poi
od r v
l
y Ihrougll an auction mechanismto
103
t tif (jnrt'fmwx ttffhtt Fintt'tat fir-xet-vc Synierti
iinn, iiisMULtnns-, n^mist \t hnudiT rait^e ufctdd lhan lhai us^d for open rnurkci t'jn.-r.il i mi1*. I hc
propi»ftl u^fr fo sel up u foreign c:<ich:in£ir swap
.in iiiLVink-nr iviMl Hu: HHA<|HHUP Qffltf] KmV lO:uldn:&>
elevated prc-isturcs • #• short-lenn dollnr funding n>urkoi>.
\ i the CI>IK'TUAI«I> *.**•'the Ji>cu^smn. the ("ommiuee
Voted SO ftrtd i Uic (\\Ural Reserve Hank oFNew York
roosluhlisli HITUI mmniain A reciprocal currency i>vsHp>
im^ngvmeni r'm the SjMem Open M;irVcl Account
with I he |:iirop<Mn t emr-jJ llanV ' : The flftaM ui Gnventars ;ipproicd ike TAT viu IH>MI i. .n V b on fAccemOE
ber 10,
AI the Cwmmlkt'^ meeting CM; [X'CLinlvr 11. pariit:ipj{iis noted ihdit tuctfininj! uiloni>:Hn>iT sug^mctl
L'LtHih>nHLL LLciiviiy huil deceit™i^J ^i^nilicnnih 1 in ilic
ti.njHh LjLLiner The housing cnninictiwi hntl sleupeiLLrd
ludlurr and pjiriieip^iiLi agreed ihiii ihc -wttor * n
ttcukcT lit;in luitl htvii i:\pcuiciJ HI \hc in-hi-L- ofifieCDQVinnltv'> prviiOihrnK.-clm£. M U H ' I ^ ^ I spilluwri frnlli
Jimt-inu to oiherprniborilifirLiirKmiy Itid K'i'mi IO
emerge: C 'omumplinn spending apjwnrcd w he soJten*
in^nuvc lhan lud bcfir arutipalcd. ttnd cmp^ciymcul
gamx :ip|>c;ircil m he ^k>^Lii^ Piiniuipimis nuicJ lhni
evidence olhirtlwr dcit:m>r<m<w m diccredn giulu^
4>fnion^ii2!Ch and oilier Joims (o hoiiselx^lds appenrcd
lo l v ••purnrii; Itrndcrs lu InrlEkT lighten iht: lL'rm> un
FH:^ i:xicii>ioi]i> ol crvdi I for J wiiktitiiL: Taii^e oftivtiii
ptfhlticls. lirtJiKul market t:ondilioii^> had uiifeened
vT^iiilicuHlv, Tht litiHiocint ^truin^ ucrc cx^ccrKilcit h>
c(>ni:cnis rcl jLtrtl \w ytvir'triJ pren>iircs in ih(*n-kTtn
lunding riKirkcr;.. uhd similar Hlrtsbt-ii-wtrc L-vuk-nt
in ihi" linnnciHi nidfktts^rrn;ifi>r lurci^u cvonoinio.
Allhougli M surge in energy prices pushed up headline
cx^nMimer price inflaTj^n during £qpicmher<ind Ottob*.T,
i'mmiuIttif mtrmlvrs j^rwO ihnl tho inflmion situiatjon
had changed I idle fn^m IJIL" time of the previous mtuting, loihcs^tiroimMiinccs. theTOMC ImicmJihc
liif^-i for iho fcit«a| fund» rau* o iiinher ?5 hs^i-s rwhitK
ht J'.x pcrccni. iind, ^I\L'II I lit? ticighicm'd unctfimnity.
ihc (\uti]nitlA.L decided To re Trim from pto\' tiling dn
•J-'-PIKII ;L^vcs%mcnt ofltie IMIHIWV ufrtiks. The Cnmmulec JIMJ mdi^K-d ihjt H u<>uld «miniiic io dVHtsu
Hie irlKiv^ of |iii;inci^il jn^^hcrde^i;lopineiiisoii MOnomic pro«ptxis mul iiti »s net'oVfl Ui fiwtei price sm
hihiy .in. I -.ii-i.iiii,ihk- BC^Htntlc gnnrfh. In uddinon io
limt policy move. Ihe Federal Rfst'nc and several oiStrr
central Kuil.'. .iniu-m:i-i-iJ on Dccc^nhef f ? ihe nitMSiires
lhtf% were inking n> address ulcvjik'tl pICSUiS ui sliortleim funding nuifittis. The 1'^tcnl fctneiTfMPUBCal
lh< crcaiiiin nrihs TAl iutd Ihc cslahlishmefii ofR>rci»n
c\charij:e S*JJJ lines wilh 1\K KmopujTi Cnei;lrul Hank
and the Swpi Hriiaoftl Bank.
Jn ii a}riftfai£t call ir>n Janiuir> ^. the CbnatdUcG
(^viewed asmni fiOteontk Jaiy j f i d finuncLBl myrkt'l Ji'vcKjpmL'nis. The information, which included
WflAflHftilUllpMtBd daHii Dti home %jlcs and employmcnl for L^eceinber, AS well as a sharp decline in equity
prices sinn: llie hL'^inuiny al'llie ycjr,fitggSStedlhal
ihc duwnside riiks ti> growth had increased siynijicanEly since Ihc lime of five tXxeinber FOMC meeting.
Moreover. |-«_
:•.-.•.• - cited concerns "l-.ii ihe slowing
of economic ^rnuilt coul<i k'tnJ to =i junher u^hccDiiifr
j f linunciiil LitmJiuoiu, winch m itim coyld rvmlorev
the ifcojiuniic slowdown. Howu^'er, pitHLCip:mL>i noltd
ihtit con? mt^itjoi) IKIJ ed^cd up in recciM pnonih^ .tm\
'• • '••• • • 'i thai oomidsodAs imcenatnty summndoti Jhe
i n J1. 1 ion am iontk.. i'n n ic ipu nis wert ^senerjl |y of the
1
ViCW Ml. 1 -'lihiKllill.il .Uklitiitn.il ]iillL'\ ^^lILt IHIJIJI
1
LVLII be nei^essiLry ta snppt>Fi eeunomit: LinEivity .m..i
i"..,ii:i":.- Ihe downside riiilu io yrtf^lh. [»mj they discussed
the possible liming oTsTich W3tem
On imiuury ZL ihc Loinmiitec \\c\i\ uJiutliLT eaoftrR K C . •'
—• •• i . i -
;
I"- -••-_ i--» «•- i n : : i • c u l l 1 1 ! .•.. i : • = • • n t r u u ^ s m
!:;i.,l-
i:i. \ . \ . \ A
. L-
'i.i.l
:iiL.-|.'ll..-\!
. H i , I l l . ;
1
l| ( • l i
ii- evtdonee luid rcinlbitcd Mtt view i:i n m.1 • 111!• •-•••-.
for economic :teiivjty wus ^v^jik. l^prticipsnt*) t>b*iyi"ved
ihiii uivt'itiK.'i uppLipemK WCK heeonim^ incrcasiii^Ly
concerned abnul ihc economic ouEloak and Ihot ihesc
• '•. • : '| i iriuiii> could lend to ait e\ccvsi\e pulLbjck in
•jfL'iin jv.iiliilnltiy \L',LIH^I I1UI1 Iwctground. tneiTibei?i
liklued IJIHI iL SLihslunlEjl e^isin^ in poliey wqn nppropnnte to tbslcr mixlerale ccunornk ^row 1h nntl rethicc I he
downside risks in economic uctivily. The C\]mrnitlee
dceided to lower the ui^el for the federal lunds RUC
75 hois p^nnts. lo V'i percern, ;nnl slaled Ihhit wppn.1dable downside fisk» io yrowih rviiiitincd- s iii •. --I:-Iinfialion was expected to edge tower over the course of
'illl^. 11:n 1 u-• p:1111-• uii'lLT-.v-i'-u'.l lli.d I?i: — HVM."\MT1I;II1 V. ii
condiiioncd irpmi inftLiiioM expecurJoos reniftining well
anchored and sikesscd that the inflation siiuatlon should
continue to Kr nmnilf>rud cjiiviully.
The JjiM rtviL'Ued yi the rcyuhrly .scheduled F O M f
meeting m Jiinuarj121* .ind 3d DuUtanad J *lidJ"r d^Ljeltuition in etoitomie growth during itic fourth (|uunvr oi
2f>H7 and omimufd u^hienm^ 0fftn>QWl cotiditinns.
Wuli [|>e eonimciinn in ihc hou&ing s^cior inien^ilyink;
.••ml ii range Q f j m x b d 'ii.nk-.-K rciniiinin^ inukT pressnreh pMrntipiini^ LLeiiei;ill\ expected economic ^ruuih
It) rcinjitji mgfe ii> the (u-i h.-M nr .^uO"-< ii.-Unv picking
up sirenyth in the second half. However, the continulii^ HtuftpTUff in home sales :ind hoose priflBB, Hi well
its die ii^hieni»^ oTurcdil condiiions for ImuKtholds
;md businesses, were seen AS pttfing downside risks to
IhettOMenaouUoBli for teoiMtaic growth, Moreover
104
4Q
Monetary Policy Report lo the Congress • Februpry 2 ( J
many purticiputits cited n-V.^ regarding iiu- |wicmiyl
Rir wivejit Feedback (xrtween ihc Fin;mdnl niiirk^-t^
and ihc eoojiomy l^mcipEinis uyprt-SM^J •.ITK- UUICLTTI
Lihoin The disypfwirninp. inMaiiim iLmt ri.i:t'ivc(J owff
•in- tastb pun MT2007. Although ninns cnp<?cicU ihut u
Icvt'linv (Hfl bfpritol Tor LTicnjiV and oilier ONitnujJilien, mich as ihnl cmhvtkicd in luluftrs nuikel*. uiid a
pt-noiJ pfhclow^4fCllJ jjioivih would cotiti ibulc tD some
miHlcratioii in itirluiioii pressure «vcr limch Ihi: torn-
injtunc believed IMJL LI Knunind Kccsssry in numiLur
jtidtiiioii devdopntatti esnftilfy Aydnsl IJUL hut^Jriip,
lia I-OMC Jecitk^l to Iowa the target Bar the Ebdenll
fund^ rutc ^11 Ni-MS rH>ii)U, to ^ percent. The Com mi (toe
h e l p e d ihut [he puiii-y ootton. couibiwl uuli iln»w
lykcn L-urlitr. UnuM liclp pn.»nio(c moderate jfr^vch
SVCf imit nnd nin^j.Lk- ihf risili^ lo OJAKMDk SCtiVitj. UoWeVttC rn^:rilhvr^ indeed lEiaL du^n^idc risks lu
»in\vf!i rem^ineii
105
Part 4
Summary of Economic Projections
fin- fatknvftig material Hpjratrvtt ai un ttthkmium stt
fill tmiuth* tff tht January 2V M 2008, mvtma tif
the tidertit O/H'ti X-fwkt'f Committee.
In conjunction wiili lhe January 200N FOMt mi.vlint:. Ibf imembers of ihu Board «f tjmemors and Iliu
pmsKtoQK of ihe Fedtsral Reserve Banks* alt or whom
participate tn ihe deliberations of nV F OMC. provided
pn ijcciions- Ibr economic growth, unemployment, and
influtian in 200K. 20(>9, and 2010. Projections tare.
\r,i:>.\l on inlVnTn,i1inn nvnileihk- IhrnujLh [he uondusion
i^l'the J,i?iu.ii\ meeting, on eaeh participanrs assumplions regarding Jrangeo f factor* likely in a fact economic outcomes, und on his or her assessment ul Appropriate monetary policy, "Appropriate monetary policy"
is ikliiK-i.) as lhc IVilure poHc> that, based un current
infoftnaiion. tfi dfrcmed must llkcl> to foster owoimcs
for economic at-tiviij und inflmum Mint ht^I MJtcsly thu
participjnl'i ink'rprctalion ui"thf ftdcraf Reserve's dual
objective!* ol'maximunn einpkn mem tifid price sEabilily.
Ihe pppfettioos, which art summarized in table i
and chart 1. suggest lhai FOMC p*rticfpams expected
Ihm ouipui would grow «l a pace appreciably below Us
trend cote m 2MS.OWing primarily to a dL*cpcning of
Lie housing contraction an4 a lightening in Iheavailability u f hou&rhuld itnd busmen credit, and lhat lite
unenipioyrnenl rate wuuU inncjise siomew ha< Given
Ihc substantial reductions in the lurgct Icdeml funds
rale through Ihe Jatntary FOMC mecUn^ as wdf as ilit
a>siLmptfupi i f approprmle policy going forward, output
%
growih lurthet ulteod wa* projected lo pick up u- i i pinr
around w a bil above its long-run trend by 2010. \nftaliun w;ii SJtpwtaJ 10 decline in 200M and 2<X1^ from
its tetent cleaned levels as ei>crgy prices leveled oul
and cconomio slack contained cosl and price incrctiev
Mo& participants judged Unit constdcniblc uncertainly
surrounded their projections Ibr output growth and
viewed the risks (o tlieir forecasts as weighted to the
dnvH,n>itle ^ majority of panicipiims viewed ihe risks to
(he Hi 1 , 1 IOO outlook us hroadly Halancetl. hul n nur^hcr
11
of participants saw the risks to inflaiion at skewed
Tlw central tendency nfparticipaiiEs' projectLt>ns for r
i D i > growth in 2NIK at 1.3 to 2.0 percent, was ccmsii
I. Economic proji;etitnns
n
i I a •••
? l u l T rf iijn
;.stii7ff
21 (0 :.j
I Km.1 i
n»!»
• i
I.
1 >ni»il|ihi)-nit-iu rtiLo
l,fuO
.iMhiiuHimlom'
i n i
Octal* <t iHittceliuih
II
1.6 M I •
Mum 1 l >
J 1
UltU
'
i
UN.:
•
•
•
. . .
M
i -i..
41. h." II
:M
4> m • I I
l\I- intttiim
l IHCII 1 IHtblltM
l i t - mflMNfun paaeM i i R U M (hwi I'K Hwflb^pMiiisi BfiSi i - . •• • M T W
•<
I»-J rn..nli riLMn^r ni .il* -...-Ht UHlltnUb! (SI; mJUm-i .mil B H K 1 iF&tfan M l
the pBTfffimni me* nf f IPKIIJJ? in, n!i[xV»H-U, Hie prwd IIKJCI r,ir |«fWMul
*.ontnui)Hn;i«i ^HKWllAKM .nnl 1tlr pnu- IIHJDH f>ir ( M I I H l l C W
O
I'll-"
nrenilinnf- -rt^liiJir^ r«iU .mil cnri*j. f n j n k ^ Lur Hw uFWifiplnyinum rn«
fie « U H r w j t e * i * i t m uBafiphmnwn w e • n • (M Rsotfi IIUM^U nr i v » >
m
ndlfflwl i ffti firi«m.ip«i,i'. pnfMMni m b m d o n iii< w ixn •
ftfifupriiikL- n«tKtir> ptrflcy
I. n w ceiilral fcmkiKV e w l u d m ifcpUffW higlw*i *
K gMtl l « i « M c Id M Ii pMC
M
7 r*ip ciRut I'flr n vunutik m it utven \SM in- luifcr M
lr.«n fora* m tn-ishcM. I I H i1ui vanable ITI il-nl year.
crjibty lower than (tic ttntrnl lefndBEtcy of the pK$BStiuna provided in, coiijunction with t l t erki tobtr FOMC
meiTEimsi, which was LBlii2.5 pertrcnl. The?icdowM'
ward rcvtstotii 10 \\i-.: lliOV outlutik -,••• ..\ •..•: from u
uuMibctdf factors, including a run her inlcnsifkalion oi
tht huuEhing fnarkei t'orrcciiyn. tighter credit condiiioiiN
jinnJ IIII.IV.I---AI BomaHRBS^oy] credit i|imhiy ^md ongoing liinnoiE tn finanirial nuifkces,, ami higher oil prices.
However. &Mm-parndputfis noicd that a h.^-.ti stunuIns gwkagc would likely prnvide-^i Uaspoaty hooM
to dfiQKtijc demand in ihe Kcend half t>f tins yciir.
Beyond 2EHJK, a nuiflher tiffuctdrswere projected lt>
buoy eetimmiic gruwih, mcludinga gntduHl uiriinrinuitl
in housing nmtlk'v^ lower incerest t . i w - assocuited with
the sub>tanliut easing of monetary policy to &AK and
appropriate adjuslnit:nis to policy guing forward, and an
anlietputed roducnon in ftiuuiciLiI markcl stnunK- Real
GDP was t'speded 10 aeceJtuslc somcwhai in 201)9 and
106
42
Monetary IVlk r > K^p<*t ki flic ITijni^ri^ss . Fcbruury 21IOS
Chart I: Central tendencies and ranges of economic projections
Ki.il <
—
—
—
—
I
^ B Caitnl mhlatcr
znu
I ''.;*]' -ii • -- :M-. :n
_-i H I -.
s
5
J
3
2
1
: > *
rare
- t
-
:IHT
:
»
w
n
un
6
aim
P( t in Hal M
anw
2007
MBS
aw
Core PCE inflation
— 2
— I
:om
.IRK.
apt
JWM
107
l >>! Oo
by 201 C lo expand al i>r a ti3ik above participants' cslit
mates of tin taic a l trend growth.
WiUi ouipui growth running below trend avm th»
nest year or M, most participants expected that the
unemployment rate would edge higher. Tin;e ciiiml Ictideney of partici pants' projections for me average r.ue
of unnnpioymtlS in the fourth quarter ofMOS was 5.2
to 5,3 pweeat. above the 4.8 lo4*J pcrtcnl unemployment rate forecasted in October and broadly suggestive
oC some stack in labtir markets, 1 he unemployment
rale was generally especial in change relalivcby link' in
ZW) and ilien w edge tower in 2QI0 as wapiti growth
pieks up, iitlhouuh in bolli years the tincrnpluymenl rale
was projected lo be a link1 higher than liad been anticipated in October.
The lugheMhfln-expeeted nltes- ofovendl and core
iullalii.n since October, which we r e driven in pan
by liie steep run-up in uil price?, had caused partieipants lo revise up somewhat I heir ptejootfOBJ tor inflatioii In Ihc near term. The central lemlency of participants' projccticflis for core PCE InflaliDH in 2(XW was
2.tl to 2,2 percent, up from the 1 1 IP 1 .9 pereenl central tendency in Ociober, However, coreinflaiinn was
expected la miHlerate nver uV neti iwo years, reflecting
Diuied pressures on resources and lairly vvell-aiK-hnred
[iillati.jii expeL-latlon-l. Overall PCE iilllailoll was projiicled to decline from Its turrenc elevated raLt ovef
tin ?cuming year, largely reflecting the aBNUinpiion ihul
energy and Ihod prices wtuild flatten mil. Ttiercalkt,
iivctall PCE inflariori was projeck'd to move largely in
slup with con; PCt" inHiHimi.
Parlicipanls'priijefiuins Tor 201(1 were iuiptinnnlly
inHucii«.-il by ilieir jiulginenn abiiiil Ibe measureil rales
of inflation coi!*iwnl wilh Ihe l-eilei;il Rcservt's dnal
tnatntale lei promote mammiim employment and price
stability and about Ihe t i n i fI'ranie over which policy
should ami Brands those rates given current economic
condiiions- Many panicipanlsjudged thm, giscn tdc
ivccnl i&nssa shocks to hath aggregate demand and
inflation, poliey would he able to loster ynly a gradual
r c tun ol key miscroceonfjmic \arinble^ lo their longerrun suslaimibk or uplifna! levels, Consequently, ihe
m[e or unemploymenl wiis prLijected by Mime participants lo remain slighTly iibme JH loneer-rtm susiatnable
tevel even in 21)1(1. und mllalion was juiiged likely Mil
to be a bit abuve levels llial some participants judged
would be consisletil with Ihe Fedml Reserve's dunl
inundate.
Risks to the Outlook
MDBI participanls viewed Ihc risks lo their GDP projections as weighted lo the downside and ihe associaied
fS ttfllte Fcdenil Re.it'n'i' SyMcin
41
risks it} their projiKliuiw o r uiicmploymcnl as tilled
to the upside. Tlie possibility thai Imuse prices could
deeline more slcep ly than anI id paled, further minting
hoiiKcliiiliis' wfiilih and access lo credit, was perceived
us a lignilicnni risk lo Ihc central millook for economic
growih and craployincnl. In addilion. despite some
recovery in money markets otter the mm of the year.
financial market conditions continued In be strained
slock prices hud declined sharply since Ihe December
matting, concerns nlioui further potcntinl losses si
ninjor finnncinl lmililuliuiu liad mounted amid mimes
ahom Ihe condition of financial jjuntanlprs, and credit
c o nditions had lightened in general Ibr bolh houschoMs
and firm*. The pntenlia] for adverse iuLcniL-lions, in
which weaker economic activity coulil lead In a »UBcntng of linancial conditions and a reduced availability
of credit, which in turn eon ld further damp economic
iirnwil i, was viewej as an especially worrisome posMhllny.
Regarding risks lo the itiflatinn outlook, several
participant* pointedl o ihe possibility that real activiiy
eould rebound lest vigorously lhau projucled. leading to
more downward pressure on costs and pnees tliari aalieipalcd. HL>wevcr. parlicipanls also saw a numher of
upside risks lo inflation. In particular, the pass-through
of recent increases in energy and commodity pri ces L S .
L
well AT, of past dollai depreciation to consume* price s
could be greater ilian espccied. In addition, participants recognized ! risk that inflaiiini espeelalums could
become less firmly anchored ifihe currcnl elevated
rales ofinflation persisted for longer than anticipated
or if the recent sutoianlial casing in monetary policy
was misinterpretedB E. rcReciing less resolve among
L orainirtee members lo maimoiti low and stable inflation. On Iwlanec. a larger nunibcr ol' partieipanls than
in Ociober viewed the risks lo Ihcii inflation forecasts
ns hmaUly balanced, although several participants continui'd lo indieulc ihal their inflalion project ions uc rv
skewed 10 the upside.
The onyoing linJincial market turbulence ,ind ticlil,
ening of ervdit conditions had incrvnsed participants'
uncertainly about the outlook for economic activity.
Most participants judged Ihat the uncertainty al tending
Ilieir Janunry projections for mil GDI' growih and for
Ilie unemployinenl rale was above typical levels seen
in the pit-it, (Tnblc 2 nrn\ ides .in estimate ofaverage
ranges of forecast uncertainly for OOP growth, unemployment, and inflation over the pail evenly yeais.")
in contrast, ihe uncertainly atmched lo participants'
rii-'ht]^ "I niLLjhf ljut>.ftinn[y~ at Hit; end ol 1 us luramni)
1
^ UIL- WUJLI 1 , unit Ual^rttallPD LJ uncenutot> in tcttnumic
r'
a anit L-vplaitt- Hit1 iippmiwih UMSJ In a s s e « Ihe uncertainly anil
108
44
Monetary ESdicy Rt-pun ru I he Congress
Ithrunrv 2(Kl8
e 2. Aicragc hMonca]
41-0
tfla
I:r*i4 l u f f * JP#»II J K ivjiuffll *•• plu* «f ininu i k
rfwrfpmic*t«K i b l w m ftln*hl M I he wmtf torn l
thaw in Ihe forccuisls submiUcd in October, ^hich m tunl
wen ciMisidcnihty more diverse ih;m those >ubniilted iti
.•i'iiiiLMiLi^:i v. u|i llit June rOMC mcelin^ ,n:ii dk-ltulal
in An: Ui*ani\ Ata/u'lury Pttticv Report tit thv t'cinjijit'jfv
• it July. Mirrormjj! (he tncrLJsc w\ divcrsiiy of views
On real GOPgrowlh, the d>>per&ion ofpurtieipaiRs"
pfujeeUoi^ for Ihe ffiie of Lneinploynitiit ,ii -.. • v. idencd
nt^hly. ppinkuinrly Ibr2009od 20in. Uisdfapa^
i, <> H t f i f •**• t trtr»<f"f o< the
« ip*Jmiat
l} I-*H1 in p»fnviLT| f
the ^whS i]nartb> irf H
nlUtkrvi it ihv Mhit ynH k\MH|tiriJ *rih h w 1hT E
> i V H M N ikf uptnf i |pftiri\*d Mnyk ix n<H Mr O
I •( itnv -M
inpialiun pfo^txlUins was gcncml^y vimvcd a* being
bnurfly in line wilh pjsl experience, atlhoiig.li se>entl
p.irlicipjnis )ud^cil th;il ihf dfgrcc ol'uiiLi:n;iihly atxpui
inJI^iion s higher lhan notrnul.
Diversity or Participants'' Views
Chart* 2<p>and 2£h> provide mrirc dmt e i
cod
ll
ii
h
i[>Hinu" ^K'US. The diip*rr>ioiu
awn ofpmiet:uoTi> for oulptii ;mJ emplovmenl sccmi'd
largely En reflect UikTcrin^ a&ses*menl& nf ihc cfTecl \*\
rirhincrial mnrkcl cond>lionti on TCA) activity, ihcspL-cd
wilh uhich trrcdil t'oiidilinnb iniulit inipn^c, Jtiil ihr
ilcfUh iiniJ JuniUoji nf t!>LL htmsiiikr market uoninictiui).
Tlw dispcriion ofpurticij*jn(s' li>nLtLT-lem> pivjecuons
WHA n\io directed to some degree by differences in their
|ndi;moii^ jhtmii Mix ccuntHny'^ ire ml t;rwfh rj[f aeut
ihe nnt.in>ploymciii rale Ihn would I v c»n%isuinl over
time with maximum employment. Views also differed
jiboul Ihc puce at whfch milpul and employmenl wtmld
nBBPWT lounrd iJiusc Icvtkovtr IKL' fovtwL^i horttmi
mid I w o n d , LJIVCII ^pprHpfiiilr mont'tary ptility. Tht"
ttispcfswn of ihc projections f«T l*f'(: mtlai IOI> in il<c
near lemn partly reflected different view* on the extern
N- w>in:h netvni irtcre^rfi in <Mictj;> 4ind oihtT ^omnuiJii\ pnee* urpidd p.iis ilirmi^h mio hiyher L'oiiMLiiier
prices und on the indiicntv thjl inllalion e^peclalions
would exert on infbiion over Ihe short AND medium run
i'jnicipiinis 1 mlliiiuu pmjL'dKms JurthfT nut wurr miTuenctrd hy ihctr views nflhi: rale oJ inft^Mtm ctmsiftL'iiL
with the Foiicra! Rcsjr\L"\ dual i>hjccti\c^ nnd tht.L unit;
it K'oulJ take lo achieve these i^oid> MMU eurrenl BPOnomic conditions and appropriate policy.
109
ots ofthe feikrut
Rwcrve Sys 45
Chart 2(a): Distribution af participants' projections (percent)
Unemployment rule
-
Jinunry prejftijuru
1*
II,,*
- M
- 12
- 10
- •
- M- 22- 11V U '-'
-0JJ
1.7
2KB
I
1
J.B-
u
•'I—
_ 201O
'-
•>• iM- la-
12-
j *
4.A -
4.H -
5D5.1
110
<ffi
Mum-un Policy H..-J«III IU (lie t'ongrea
Chun 2(b): Disiribtuion o f partic i pan ts' projections (percenl)
PCE infliltinn
_
2009
Core K B indBlion
y
-
16
— — • October
-
••HIX
H
••
-
l^.
1.7-
Lt
l.«
if.
is-
I!
-
Jiniurr prorcciiixLi
W
if.
JJJ
MOT
2IHW
,
1
1 !
1
1
11I.N
1.V2tt
1
M
22
1
3.32.ft
IJ-l.
I—n
•
1
It
- n
-
!1
1.9-
2A
11-
IJ-
U
-
1.7.
1 >
!
•
•
Ml
;'
\&
,1
i r>l r.n^ifxak
.
-
1.7.
:
:
1 J.
1 t\
2UIU
IJ'<.
1
IU
Ill
a! itf tin.* /-Wfrtr/ flwrnr System
Forecast Uncertainly
Ttiu Qconomf fTcjprriKins pf<:*V«MI by iPn*m»rfnben of the Baud oP GovaiHH^ JHKS itw prmi'
ik^bt^ uf f l u Fedorji tji.'icjve Boi'iVi huip .ttidpo
monetary policy and cannici public undeislunding of the b#m for polity actions Com'CK.vabte
tKKCr(nin1y iillcnth M w p'njcctiri'nf. Px*wcvcr
the fKOiwinLc A*Mi 441 FUiui fnocldh j m i tkaIIOrrtl>tfr> iJV-^l 10 'KJlp iNOOuct* tftQflOmc hJrCttiiui jre rMKP^dr^Ey iinperfiKHdAcrl^JUDnqof
Iho r n i l wmId. And tno fuluro j>olb of tnc L*xmo>
my can bo uffmitod by ntyriad nnforopen iHrveh
opiittvitb \yit$ flvenii Titi*s in -joiiing ihrj startc-e
oTroonciafy padcy, [Kiaicipmtts ron^nclw not
only whsl apptii'^ to On Ihp nvxn lihdy ccDnoniic oiHoome a^ omnodtcd in iheii prnjeclioos,
bitt fliv> ihn iai>q*" o nliinniiiL^^ puvuinUHP*. ihe
V
m OLtufikHi gp>d iho potvtHtAk
o ihfl (Ki-f^KXity should iPwy occur
ilo ? Miinmiv^TfK dw nwroqc hiyorical
c y of a range of Forecast*. incluOin/) uvsc
Hi in pastMundaiy Poury RcftoiU j n d
ptoi and m a n
broadly luilaoccd. mn number* reported +ri lobls
2 mini it JrnpLy a [jfoti^l^J hty of 4boul 70 i)fct*nt
ihnt actual GDP would p * p * i d brtvr'1
ceni \f?4 Z {Wcem in iin; civrgni yvat dnd
1 rj ntwrijfil In 4 4 pyfC'^nl m Ihc >0<t>nr} HIVJ
mwd yttir^ TtH> totn^porwtirrtj 70 pcri:«ni ccnifk'
(JW*Cth I'UCfVJts for uuuMH iriJla1io>i would bt
I percent lu i p w c c o l inilvciprrant a i d second
yoiK^r and 1-1 pon:cfH(D 2 9 percwn m ihc Hind
ymr
B^CituW ci>rt4KH cotKliEiAr^ iTif^y differ ftntn
HmelTml pf*^airivj on H i v n ^ 1 0*"* hisli.vy.
iNirlic^Ktnh ivnvpctajucJgniarii^ AA to whether ttte
»jncerMuiiy ^il^ched |D ilie^r fnojetiiinVb o* isttn
vHnaWfl < i)f«rftiof tfifln. u m H d lhan or tiruwJiy
s
urinfor loiypicni levels u4 focxnu uncenainty
In l i t pitsi * i shown In idbic. ^ PrtFiicip»in|s
nlw ivovxtn ii«JgiT¥>nis nsfo wtwrhcr Ihe ri4kv
lo Ibrar projedions are wepqiilen lo fne up4iQ>>.
fluwmlde. fir an; tvKHlly UnnVK^d. 1\na h, [av-
n pf ITHN<Iirigs til ifw fimlm.n Qcxn Mnckei
projWlion effof ranges ^hown
in ihoraliio ^Pluurotc Ihc coniovawc vncur
Idinty a^ncidied wtih cfonoinlc torecjdis For
(?armipic. fupptrtcd paFiicipinl projotis Ibal rocir
COP iimi toial conujnm prices will rise stearliiy
11 iinnuol falcs of iCSpedrvety. ^pcrccni tpnf|
?pcfG£nt. If Ihe uncwiamty otlRmliiij itwse pmjGdinrts is^kmiHj taUui cxperiencArj i n m t
likely 10 ix? nihovis or twiowtiwir p<oj«:|ion& of
ihu mosl KKcly outcome. Thtse }udnmenl& abotJi
ihp unctd-iinty ;ind thp risks attendUM} ooctt
pudjcipunrs projecbons aro rimfncl from the
dwcrsfly ot pnpuciponis VJOV^ itboul I in? mosl
Uknly oulcornc* FOTRUK( uncnrtnlnty w enn^
i;t*n«| |MV I V ^isttv dv»OCijlie<l wilh D |Vu|k:ulAi
projeciKXi. •••Ehf.i rPiinn
number of d^ffuvnt pro
47
@FedFRASER