Full text of Monetary Policy Oversight : Senate Hearings : Federal Reserve's First Monetary Policy Report for 2011 : Hearing Before the Committee on Banking, Housing, and Urban Affairs, United States Senate, One Hundred Twelfth Congress, Second Session

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S. HRG. 112–8

FEDERAL RESERVE’S FIRST MONETARY POLICY
REPORT FOR 2011

HEARING
BEFORE THE

COMMITTEE ON
BANKING, HOUSING, AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED TWELFTH CONGRESS
FIRST SESSION
ON
OVERSIGHT ON THE MONETARY POLICY REPORT TO CONGRESS PURSUANT TO THE FULL EMPLOYMENT AND BALANCED GROWTH ACT OF 1978

MARCH 1, 2011

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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
TIM JOHNSON, South Dakota, Chairman
JACK REED, Rhode Island
RICHARD C. SHELBY, Alabama
CHARLES E. SCHUMER, New York
MIKE CRAPO, Idaho
ROBERT MENENDEZ, New Jersey
BOB CORKER, Tennessee
DANIEL K. AKAKA, Hawaii
JIM DEMINT, South Carolina
DAVID VITTER, Louisiana
SHERROD BROWN, Ohio
MIKE JOHANNS, Nebraska
JON TESTER, Montana
PATRICK J. TOOMEY, Pennsylvania
HERB KOHL, Wisconsin
MARK KIRK, Illinois
MARK R. WARNER, Virginia
JERRY MORAN, Kansas
JEFF MERKLEY, Oregon
ROGER F. WICKER, Mississippi
MICHAEL F. BENNET, Colorado
KAY HAGAN, North Carolina
DWIGHT FETTIG, Staff Director
WILLIAM D. DUHNKE, Republican Staff Director
LYNSEY GRAHAM REA, Chief Counsel
LAURA SWANSON, Professional Staff Member
ANDREW J. OLMEM, JR., Republican Senior Counsel
MICHAEL PIWOWAR, Republican Senior Economist
DAWN RATLIFF, Chief Clerk
WILLIAM FIELDS, Hearing Clerk
SHELVIN SIMMONS, IT Director
JIM CROWELL, Editor
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C O N T E N T S
TUESDAY, MARCH 1, 2011
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Opening statement of Chairman Johnson .............................................................
Opening statements, comments, or prepared statements of:
Senator Shelby ..................................................................................................

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WITNESS
Ben S. Bernanke, Chairman, Board of Governors of the Federal Reserve
System ...................................................................................................................
Prepared statement ..........................................................................................
Responses to written questions of:
Chairman Johnson ....................................................................................
Senator Reed ..............................................................................................
Senator Akaka ...........................................................................................
Senator Merkley ........................................................................................
Senator Vitter ............................................................................................
Senator Wicker ..........................................................................................
ADDITIONAL MATERIAL SUPPLIED

FOR THE

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RECORD

Monetary Policy Report to the Congress dated March 1, 2011 ............................
(III)

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75

FEDERAL RESERVE’S FIRST MONETARY
POLICY REPORT FOR 2011
TUESDAY, MARCH 1, 2011

U.S. SENATE,
URBAN AFFAIRS,
Washington, DC.
The Committee met at 10:03 a.m., in room SH–216, Hart Senate
Office Building, Hon. Tim Johnson, Chairman of the Committee,
presiding.
COMMITTEE

ON

BANKING, HOUSING,

AND

OPENING STATEMENT OF CHAIRMAN TIM JOHNSON

Chairman JOHNSON. I would like to call this Committee to order.
I want to thank Chairman Bernanke for being here today to deliver the Semiannual Monetary Policy Report to the Congress.
Chairman Bernanke, your reports to this Committee are a reminder of how far we have come in just a few short years, but it
is also the challenges our Nation continues to face.
I am pleased that our economy continues to show positive signs
of recovery. Two-point-eight percent growth in 2010 is a start. But
I remain concerned about sustaining the recovery and being able
to strike the right balance of positive growth, low inflation, increased employment, and long-term deficit reduction.
As Chairman of the Fed, you have strived to strike that balance,
but not without some controversy. The Fed has taken unprecedented steps to minimize the negative impact of the financial crisis
and get us back on track, including a second round of quantitative
easing. While some critics have been very vocal, even going so far
as to call for an end to the Fed’s dual mandate, I believe that you
should be commended for your work. As the economy continues to
struggle to recover, we should be using every tool in the toolbox to
create jobs and spur growth. Taking tools away from the Fed now
is the wrong idea at the wrong time.
Clearly, there are many challenges ahead and the Fed has an important role to play. American consumption continues to be depressed, and without increased demand, businesses will be reluctant to expand, increase output, or hire new employees. It was encouraging to see the unemployment rate drop to 9.0 percent in December, but the duration of the average unemployment period has
increased. While subprime mortgages made up the initial wave of
the foreclosure crisis, we are now also seeing millions of families
facing foreclosure because of unemployment. Even optimistic forecasters say it will take several years before the unemployment rate
returns to precrisis levels, but it is going to require effective policies to jump-start hiring, production, and exports.
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2
Congress has taken steps to spur growth, including measures to
increase small business lending and to provide needed certainty
and protection in the financial system. There is certainly more we
as Congress can do and must do to ensure our economy is on solid
ground, and only then can we turn our focus entirely to deficit reduction.
Chairman Bernanke, today, I am very interested in hearing your
analysis of our current economic situation and what more Congress
and the Fed can do to increase output, employment, and overall
economic growth. I would also like to hear your thoughts on how
we balance sustainable economic growth amid calls to cut Government spending and reduce the Nation’s deficit. As a Nation, we
face significant challenges and I appreciate your thoughts on these
challenges today.
Ranking Member Shelby.
STATEMENT OF SENATOR RICHARD C. SHELBY

Senator SHELBY. Thank you. Thank you, Chairman Johnson.
Chairman Bernanke, welcome again to the Committee.
Over the past year, the Fed’s balance sheet has increased to $200
billion and now stands at over $2.5 trillion. In the upcoming
months, the Federal Reserve’s balance sheet is expected, Mr.
Chairman, as I understand it, to balloon even further.
Last November, the Federal Open Market Committee, FOMC,
announced its intent to purchase an additional $600 billion of
Treasuries by the middle of this year. The second round of so-called
quantitative easing, commonly referred to as QE2, means that the
Fed will be purchasing the equivalent of all Treasury debt issued
through June. Chairman Bernanke has said that the QE2 is necessary because of the high unemployment rate, low inflation rate,
and near zero Federal funds rate.
QE2, however, has not been strongly embraced by all of the
members of the Federal Open Market Committee. From the beginning, one Fed bank president has voted against QE2 because the
purchase of additional securities could cause, he thinks, an increase in long-term inflationary expectations and thereby destabilize the economy. Three other members of the FOMC have publicly stated that an early end to QE2 may be required to help limit
inflation pressures. And a fifth member has said that we are,
quote, ‘‘pushing the envelope’’ with the QE2 purchases.
In addition, several prominent economists have publicly urged
the Fed to discontinue QE2, stating that it risks sparking inflation
and it is not helpful in addressing our fundamental economic problems.
These are serious questions, Mr. Chairman, of the QE2. After all,
once price stability has been lost, as you well know, it is difficult
and very costly to regain. I think we only need to remember the
soaring interest rates and high unemployment that followed Chairman Volcker’s efforts in the early 1980s to regain control over inflation.
In light of the risk that the Fed is taking with QE2, I believe it
is appropriate that the Fed provide a more thorough explanation
of what it hopes to accomplish with QE2. Is it an effort to reduce
unemployment by tolerating a higher inflation rate? Is the purpose

3
to help the Administration out of its fiscal problems by monetizing
Federal debt? Is the purpose to inflate our way out of our housing
problems, or is it something else?
Additionally, the Fed has not yet clearly articulated the basis on
which QE2 should be judged. For example, if inflation rises to 3
percent, is QE2 still deemed a success? If unemployment stays
above 8 percent, is QE2 a success? If inflation falls to near zero,
is QE2 a success?
These basic questions cannot be answered without clearer guidance from the Federal Reserve. Today, Mr. Chairman, I hope that
you explain how the Fed will determine if QE2 is working and how
the Fed believes QE2 should be evaluated. I hope to hear what indicators the Fed will use to determine if QE2 needs to be scaled
back or expanded.
Make no mistake. We all know the Fed has had to respond to
the worst economy in a generation. Unemployment stands at 9 percent. Home prices continue to decline. And the Federal deficit exceeds $1.3 trillion. Monetary policy is always a difficult task, but
our fragile economy and perilous fiscal situation have presented
new and difficult challenges for the Fed, Mr. Chairman, as you
know.
However, I believe that the public, the American taxpayer, deserves to have clear measures by which it can easily evaluate Fed
policy, especially extraordinary actions like QE2. Without clear
metrics, the public cannot determine if QE2 was a success, nor can
it hold the Fed accountable for failure or success.
Thank you, Mr. Chairman.
Chairman JOHNSON. Thank you, Senator Shelby.
I would like to briefly introduce our witness, the Honorable Ben
S. Bernanke, Chairman of the Board of Governors of the Federal
Reserve System, currently serving his second term, which began on
February 1, 2010. Prior to becoming Chairman, Dr. Bernanke was
Chairman of the President’s Council of Economic Advisors from
2005 to 2006. In addition to serving the Federal Reserve System
in a variety of roles, Dr. Bernanke was previously a Professor of
Economics and Public Affairs at Princeton University.
I want to thank you again for being here today. Chairman
Bernanke, you may begin your testimony.
STATEMENT OF BEN S. BERNANKE, CHAIRMAN, BOARD OF
GOVERNORS OF THE FEDERAL RESERVE SYSTEM

Mr. BERNANKE. Thank you, Mr. Chairman. Chairman Johnson,
Ranking Member Shelby, and other Members of the Committee, I
am pleased to present the Federal Reserve’s Semiannual Monetary
Policy Report to the Congress. I will begin with a discussion of economic conditions and the outlook before turning to monetary policy.
Following the stabilization of economic activity in mid-2009, the
U.S. economy is now in its seventh quarter of growth. Last quarter,
for the first time in this expansion, our Nation’s real GDP matched
its precrisis peak. Nevertheless, job growth remains relatively
weak and the unemployment rate is still high.
In its early stages, the economic recovery was largely attributable to the stabilization of the financial system, the effects of expansionary, monetary, and fiscal policies, and a strong boost to pro-

4
duction from businesses rebuilding their depleted inventories. Economic growth slowed significantly in the spring and early summer
of 2010, as the impetus from inventory building and fiscal stimulus
diminished and as Europe’s debt problems roiled global financial
markets.
More recently we have seen increased evidence that a self-sustaining recovery in consumer and business spending may be taking
hold. Notably, real consumer spending has grown at a solid pace
since last fall and business investment in new equipment and software has continued to expand. Stronger demand, both domestic
and foreign, has supported steady gains in U.S. manufacturing output.
The combination of rising household and business confidence, accommodative monetary policy, and improving credit conditions
seems likely to lead to a somewhat more rapid pace of economic recovery in 2011 than we saw last year. The most recent economic
projections by the Federal Reserve Board members and Reserve
Bank presidents, prepared in conjunction with the FOMC meeting
in late January, are for real GDP to increase 3.5 to 4 percent in
2011, about one-half percentage point higher than our projections
made in November. Private forecasters’ projections for 2011 are
broadly consistent with those of FOMC participants and have also
moved up in recent months.
While indicators of spending and production have been encouraging on balance, the job market has improved only slowly. Following the loss of about eight-and-three-quarter million jobs from
early 2008 through 2009, private sector employment expanded by
only a little more than one million during 2010, a gain barely sufficient to accommodate the inflow of recent graduates and other entrants to the labor force.
We do see some grounds for optimism about the job market over
the next few quarters, including notable declines in the unemployment rate in December and January, a drop in new claims for unemployment insurance, and an improvement in firms’ hiring plans.
Even so, if the rate of economic growth remains moderate, as projected, it could be several years before the unemployment rate has
returned to a more normal level. Indeed, FOMC participants generally see the unemployment rate still in the range of 7.5 to 8 percent at the end of 2012. Until we see a sustained period of stronger
job creation, we cannot consider the recovery to be truly established.
Likewise, the housing sector remains exceptionally weak. The
overhang of vacant and foreclosed houses is still weighing heavily
on prices of new and existing homes, and sales and construction of
new single-family homes remain depressed. Although mortgage
rates are low and house prices have reached more affordable levels,
many potential home buyers are still finding mortgages difficult to
obtain and remain concerned about possible further declines in
home values.
Inflation has declined since the onset of the financial crisis, reflecting high levels of resource slack and stable longer-term inflation expectations. Indeed, over the 12 months ending in January,
prices for all of the goods and services consumed by households, as
measured by the Price Index or personal consumption expendi-

5
tures, increased by only 1.2 percent, down from 2.5 percent in the
year earlier period.
Wage growth has slowed, as well, with average hourly earnings
increasingly only 1.9 percent over the year ending in January. In
combination with productivity increases, slow wage growth has implied very tight restraint on labor cost per unit of output.
FOMC participants see inflation remaining low. Most project
that overall inflation will be about 1.25 to 1.75 percent this year,
and in the range of one to 2 percent next year and in 2013. Private
sector forecasters generally also anticipate subdued inflation over
the next few years. Measures of medium- and long-term inflation
compensation derived from inflation indexed Treasury bonds appear broadly consistent with these forecasts. Surveys of households
suggest that the public’s longer-term inflation expectations also remain stable.
Although overall inflation is low, we have seen significant increases in some highly visible prices, including those of gasoline
and other commodities. Notably, in the past few weeks, concerns
about unrest in the Middle East and North Africa and the possible
effects on global oil supplies have led oil and gasoline prices to rise
further. More broadly, the increases in commodity prices in recent
months have largely reflected rising global demand for raw materials, particularly in some fast-growing emerging market economies, coupled with constraints on global supply in some cases.
Commodity prices have risen significantly in terms of all major currencies, suggesting that changes in the foreign exchange value of
the dollar are unlikely to have been an important driver of the increases seen in recent months.
The rate of pass through from commodity price increases to
broad indexes of U.S. consumer prices has been quite low in recent
decades, partly reflecting the relatively small weight of material inputs and total production costs, as well as the stability of longerterm inflation expectations. Currently, the cost pressures from
higher commodity prices are also being offset by the stability in
unit labor costs. Thus, the most likely outcome is that the recent
rise in commodity prices will lead to a temporary and relatively
modest increase in U.S. consumer price inflation, an outlook consistent with the projections of both FOMC participants and most
private forecasters.
That said, sustained rises in the prices of oil or other commodities would represent a threat both to economic growth and to overall price stability, particularly if they were to cause inflation expectations to become less well anchored. We will continue to monitor
these developments closely and are prepared to respond as necessary to best support the ongoing recovery in a context of price
stability.
As I noted earlier, the pace of recovery slowed last spring to a
rate that, if sustained, would have been insufficient to make meaningful progress against unemployment. With job creation stalling,
concerns about the sustainability of the recovery increased. At the
same time, inflation, already at low levels, continued to drift downward, and market-based measures of inflation compensation moved
lower as investors appeared to become more concerned about the
possibility of deflation, or falling prices.

6
Under such conditions, the Federal Reserve would normally ease
monetary policy by reducing the target for its short-term policy interest rate, the Federal Funds Rate. However, the target range for
the Federal Funds Rate has been near zero since December 2008
and the Federal Reserve has indicated that economic conditions are
likely to warrant an exceptionally low target for an extended period.
Consequently, another means of providing monetary accommodation has been necessary since that time. In particular, over the
past 2 years, the Federal Reserve has eased monetary conditions
by purchasing longer-term Treasury securities, agency debt, and
agency mortgage-backed securities on the open market. The largest
program of purchases, which lasted from December 2008 through
March 2010, appears to have contributed to an improvement in financial conditions and a strengthening of the recovery. Notably,
the substantial expansion of the program announced in March
2009 was followed by financial and economic stabilization and a
significant pick-up in growth in economic activity in the second half
of that year.
In August 2010, in response to the already mentioned concerns
about the sustainability of the recovery and the continuing declines
in inflation to very low levels, the FOMC authorized a policy of reinvesting principal payments on our holdings of agency debt and
agency MBS into longer-term Treasury securities. By reinvesting
agency securities rather than allowing them to continue to run off,
as our previous policy had dictated, the FOMC ensured that a high
level of monetary policy accommodation would be maintained.
Over subsequent weeks, Federal Reserve officials noted in public
remarks that we were considering providing additional monetary
accommodation through further asset purchases. In November, the
Committee announced that it intended to purchase an additional
$600 billion in longer-term Treasury securities by the middle of
this year. Large-scale purchases of longer-term securities are a less
familiar means of providing monetary policy stimulus than reducing the Federal Funds Rate, but the two approaches affect the
economy in similar ways.
Conventional monetary policy easing works by lowering market
expectations for the future path of short-term interest rates, which
in turn reduces the current level of longer-term interest rates and
contributes to both lower borrowing costs and higher asset prices.
This easing in financial conditions bolsters household and business
spending and thus increases economic activity.
By comparison, the Federal Reserve’s purchases of longer-term
securities by lowering term premiums put downward pressure directly on longer-term interest rates. By easing conditions in credit
and financial markets, these actions encourage spending by households and businesses through essentially the same channels as conventional monetary policy.
A wide range of market indicators supports the view that the
Federal Reserve’s recent actions have been effective. For example,
since August, when we announced our policy of reinvesting principal payments and indicated that we were considering more securities purchases, equity prices have risen significantly, volatility in
the equity market has fallen, corporate bond spreads have nar-

7
rowed, and inflation compensation as measured in the market for
inflation indexed securities, has risen to historically more normal
levels. Yields on 5- to 10-year nominal Treasury securities initially
declined markedly as markets priced with respect to Fed purchases. These yields subsequently rose, however, as investors became more optimistic about economic growth and as traders scaled
back their expectations of future securities purchases.
All of these developments are what one would expect to see when
monetary policy becomes more accommodative, whether through
conventional or less conventional means. Interestingly, these market responses are almost identical to those that occurred during the
earlier episode of policy easing, notably in the months following our
March 2009 announcement.
In addition, as I already noted, most forecasters see the economic
outlook as having improved since our actions in August. Downside
risks to the recovery have receded and the risk of deflation has become negligible. Of course, it is too early to make any firm judgment of how much of the recent improvement in the outlook can
be attributed to monetary policy, but these developments are consistent with it having had a beneficial effect.
My colleagues and I continue to regularly review the asset purchase program in light of incoming information and we will adjust
it, as needed, to promote the achievement of our mandate from the
Congress of maximum employment and stable prices. We also continue to plan for the eventual exit from unusually accommodative
monetary policies and the normalization of the Federal Reserve’s
balance sheet. We have all the tools we need to achieve a smooth
and effective exit at the appropriate time.
Currently, because the Federal Reserve’s asset purchases are settled through the banking system, depository institutions hold a
very high level of reserve balances with the Federal Reserve. But
even if bank reserves remain high, our ability to pay interest on
reserve balances will allow us to put upward pressure on shortterm market interest rates and thus to tighten monetary policy
when required.
Moreover, we have developed and tested additional tools that will
allow us to drain or immobilize bank reserves to the extent needed
to tighten the relationship between the interest paid on reserves
and other short-term interest rates. If necessary, the Federal Reserve can also drain reserves by seizing the reinvestment of principal payments on the securities it holds by selling some of these
securities on the open market. The FOMC remains unwaveringly
committed to price stability, and in particular to achieving a rate
of inflation in the medium term that is consistent with the Federal
Reserve’s mandate.
The Congress established the Federal Reserve and set its monetary policy objectives and provided it with operational independence to pursue those objectives. The Federal Reserve’s operational
independence is critical, as it allows the FOMC to make monetary
policy decisions based solely on the longer-term needs of the economy and not in response to short-term political pressures. Considerable evidence supports the view that countries with independent
central banks enjoy better economic performance over time.

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However, in our democratic society, the Federal Reserve’s independence brings with it an obligation to be accountable and transparent. The Congress and the public must have all the information
needed to understand our decisions, to be assured of the integrity
of our operations, and to be confident that our actions are consistent with the mandate given to us by the Congress.
On matters related to the conduct of monetary policy, the Federal Reserve is one of the most transparent central banks in the
world, making available extensive records and materials to explain
its policy decisions. For example, beyond this Semiannual Monetary Policy Report that I am presenting today, the FOMC provides
a postmeeting statement, a detailed set of minutes 3 weeks after
each policy meeting, quarterly economic projections together with
an accompanying narrative, and with a 5-year lag, a transcript of
each meeting and its supporting materials. In addition, FOMC participants often discuss the economy and monetary policy in public
forums, and Board members testify frequently before the Congress.
In recent years, the Federal Reserve has also substantially increased the information it provides about its operations and its balance sheet. In particular, for some time, the Federal Reserve has
been voluntarily providing extensive financial and operational information regarding the special credit and liquidity facilities put in
place during the financial crisis, including full descriptions of the
terms and conditions of each facility, monthly reports on, among
other things, the types of collateral posted and the mix of participants using each facility, weekly updates about borrowings and repayments at each facility, and many other details.
Further, on December 1, as provided by the Dodd-Frank Act, the
Federal Reserve Board posted on its public Web site the details of
more than 21,000 individual credit and other transactions conducted to stabilize markets and support the economic recovery during the crisis. This transaction-level information demonstrated the
breadth of these operations and the care that was taken to protect
the interest of the taxpayer. Indeed, despite the scope of these actions, the Federal Reserve has incurred no credit losses to date on
any of the programs and expects no credit losses in any of the few
programs that still have loans outstanding.
Moreover, we are fully confident that independent assessments of
these programs will show that they were highly effective in helping
to stabilize financial markets, thus strengthening the economy. Indeed, the operational effectiveness of the programs was recently
supported as part of a comprehensive review of six lending facilities by the Board’s independent Office of Inspector General.
In addition, we have been working closely with the GAO, the Office of the SIGTARP, the Congressional Oversight Panel, the Congress, and private sector auditors on reviews of these facilities as
well as a range of matters relating to the Federal Reserve’s operations and governance. We will continue to seek ways of enhancing
our transparency without compromising our ability to conduct policy in the public interest.
Thank you for your attention. I would be very pleased to take
your questions.
Chairman JOHNSON. Thank you, Mr. Chairman.

9
I will remind my colleagues that we will keep the record open for
7 days for statements, questions, and any other material you would
like to submit, and I will ask the Clerk to put 5 minutes on the
clock for each Member’s questions. I will not cut you off
midsentence, but I would appreciate it if you would begin winding
down with the clock.
Mr. Chairman, have the bipartisan tax cuts enacted last December been a boost to economic growth, and to what extent does it
complement the Fed’s QE2 program short term?
Mr. BERNANKE. Yes, Mr. Chairman. Everything else equal, the
additional tax cuts, including the payroll tax cut and the business
expensing provisions, should add to aggregate demand and contribute somewhat to growth in 2011 and 2012. And so in that respect, it is complementary to the Fed’s monetary policy actions.
I should say that in our projections and forecasts, we try to make
an assessment of what we think is most likely in terms of fiscal
policy and we had anticipated, as of November, that many of these
provisions, including the UI and most of the tax cuts, would be extended, and so we had taken that into account in our analysis.
That being said, there was some additional stimulus coming from
the payroll tax cut, which we had not anticipated when we were
looking in our forecast in November.
Chairman JOHNSON. What do you see as the impact of rising gasoline prices?
Mr. BERNANKE. Well, this is something we have to pay very close
attention to because it affects both sides of our mandate. On the
one side, it obviously directly affects the inflation rate, and to the
extent that it raises inflation expectations or reduces confidence in
the public in the maintenance of low inflation, it can be an inflation risk.
At the same time, higher gas prices take income out of the pockets of consumers and reduces their spending and their confidence,
and so it can also be a problem for recovery, and so we have to look
at it from both perspectives.
My sense is that the increases that we have seen so far, while
obviously a problem for a lot of people, do not yet pose a significant
risk either to the recovery or to the maintenance of overall stable
inflation. However, we will just have to continue to watch, and if
we see any significant additional increases, we will obviously have
to take that very seriously.
Chairman JOHNSON. What is your perspective on how we can
promote long-term growth in light of the need to reduce the size
of the deficit? Are there particular policies or Government investments that will promote U.S. economic growth and our international competitiveness over the long term even as we work to reduce spending overall?
Mr. BERNANKE. Mr. Chairman, I spoke about this a bit in testimony before the Senate Budget Committee. The fiscal situation is
very challenging, so on the one hand, it is clearly important and
indeed a positive thing for growth to achieve long-term fiscal sustainability. That will help keep interest rates down. That will increase confidence. That will mean that future taxes will be lower
than they otherwise would be, and that will be beneficial for
growth.

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At the same time, to the extent possible, I hope that Congress
will not just look at the inflow and outgo but will also think about
the composition of spending and the structure of the tax code. On
the tax side, I think there is a good bit that could be done to make
the tax code more efficient and also more fair and less difficult to
comply with. On the spending side, I think attention should be paid
to important areas like research and development, education, infrastructure, and other things that help the economy grow and provide a framework that allows the private sector to bring the economy forward.
So it is a double challenge. On the one hand, the need to control
longer-term spending, on the other hand, not to lose sight of the
importance of making sure that the money that is spent is spent
effectively and with attention to long-term growth.
Chairman JOHNSON. Senator Shelby.
Senator SHELBY. Thank you. Thank you, Mr. Chairman.
Chairman Bernanke, how did the Federal Reserve initially determine that $600 billion was the appropriate amount for QE2 and
that 8 months was the appropriate timeframe?
Mr. BERNANKE. Well, first, Senator, I want to emphasize that in
last August or so when we were looking at this possibility, we were
quite concerned about where the economy was. Inflation was declining and deflation risk was rising. Growth had slowed to a point
where we were unsure that unemployment would even continue to
decline. It might even begin to rise. And so there was a lot of talk
about double-dip and that kind of thing. So we felt that we needed
to take some action.
In terms of the $600 billion, we have tried through a number of
methods to establish a correspondence between these purchases
and what our normal interest rate policies would be, and a rule of
thumb is that $150 to $200 billion in purchases seems to be roughly equivalent to a 25 basis point cut in the Federal Funds Rate in
terms of the stimulative power for the economy. So $600 billion is
roughly a 75 basis point cut in the policy rate in terms of its broad
impact.
Seventy-five basis points in normal times would be considered a
very strong statement, but not one outside of the range of historical
experience. It would be one that would be taken at a period of concern and then we would observe the effect. So that was roughly the
analysis that we did.
Senator SHELBY. In your testimony, you state, and I will quote
you today, ‘‘The Federal Reserve’s independence brings with it the
obligation to be accountable and transparent.’’ As I mentioned in
my opening statement here, I believe that there needs to be a clear
basis for judging if QE2 is a success or a failure. What specific
metrics should the public use to evaluate your performance in
achieving the goals of QE2? In other words, on what basis should
we judge the success or failure of QE2?
Mr. BERNANKE. That is an excellent question, Senator, and a
very fair question. First, there is the question of whether or not it
actually works, whether it has effects——
Senator SHELBY. That is right.
Mr. BERNANKE. ——and some have claimed that it does not. As
I talked about in my testimony, as we look at financial markets,

11
which is the way all monetary policy is transmitted to the real side
of the economy, the movement of the wide variety of financial
prices and returns are quite consistent with what you would expect
to see with that 75 basis point cut in interest rates, and I mentioned the stock market spreads, inflation expectations, interest
rates, and the like.
So our assessment of the effects of the policy are that it is providing stimulus through the usual mechanisms that monetary policy works and we can use our econometric tools to judge how important and how powerful that stimulus is.
Now, for the public, what they want to see is results, and I would
argue that we have basically two objectives corresponding to the
two sides of our mandate. The first is to stabilize inflation at a
long-run normal rate, which is about 2 percent, which is consistent
with international standards of where inflation should be to appropriately trade off the benefits of low inflation against the risks of
being too close to a deflationary zone, and we are moving in that
directly, and clearly, deflation risk has greatly declined.
On the other side, I think it is a little harder to be quantitatively
specific, but I think the key here is that instead of unemployment
stagnating or going up, that we see a sustainable recovery moving
forward, and I think we are beginning to see that and over the next
few months we will be able to make a judgment as to whether this
economy now has enough momentum to move ahead on its own
and, therefore, the additional support from policy can begin to be
withdrawn.
Senator SHELBY. Over the past year, the total amount of public
debt outstanding increased by about $1.7 trillion under the financial spending policy of the Administration. Over that same time period, the Fed increased its holdings of U.S. Treasury securities by
$337 billion. In other words, the Fed alone was responsible for financing almost 20 percent of the massive increase in Government
spending. How has the lack, Mr. Chairman, of fiscal discipline complicated the Fed’s conduct of monetary policy, and when the Fed
ends its large-scale purchases of Treasury debt, what impact will
it have on the ability of the Treasury to finance our public debt?
Mr. BERNANKE. Well, the intent of the program first was to hold
down interest rates or term premium relative to where they otherwise would be——
Senator SHELBY. Has that worked?
Mr. BERNANKE. That seems to be working, yes.
Senator SHELBY. A lot of people dispute that, but go ahead.
Mr. BERNANKE. Well, as I noted in my testimony, interest rates
have gone up. The same thing happened in 2009 after our previous
policy because interest rates depend on future expectations of
growth as well as on policy actions.
But that being said, we certainly want to be sure to remove that
stimulus at the appropriate time, so I am at least as concerned as
you, Senator, about inflation. We want to be sure we do not have
an inflationary effect. So we must remove that at an appropriate
time.
We learned in the first quarter of last year when we ended our
previous program that the markets had anticipated that adequately and we did not see any major impact on interest rates, and

12
so I do not expect, when the time comes for us to end the program,
that we will see a big impact. I think it is really the total amount
of holdings rather than the flow of new purchases that affects the
level of interest rates.
Now, all that being said, you asked whether the fiscal policy was
a problem. I think the long-term unsustainability of our debt is a
significant problem because it threatens higher interest rates, less
confidence, and it could have impact on the current recovery. And
so I had been urging Congress to address these problems, not just
in the current fiscal year, but looking over a longer timeframe, because it is over the next 10 or 20 years that these problems are
going to be extraordinarily pressing.
Senator SHELBY. Is that our number one problem, as you see it,
is our unsustained—I mean, our continued spending and our accumulation of the debt?
Mr. BERNANKE. It is—yes, I would say it is——
Senator SHELBY. The number one economic problem facing this
country?
Mr. BERNANKE. Over the longer term, and it is certainly something that must be addressed to get us back on a sustainable path.
Now, that cannot all be done next week, but we need to look over
the next 5, 10, 15 years about how we are going to get back on a
sustainable path.
Senator SHELBY. Thank you. Thank you, Mr. Chairman.
Chairman JOHNSON. Senator Reed.
Senator REED. Thank you very much, Mr. Chairman.
Chairman Bernanke, I assume you are familiar with two recent
reports by Moody’s Analytics and Goldman Sachs which talked
about the proposed House Republican budget. Their conclusion is
that, if passed without modification, there could be as much as a
2-percent decrease in the growth next year going forward and as
many as 700,000 jobs lost because of the contraction of spending
at the Federal level. Do you agree with that analysis?
Mr. BERNANKE. If that is referring to a $60 billion cut, obviously,
that would be contractionary, to some extent. But our analysis does
not give a number that high——
Senator REED. Well, the proposed cut——
Mr. BERNANKE. ——gives us a smaller number.
Senator REED. ——this year is $100 billion in the House.
Is that what you used for your projection report?
Mr. BERNANKE. We are assuming 60 this year and 40 next year,
which would be the $100 billion over the fiscal year. We also assume a normal spend-out. The impact is not immediate, but it is
spent out over time. The reduction is effective over time. And we
get a smaller impact than that. I am not quite sure where that
number——
Senator REED. What is your impact?
Mr. BERNANKE. Several tenths on GDP.
Senator REED. And jobs?
Mr. BERNANKE. I do not have that number, but it would be certainly much less than 700,000.
Senator REED. And that is—I just want to understand what
the—the assumed cut would be in this year, because some of the

13
things we have heard in the House proposal, it is a $100 billion cut
for this year——
Mr. BERNANKE. This year.
Senator REED. ——which would be $40 billion larger than you
would—that you are using as a parameter?
Mr. BERNANKE. Well, then I would multiply it by one time, twothirds greater. I am happy to send you our analysis, Senator, but
I, 2 percent is an enormous effect. Two percent of the GDP is $300
billion right there, so assuming a multiplier of one, $60 to $100 billion is not sufficient to get to that level. But it would have the effect of reducing growth on the margin, certainly.
Senator REED. It would have the effect of reducing growth, which
would—again, the question is how much, which would be contradicting or at least a countervailing force to your stimulus effect of
QE2, is that——
Mr. BERNANKE. To some extent, that is right, and that is why I
have been trying to emphasize, and I know that this Congress will
be looking at this, the need to think about the budget issue not as
a current year issue, because whatever can be done, $60 billion is
not going to have much impact on the long-run imbalances in our
economy in fiscal policy. I think it is much more effective both in
terms of its short-term effects on the economy, but also in terms
of longer-term sustainability and confidence to address the budget
deficits over at least a 5- to 10-year window, not simply within——
Senator REED. Well, I agree with you——
Mr. BERNANKE. ——the next quarters.
Senator REED. ——but the issue that confronts us is this year’s
budget and next year’s budget. That is an issue du jour, literally.
Mr. BERNANKE. Right.
Senator REED. Again, my presumption is the last quarter of GDP
was originally estimated about 3.2 percent, downgraded to about
2.8 percent. Is that your rough understanding, Chairman?
Mr. BERNANKE. That is what the Bureau of Economic Analysis
said, yes.
Senator REED. And their conclusion was a lot of that was a result
of contraction and spending at the State and local governments.
Mr. BERNANKE. That is correct.
Senator REED. So I am just wondering here, if we contract spending at the Federal level, which has a ripple effect at the local level
very quickly, because many of the programs that we support are
really run by and delegated to and staffed by State and local employees, you do not anticipate a fall-off, a significant fall-off in
growth?
Mr. BERNANKE. It would have a negative impact, but again, I
would like to see their analysis. It just seems like a somewhat big
number relative to the size of the cut.
Senator REED. And you are, again, just for the record, you are
assuming in this year’s budget a reduction of $60 billion from the
President’s proposal?
Mr. BERNANKE. Yes, that is right.
Senator REED. That is right?
Mr. BERNANKE. Yes.

14
Senator REED. And we have heard from the Republican side, the
House side, $100 billion. So there is a $40 billion which you have
not factored into your estimates.
Mr. BERNANKE. Is it $100 billion in calendar year 2011?
Senator REED. It is the fiscal year 2011, I believe.
Mr. BERNANKE. Well, that goes into next calendar year, so——
Senator REED. June 30.
Mr. BERNANKE. So talking about——
Senator REED. Excuse me——
Mr. BERNANKE. Talking about calendar year 2011——
Senator REED. No, we are talking fiscal year 2011.
Mr. BERNANKE. Well, in terms of growth numbers, it would be
an effect this year of a tenth or two, and then it would be an additional effect in 2012, assuming that those cuts continued and also
that the effects of them spread out over time beyond the fiscal year
itself.
Senator REED. Thank you.
Chairman JOHNSON. Senator Crapo.
Senator CRAPO. Thank you, Mr. Chairman, and Mr. Chairman,
thank you for being with us.
I would like to follow up on that line of questioning for just a
minute because we get into these constant debates here whenever
we try to reduce spending at the Federal level, about whether that
is going to cost jobs or whether it is going to cause a decrease in
the economy. But do you not believe that at some point, Congress
has to start paring back the spending?
Mr. BERNANKE. Certainly, and I have said so many times. But
again, we do not have a single-year problem. We have a long-term
problem and it needs to be addressed on a long-term basis.
Senator CRAPO. Several economists talked to the President’s Fiscal Commission about this fact, and they were talking about the
long-term commitment that is needed. They indicated that one of
the best things we could do for our economy was to, as a Congress,
adopt a long-term plan that made sense and that would show the
world economies that we were committed to dealing with our fiscal
problems. Would you agree with that?
Mr. BERNANKE. Yes, Senator. I was the first witness for the Fiscal Commission and I made basically that point. And to the extent
that we can address the longer-term trajectory, which currently is
not sustainable, we could ensure lower interest rates, greater confidence, and it would, at a minimum, be helpful to the current recovery, but more importantly, it would protect us from fiscal or financial crisis down the road.
Senator CRAPO. And I would just add as a comment—you do not
need to comment on this unless you would like to—I would just add
that Congress budgets on a 1-year at a time basis, and so, frankly,
we have to look at the year we are dealing with as we move forward. And so although I agree that we have to look long term, we
do not adopt long-term budgets here, at least historically, and some
of us are going to try to get us to do that. Thank you very much
for your involvement in that process.
In the context of the transparency issues that you have discussed
with us, I would like to focus for a minute on the GSE reform,
Fannie Mae and Freddie Mac, in particular, because I am one who

15
believes that it is imperative that Congress grapple with the need
to deal with Fannie Mae and Freddie Mac and to determine how
we will proceed. And I have my opinions on how we should proceed
in that context, but at least a start, I think it is important that we
begin what I consider to be honest accounting with regard to the
Federal obligations represented by Fannie Mae and Freddie Mac.
In a January 2010 CBO report, it was concluded that Fannie
Mae and Freddie Mac have effectively become Government entities
in the way that they are now managed and their operations should
be included in the Federal budget. Do you agree with that CBO report in that context, in the—in other words, whether the debt obligations of Fannie Mae and Freddie Mac should be included in our
Federal budget?
Mr. BERNANKE. Well, I am not an accountant. I defer to those
with better knowledge on that point. But I would just say that if
you do that you would add to the Federal debt, but you would also
have to offset that, to some extent, with the assets that Fannie and
Freddie hold. So whether you consolidate or whether you simply
take as a charge the obligations that the Government has to support Fannie and Freddie, you would still have the same net effect
on the Government’s fiscal position overall.
Senator CRAPO. Yes. At a minimum, it seems to me that we
ought to acknowledge the taxpayer is on the hook for the debt and
we ought to let the American public know what that is, and I fully
agree that if we also need to show the assets, so be it. But right
now, the American public is on the hook for the debt, We are not
necessarily going to be able to obtain access to the assets. It is
going to be very interesting to see how Congress moves forward to
deal with this.
Another question, just shifting subjects for a minute, is do you
believe that an explicit inflation target would help to promote the
credibility of the Federal Reserve by being explicit about its objectives and help it to anchor inflation expectations?
Mr. BERNANKE. Well, I have supported this idea for many, many
years, and the subtlety is helping everyone understand that by giving a number which would help clarify what the Fed is trying to
achieve and would help, we hope, anchor expectations more firmly,
that we would not be abandoning in any sense the other part of
the Congressional mandate to maximum employment. We have
moved partway in that direction in that we provide information in
our projections about what the Committee individually thinks is
the best long-run inflation outcome, and that currently is somewhere between 1.5 and 2 percent on the PCE price index, but we
have not gone all the way to a formal inflation target. Again, the
communication issue here is to make people understand that this
is a way of improving communication in general without necessarily abandoning the other side of our mandate.
Senator CRAPO. Thank you. I see my time has expired.
Chairman JOHNSON. Senator Menendez.
Senator MENENDEZ. Thank you, Mr. Chairman. Thank you,
Chairman Bernanke, for your service.
You know, my main goal every day is how do we grow this economy and how do we get people back to work, certainly from my
home State of New Jersey and, for that fact, every American. It

16
was my hope that the quantitative easing that the Fed was in the
midst of would produce more jobs, more exports, more investments,
and ultimately a smaller budget deficit by obviously generating
profits that would go into the Treasury’s coffers. But as we expand
this balance sheet and buy Treasuries and buy from entities like
Goldman Sachs and expect that these ultimately get deposited in
banks or that those banks would ultimately lend, I have to be honest with you, I am not quite sure—and this is where I am headed
in terms of my question, I’d like to get a grasp from you—I do not
see that lending still taking place, and I hear it all over my State.
I see food prices rising. I see gas prices rising, even before what
was happening in North Africa, although that certainly is an exacerbating reality. Tuition rates rising. And so while we are worried
about deflation, I just see a combination of rising prices for the average family, of the lack of investment that I hoped would take
place here, and so would you give me your view of how the first
and second rounds of quantitative easing are working?
Mr. BERNANKE. I think they are working well. The first round in
March 2009 was almost the same day as the trough of the stock
market, and since then, the market has virtually doubled. The
economy was going from total collapse at the end of the first quarter of 2009 to pretty strong growth in the second half of 2009, and
as I said, it is now in the seventh quarter of expansion. So I think
that was clearly a positive.
The current QE, as it is called, appears to have had the desired
effects on markets in terms of creating stimulus for the economy,
and I cited not just Federal Reserve forecasts, but private sector
forecasts which have almost uniformly been upgraded since August, since November, suggesting that private sector forecasters are
seeing more growth and more employment this year than they had
previously expected. And so I think it is having benefits for growth
and employment.
On the inflation side, as I have said before, I think the bulk of
the commodity price movements are not resulting from Federal Reserve policy but are resulting from global supply and demand factors. For example, in the case of food, there have been major crop
failures and weather issues and things around the world which
have affected supply. And on the demand side, you have emerging
market economies which are growing very quickly and creating
extra demand for raw materials, and that is what is happening
there.
Even with that increase in commodity prices, overall inflation, as
I mentioned, still remains quite low in the United States and we
are determined to make sure that higher gas prices and food prices
do not become imbedded in the overall inflation——
Senator MENENDEZ. I appreciate the market going up. We are
thrilled to see that. But to be honest with you, if you talk to an
average family in New Jersey and you say, what is your food bill,
what is your gas price, what is your tuition rising, they are not
going to tell you there is deflation. And so in a real context, I am
wondering how this macroeconomic policy is going to get to the average person in a way that changes their lives in a more positive
way. Certainly, the market is a nice indicator in one sense, but it
is not for everybody in their lives.

17
And that brings me to the question, how will you decide how to
tighten monetary policy? How do you know when you have reached
the point where that is wise, and what type of considerations are
you going to take into account?
Mr. BERNANKE. Well, monetary policy works with a lag, and
therefore, we cannot wait until we get to full employment and the
target inflation rate before we start to tighten. We have to think
in advance, which means we have to use our models and our other
forms of analysis and market indicators and so on to try to project
where the economy is heading over the next 6 to 12 months. Once
we see the economy is in a self-sustaining recovery and employment is beginning to improve and labor markets are improving,
and meanwhile that inflation is stable at approaching roughly 2
percent or so, which, I think, is where you want to be in the long
term in inflation, at that point, we will need to begin withdrawing.
I just want to emphasize, it is not at all different from the problem that central banks always face, which is when to take away
the punch bowl, and the only way you can do that is by making
projections of the economy and moving sufficiently in advance that
you do not stay too easy too long. And we are quite aware of this
issue and quite committed to price stability and we will continue
to analyze our models and our forecasts and move well in advance
of the time that the economy is completely back to full employment.
Senator MENENDEZ. Well, thank you, Mr. Chairman. My time is
up, and I look forward, maybe off of the hearing, to pursue some
of this with you.
Mr. BERNANKE. Certainly.
Chairman JOHNSON. Senator Corker.
Senator CORKER. Thank you, Mr. Chairman, and Mr. Chairman,
thank you for your testimony and your service.
I appreciate your comments regarding the Goldman report. I
know a lot of people may not have seen it, but 47 economists came
out quickly thereafter to basically say the Goldman report regarding cutting spending was way off base and the thing we can do to
get our country moving ahead is to begin having some fiscal discipline. I agree with you, we need a long-term plan. It cannot all
happen in 1 year. But we have to begin at some point, and we are
working together, I hope, to put Congress in a straightjacket so
that over the course of the next 10 years, we will have the discipline we need.
You talked a little bit with Senator Crapo about inflation and an
explicit target and you now have a dual mandate, unlike the European Central Banks, unlike the Bank of England. What policy rubs
does that create internally or perception issues, having the dual
mandate that you now have?
Mr. BERNANKE. Well, it means that we have to look at both sides
of the mandate in making our policy decisions. Sometimes that
causes a conflict in a stagflationary situation where unemployment
is too high but inflation is also too high. Currently, there is not
really that much of a conflict because inflation and employment
have been quite low, and so accommodative policy has been appropriate in any case.

18
Senator CORKER. I guess at rare times, you have high inflation
and high unemployment, and I think that is what people are concerned about possibly happening now. That would create a conflict
with that dual mandate, is that correct?
Mr. BERNANKE. It would pose a very difficult situation. I think
we have learned that there is no way to have sustained economic
growth with high and variable inflation. So keeping inflation low
and stable is, whatever your mandate, is absolutely essential and
we are committed to doing that.
Senator CORKER. Would it give the Fed greater credibility if you
had the single mandate, since, in essence—I know we have had a
lot of conversations—price stability, I think by most people, is the
thing that helps create maximum employment more than anything
else. Would it help if we clarified that for you?
Mr. BERNANKE. Well, we have been functioning under the dual
mandate. We think it is appropriate and we are not right now
seeking any change. Congress can certainly discuss that issue and
we will do whatever Congress tells us to do.
Senator CORKER. But it does create a policy rub from time to
time, or can, to have a bipolar mandate.
Mr. BERNANKE. It can, but on the other hand, there may be circumstances when a monetary policy can be constructive on the employment side and would we want to ignore that.
Senator CORKER. You are lauded for being a great student of the
Great Depression. As we have gone through hopefully three-quarters of what it is we are dealing with—again, hopefully—what is
it about that model that is relevant to what we have been dealing
with over the last couple of years and what is not?
Mr. BERNANKE. Well, I have done a lot of work on the Depression
and thought about it quite a bit. There are two basic lessons that
I personally took from my studies of the Depression. The first had
to do with monetary policy. The Federal Reserve and other countries were very, very passive on monetary policy, and as a result
permitted a deflation of actually about 10 percent a year for several
years, which was highly destructive to the economy. This was a
point that Milton Friedman made in his history of the monetary
history of the United States, and he argued that that was the primary cause of the Great Depression. The Federal Reserve, in this
particular episode, was more proactive and aggressive in terms of
easing monetary policy to ensure that we did not have deflation
risk and excessively tight monetary policy.
The other lesson I take is that financial instability can be extremely costly to the economy. We had in the fall of 2008 a financial crisis which was, in many ways, as big or bigger than anything
they saw in the 1930s. But we know that in the 1930s, the collapse
of a big Austrian bank and a number of other problems, including
the failure of about a third of the banks in the United States, was
a major blow to credit extension, to confidence, and to prices, and
was a big source of the Depression. And so for that reason, we were
very aggressive, working with the Treasury and others, to try to
stabilize the financial system as quickly as possible. Even so, the
impact on the economy was quite substantial.
Senator CORKER. I see my time is up and I thank you for your
testimony.

19
Chairman JOHNSON. Senator Bennet.
Senator BENNET. Thank you, Mr. Chairman.
Chairman Bernanke, it is nice to see you again. Thank you for
your testimony.
You talked a little bit in your remarks about the importance of
not just talking about cutting, not just talking about what the composition of the spending looks like, what the comprehensive approach to taxation looks like, but your view, I think, is more
nuanced than the headlines that come out of this place and I appreciate it very much.
I wanted to ask you in that context how you evaluate the product
of the Fiscal Commission. What do you think about their suggestions about their mixes of cuts versus—cuts to spending versus revenue? Do you think it should be weighted one way or another? I
realize you are here to talk about monetary policy, not fiscal policy,
but you testified there. Senator Crapo was on the Committee, took
a courageous vote to support the Commission report. So I wonder
if you would spend a few minutes sharing your views on it.
Mr. BERNANKE. What I think is impressive about the Deficit
Commission is that it highlighted the size of the problem. Second,
it, made a set of proposals that, while obviously painful, would address the problem. I say that for the most part, because in some
areas they kind of punted. Like on health care spending, which is
really the biggest single issue, they just sort of assumed that cuts
would be made and they did not give many details.
So I appreciate that it was a bipartisan effort and I think it was
very successful in the sense that it gave a sense of the magnitude
of the response that is needed and showed at least one path forward to addressing the problem. And some other commissions, like
the Rivlin Commission and others, have done similar things.
I would not want to tie myself down too much to the details of
that commission, I am sorry, because I think there are many different ways that you could address it. And ultimately, fiscal priorities are the Congressional prerogative, not the Federal Reserve’s.
But certainly one element is the importance of addressing the
long-term entitlement issues, which are going to become bigger and
bigger and need somehow to be managed in a way that will provide
essential services, but will be affordable to the country.
Senator BENNET. I appreciate you not wanting to endorse the
specifics of the plan. I guess, directionally—let me try it this way.
We are at a place right now where we have a $1.5 trillion, roughly,
deficit, $14 trillion of debt. The Fed’s balance sheet has expanded
dramatically in order to deal with this crisis. And one of the things
that I worry about is that if the capital markets decide 1 day that
they do not want to buy our debt at the price that they are now
buying it, that the result of that is going to be catastrophic, and
because of the position we are in today with your balance sheet and
with the Federal Government’s balance sheet, that there is no room
for a policy response at that point.
So while you talked about how painful some of the suggestions
are from the Commission report, I wonder if you could tell the
Committee a little bit how painless that would seem compared to
the pain we would go through in the scenario that I just described.

20
Mr. BERNANKE. No, there, I am in complete agreement. I think
the thing to understand is that the long-term imbalances are not
just a long-term risk. They are a near and present danger.
Senator BENNET. Right.
Mr. BERNANKE. To the extent that markets lose confidence in the
Congress’ ability to make tough choices, and they are going to be
tough, there is the risk of an increase in interest rates, which
would just make things worse because it would increase the deficit
because of higher interest payments.
So I think the sooner that a long-term plan is put in place to
make significant and credible reductions in the path of the deficit,
the better it will be and it would actually have benefits in the near
term, not just 20 years from now.
Senator BENNET. Right. I think that is very important, because
earlier, there was some discussion about 10 years or 20 years. I
just want to underscore and underline your observation that this
is actually a near and present danger and that the sooner that we
get after it, the less painful it is actually ultimately going to be,
and the more likely we are to protect ourselves. You said financial
instability is extremely costly to the economy. I would argue that
the financial instability that would come in the scenario I was talking about actually would be more costly than what we have just
been through. I wonder if you have got a view on that.
Mr. BERNANKE. No. That is very possible. It would create both
a fiscal crisis and require a scramble by the Congress to try to find
any kind of cut or tax increase to address the problem. But a spike
in interest rates would have also very adverse effects on a lot of
institutions and portfolios and could create a financial panic, as
well. So it is really a very worrisome situation.
Now, fortunately, the markets to this point seem to have a lot
of confidence that we will address the problem, and I hope we can
make that confidence—that we can meet that expectation.
Senator BENNET. Thank you. Thank you, Mr. Chairman.
Chairman JOHNSON. Senator Vitter.
Senator VITTER. Thank you, Mr. Chairman. Thank you, Mr.
Chairman, for your work and your testimony.
I want to build on some of the discussion we have been having
about the fiscal situation. I think you have said we are on—fiscally,
we are on an unsustainable path. That challenge is a long-term
challenge. However, it can have very immediate consequences. Who
knows when it can break in terms of the consequences if we do not
start to deal with it. Is that a fair summary of some of the things
you have said?
Mr. BERNANKE. Yes, Senator.
Senator VITTER. In that context, I am wondering the following.
We are coming up on a big deadline—several big deadlines. Probably the biggest is our reaching our debt limit as a Nation sometime between late March and May. What do you think it would do
to the viewpoint on all of this, on our seriousness about correcting
our fiscal situation, if Congress increased that debt limit without
at the same time passing some meaningful budget reform?
Mr. BERNANKE. Well, Senator, as I hope I have made clear, I
think it is extremely important that you address this issue. So in
no way am I disagreeing with your basic premise that you have to

21
address this long-term budget issue. I am just worried about using
the debt limit as the vehicle. The reason being that if it were even
a possibility that the Government would default on its existing
debt, not pay the interest and principal on existing debt, some of
the financial crisis issues that Senator Bennet mentioned would
immediately happen because currently there is absolute confidence
that the U.S. Government will pay its bills. If you do not do that,
it would have very negative effects on financial markets and on our
economy, and for a very long afterwards, the U.S. would have to
pay higher interest rates in the market and that would make our
deficit problems even more intractable.
So again, I very strongly support efforts to address the long-term
deficit problem, but I am a little nervous about taking the chance
that we would not be paying the interest and principal on our debt.
Senator VITTER. Let me ask the same question in a different
way. Would it be better to increase the debt limit and go along our
merry way on the present fiscal path, or would it be better to increase the debt limit and at the same time pass meaningful budget
reform?
Mr. BERNANKE. Well, clearly, the latter. You want to make sure
that the debt is paid, interest is paid. Meaningful budget reform is
highly desirable. I am just concerned that there be a significant
probability that we would not raise the debt limit and that would
cause real chaos. So I am completely with you, Senator, on the
need for budget reform and I hope that Congress will be able to
come together and make some tough decisions.
Senator VITTER. Well, again, let me go back to my first point. I
understand your concerns about the consequences of not raising the
debt limit. However, that event is so big, it seems to me if we do
it and do not do any meaningful budget reform, that is a very clear,
very strong negative signal about how serious we are about correcting our fiscal path. That is my point. Would you disagree with
that?
Mr. BERNANKE. I guess I draw a distinction between not increasing the debt limit and maybe even shutting down the Government,
those sorts of things. Not increasing the debt limit is like saying
we are going to solve our family’s financial problems by refusing to
pay our credit card bills. These are bills that have already been accrued, as opposed to cutting up the credit card and saying we are
not going to do any more spending. But these are—this is money
we have already borrowed. These are commitments we have already made to contractors, to senior citizens, and so on, and what
we are saying here is we are not going to make these payments
that we promised. So I would rather that we be forward-looking
and say we are going to restrict new spending or new commitments
until we have reform.
Senator VITTER. Well, maybe you misunderstood me. I was not
suggesting not acting on the first. I was just suggesting that we
should act on both together, because if we do not, I think that is
a very strong negative signal about our lack of commitment to
changing our fiscal path.
Mr. BERNANKE. I really support a program to improve the longterm fiscal sustainability.
Senator VITTER. Thank you.

22
Chairman JOHNSON. Senator Merkley.
Senator MERKLEY. Thank you, Mr. Chair, and thank you, Mr.
Chairman.
You commented that our deficit is not a single-year problem, but
a long-term problem, our deficit, our debt. The Budget Committee
plan from last year sought to essentially stop digging the hole any
deeper after about 4 years, but to avoid driving us into a doubledip recession, a more serious recession, in the short term. When
you are talking about a long-term problem, and as we wrestle with
the short-term impacts, is that type of framework, where within a
couple of years you are getting to a point you do not dig the hole
any deeper, and then from that point you are reducing it, is that
kind of the type of profile you are talking about in terms of the
long-term, short-term tradeoffs?
Mr. BERNANKE. Well, one criterion which is very useful is looking
at the primary budget deficit, which is the deficit less interest payments, and you need to get the primary budget deficit down to zero
in order to avoid increases in the debt-to-GDP ratio. Currently,
under current CBO projections, the primary budget deficit is 2 percent in 2015 and 3 percent in 2020, of GDP. That gives a sense of
the kind of cuts we would like to see over the next 10 years—that
would help stabilize that debt-to-GDP ratio over that period, and
so that is the kind of criterion I would be looking for, over the next
5 to 10 years, reducing the structural deficit by 2 to 3 percent.
Senator MERKLEY. Thank you. Now let me switch to energy policy. There is a lot of discussion now about the impact of foreign oil
price shocks and the possibility that oil at $125 or higher might
trigger a real challenge. Does it make sense for us to have a national strategy to radically reduce our dependence on foreign oil?
Mr. BERNANKE. I think that anything we can do to diversify our
energy sources is probably helpful. We want to make sure what we
do is economic, but it is true that oil does bring with it geopolitical
risks and uncertainties that other forms of energy might not have
and that probably should be taken into account as we think about
the range of energy sources. I think the recent developments in
natural gas here in the United States and the increased supply of
that is a very good development. It is going to be very helpful. I
know that some people are supporting additional nuclear powered
utilities, energy producing. So, yes, I think some attention to diversifying the energy sources that we use is a good idea to avoid some
of these risks.
Senator MERKLEY. I will keep jumping topics here, given the
short time I have, but commercial lending has been in a real challenging position, with a lot of balloon mortgages, 7- to 10-year
mortgages coming due and banks reluctant to relend because of the
declining value of the buildings. The Fed was involved in the Term
Asset-Based Securities Loan Facility, or TALF, which helped in the
short term, and then they kind of pulled back from that. Where are
we now in terms of commercial lending being a major structural
challenge for our economy?
Mr. BERNANKE. Well, the TALF was about stimulating the commercial mortgage-backed securities market, and there was a story
in the paper this morning to the effect that the CMBS market, not

23
in a big way but in a modest way, is coming back, at least for the
better properties. So that is a positive development.
The Fed has also worked with banks, providing guidance about
how to rework, restructure CRE loans, which seems to be having
some beneficial effects, as well.
We had a Fed testimony by Pat Parkinson recently on this topic
and I would say, overall, that some of the worst fears about commercial real estate seem not to be coming true, that there is some
stabilization of vacancy rates and prices and so on in this market.
That being said, there is still a lot of properties that are going to
have to be refinanced and probably some losses that banks are still
going to have to take. So it is still certainly a risk to the financial
system, but it does seem to be looking at least marginally better
than we were fearing 6 months ago.
Senator MERKLEY. Thank you.
Chairman JOHNSON. Senator Johanns.
Senator JOHANNS. Mr. Chairman, thank you, and Mr. Chairman,
good to see you again.
As I was listening to the discussion about QE2, which you know
I have been a critic of that, I am not supportive of what you are
doing, but having said that, it occurred to me that maybe we are
focusing on consequences and not focusing enough on the reasons
that maybe got you to that decision point. So let me, if I might,
offer a thought about that, and I would like your reaction to it.
Never in the history of this country has there been a greater
need for people, foreign countries, whoever, to buy our debt than
now. In fact, nothing comes close to it. It is kind of breathtaking
in its magnitude. Just week after week after month after month,
somebody has to be out there buying this massive amount of debt.
I look at what has happened to commodity prices, which have
been so very strong. I look at what has happened to the Dow and
the NASDAQ, and that also has been strong. It has been quite a
run. There is so much competition out there. So as the economy improves, there is more reason to be in those investments than getting less than a percent return on a 2-year Treasury or, I do not
know, 2 percent-plus on a 10-year Treasury.
So it just occurs to me, Mr. Chairman, that part of what is driving this is the real, genuine, bona fide worry that in order to attract people to buy Treasuries, the Government would have to entice them with higher yields. And eventually, heaven forbid, good
Lord forbid, there is a day at which there just is not an appetite
to buy more paper, because those who are in that marketplace look
at the U.S. Government and say, you know, you have so detached
the joy of spending from the pain of taxation that you do not have
a fiscal plan.
And then I look at the impact on real people, like there was talk,
well, we do not have to do anything about Social Security. Well,
that assumes that we can keep borrowing, because there is no trust
fund. It is just paper, again. And if we are not able to borrow more
money, we cannot even pay current beneficiaries.
So it seems with those kinds of weighty issues, all of which I
think are accurate, if I am reading this correctly, you almost had
no choice. You have got to be in this marketplace to keep interest
rates low to start out with. And you have become a big player in

24
buying our debt, and you must lay awake at night wondering, if I
exit this marketplace, what happens? Tell me where I am wrong
in that thinking.
Mr. BERNANKE. Well, that was not our motivation for getting into
this. Our motivation was the state of the economy, which as of last
summer and fall, we had significant concerns that the recovery was
going to stall, that growth was not sufficiently fast to bring down
unemployment, and that inflation was moving down and down and
down to where we were getting closer and closer to the deflation
zone. So that was the reason we took the action and we felt, although there are admittedly risks with the QE2 program, that
there were also very significant risks to not taking the action. So
we did it for the same reasons that monetary policy is always used,
which is to try to meet our dual mandate for employment and inflation.
Our policies affect interest rates in two ways. One is as we promote growth, that is causing interest rates to rise for the reasons
you were describing, because other investments become attractive,
but also it is important for us to keep inflation low and well under
control because inflation also affects the level of nominal interest
rates.
So we were not motivated by anything related to the deficit or
the debt and I do not—and I would make two points. One is that
when we stop buying, whenever that may be, our previous experience suggests that the market takes it in stride because the market
anticipates at some point that the purchases will stop. And then we
are not monetizing the debt because we will be returning our balance sheet to a more normal level ultimately.
I think what it all comes down to is that what the markets are
looking at is the long-term fiscal discipline of the U.S. Government,
and whether or not interest rates will spike or whether they will
remain reasonable depends far more on Congress’ decisions about
long-term fiscal planning than anything the Fed is going to do.
Senator JOHANNS. Thank you, Mr. Chairman.
Chairman JOHNSON. Senator Hagan.
Senator HAGAN. Thank you, Mr. Chairman. I am honored to be
on this Committee. Thank you so much.
Chairman Bernanke, in your last Monetary Policy Report to Congress, you touched on housing finance when you noted that, on balance, interest rates on fixed-rate mortgages decreased over the first
half of 2010. But you also acknowledged that despite falling mortgage rates, the availability of mortgage finance continued to be constrained.
I hear time and time again from constituents throughout my
State in North Carolina that they are having difficulty taking advantage of the low rates that are out there. As you know, one of
my biggest priorities during the consideration of the Dodd-Frank
Act was to include a qualified residential mortgage standard in the
bill. I worked with Senator Landrieu and Senator Isakson and we
worked to include a standard that would provide access to safe, stable, and affordable home loans for creditworthy borrowers. I understand that risk retention might serve as a deterrent to types of excessive risk taking, but I am concerned that risk retention could
impose significant costs and reduce liquidity in the mortgage mar-

25
ket. As a result, we tried to fashion an amendment that addressed
the primary causes of the problem directly and yet also provided
an incentive for lenders to originate safe, stable, and affordable
mortgages.
I was hoping you could speak a little bit more today about the
state of the mortgage market and the impact that the qualified residential mortgage definition that is currently being written will
have on housing finance. Are we going to continue to see constrained credits, and if regulators were to draw too narrow an exemption, for example, if they required a 20 percent down payment,
as advocated by some, would credit further be constrained? I am
really concerned that if loans do not meet the qualified residential
mortgage standards and lenders have to set aside the extra capital
to meet this risk retention requirement, we are going to see constrained credit going forward.
Mr. BERNANKE. Well, Senator, we are working very hard on the
QRM in conjunction with the FDIC and other agencies and we expect to have some rules available for comment very shortly. We
have been discussing in particular to what extent servicing requirements should be attached to the QRM. So the goal there is to have
a definition of mortgages that are of sufficiently high quality and
meet sufficiently high underwriting standards that the risk retention is not necessary, and so that would reduce the cost of those
mortgages.
So on the one hand, I understand you do not want it to be too
narrow or too tough, but on the other hand, you want this to be
a good mortgage. You want it to be one that will be safe, well underwritten, and that investors will be happy to buy even without
the risk retention. So we are trying to balance those two issues.
Unfortunately, in terms of the mortgage market, most of the
mortgage market is still Fannie and Freddie at this point, and so
we know directly what is happening there, which is that they are
continuing to keep pretty tight standards in terms of a de facto 20
percent down, pretty high FICO scores. So terms and conditions for
getting a mortgage are quite tight, particularly relative to the excessively loose terms that were in play before the crisis.
My own guess is that improving the economy will cause lenders
to be a little bit less restrictive, but on the other hand, as we move
toward a fully privatized market, as the GSEs become less and less
important, the private sector may decide to keep terms moderately
tight.
So currently, the terms are pretty tight. That is a problem for
the housing market. I expect some modest improvement, but probably not anything dramatic in the near term. We continue to work
on the QRM, and I think that will be a constructive addition to the
housing finance programs that we have.
Senator HAGAN. Well, I am sure you will continue to be hearing
from us. We are really concerned about not making it so restrictive
that we cannot have as many well-qualified loans as possible, obviously recognizing that there does need to be a good definition of
that.
Mr. BERNANKE. OK. Thank you.
Senator HAGAN. Also, the FOMC has used unconventional monetary policy tools since late 2008 to promote economic recovery and

26
price stability. Most recently, as you have been talking about,
quantitative easing and the purchase of Government bonds with
the newly printed money has made monetary policy more complicated. We still do not know the long-term effects this policy may
have, and more importantly, what effects unwinding these policies
may have.
I understand that these tools, especially the asset purchases, will
take time to unwind and that economic conditions will dictate
much of the decision making. A recent study by a group of Federal
Reserve Board economists constructed a baseline scenario for
unwinding the large-scale asset purchases that would see the Fed’s
$2.6 trillion balance sheet normalize in size and composition by
2017. Do you agree with this baseline trajectory? What are the factors that will influence this trajectory toward balance sheet normalization? Will the price stability or maximum employment drive
the decision making?
Mr. BERNANKE. Well, Senator, we had had earlier discussions
about the pace of normalization and one concern we had was not
to sell off our securities so quickly that it would disrupt the market. And so the sense was that it would be a relatively slow process
and one that would be clearly announced in advance so that markets would be able to anticipate.
What I need to emphasize here is that that does not mean that
QE will continue until 2017 or easy money will continue until 2017.
We have tools that will allow us to tighten monetary policy in more
or less the normal way even if the balance sheet remains large.
For example, we have the authority to pay interest on reserves.
By raising the rate that we pay on reserves to banks, we can effectively raise the short-term money market rate and that will work
through the financial system just pretty much the same way that
a higher Federal funds rate target will work.
So there are different ways for us to unwind. Obviously, as Senator Shelby has pointed out, it is important for us to get back to
a more normal size of our balance sheet and we will do so, but the
pace at which we do that does not constrain us from tightening
monetary policy at the appropriate time. And as I was trying to explain also to Senator Shelby, we want to be sure that price stability
is maintained, that inflation remains low and stable, and in doing
that, we will have to look ahead to where inflation is going, not just
where it has been, but also to the extent that is consistent with
that, we want to make sure that recovery is self-sustaining, that
the private sector is leading the recovery so that the artificial support from the Fed and from fiscal authorities and so on can be
withdrawn and let the private economy lead the recovery.
Senator HAGAN. Thank you, Mr. Chairman.
Chairman JOHNSON. Senator Wicker.
Senator WICKER. Am I next?
Chairman JOHNSON. Yes.
Senator WICKER. Thank you. Let me see if I understand an answer that I believe you gave Senator Merkley. You said the commercial mortgage-backed security market is coming back to a small
extent.
Mr. BERNANKE. Correct.
Senator WICKER. And I assume that is a good thing.

27
Mr. BERNANKE. Yes, because that is an important source of finance for commercial real estate, and given that banks are not expanding their balance sheets and we need alternative sources of finance.
Senator WICKER. Right. And I got information from CRS yesterday that with regard to residential mortgage-backed securities,
that market is virtually dead, is that correct?
Mr. BERNANKE. Yes.
Senator WICKER. Would it be a good thing if that came back?
Mr. BERNANKE. Well, I would think so, although it is important
to remember that a lot of bad lending took place through that market and helped contribute to the crisis. But conditional on underwriting standards or other oversight that makes the loans created
through that process of sufficiently good quality, then again, it
would be good to have multiple sources of financing for the housing
market.
Senator WICKER. OK, and that is what my question is sort of directed toward, as to what standards you might recommend in that
regard. You know, most of us have had to go to school since 2008
on this whole issue of mortgage-backed securities and what we
learned is that as they were leading up to 2008, they were outside
many of the SEC’s regulatory structures because they were privately placed transactions. And so with regard to the definition of
delinquency or being in default or the classification of the mortgages or how those mortgages are worked out when they get in
trouble, there were not those standards in place because generally
they were considered transactions involving the big boys.
So would it be helpful, and what suggestions would you have in
this regard about having standards, greater disclosures, and structural reforms put in place to perhaps revive the private mortgagebacked security market and bring back more private mortgage capital into the residential market?
Mr. BERNANKE. Well, there are a number of steps taken in the
Dodd-Frank Act to try to address this. For example, one of the
problems in the crisis was conflicts of interest or shopping around
for credit ratings, and so there are some new regulations, regulatory authorities at SEC to reduce those conflicts of interest and
the credit rating agencies have been reworking their models for
securitized products. What we saw in the crisis, where firms would
take a whole bunch of lousy mortgages and then use financial engineering to make them into triple-A securities, that should not be
possible anymore if the credit rating agencies are forced to meet
certain standards.
Second, the——
Senator WICKER. Let me interject here.
Mr. BERNANKE. Sure.
Senator WICKER. Did we adequately address that issue in DoddFrank, or is there really a need to——
Mr. BERNANKE. Well, before I can answer that question, I would
like to see the full panoply of steps that the SEC takes. But I know
they are serious about trying to address particularly the shopping
around problem, where a securitizer would try different agencies
until they found one who gave them the rating they wanted. So
more disclosures on that, for example, would be helpful.

28
Then I was just talking to Senator Hagan about the QRM, the
qualified residential mortgage, which would set some standards for
high-quality mortgages, and mortgages that did not meet that
would have to have a skin-in-the-game credit risk retention element that is provided by Dodd-Frank. I think that supervisors will
be paying more attention to this in the future and we should pay
more attention to it.
And finally, one thing that the Federal Reserve is very interested
in, and we have been talking about this with Congress and with
other agencies, is to have national servicing standards, because
that turns out to be an important part of the process of making
sure that people who do run into trouble are able to get restructured mortgages and a chance to keep their home. So there are a
number of things in the bill, but I think as we go forward, we will
want to make sure that we have sufficient oversight that we can
assure that the mortgages are of good quality.
I think that as the GSEs begin to pull back, as they inevitably
will, that we will see private label mortgage-backed securities coming back into the market, but it is pretty limited right now.
Senator WICKER. OK. Well, my time has expired. Would you take
for the record the question of some recommendations about how to
go further on structural changes that might make the mortgagebacked security market more viable with regard to residences?
Mr. BERNANKE. Certainly.
Senator WICKER. Thank you, sir.
Chairman JOHNSON. Senator Warner.
Senator WARNER. Thank you, Mr. Chairman, and Mr. Chairman,
it is good to see you again, as well.
I think one of the comments you made earlier, we all need to
bear in some level of mind. While you have had to take some extraordinary actions, when we reflect back on where we were in the
spring of 2009 and how deep a ditch we were in and the prognostications at that point, while clearly employment numbers are not
where we would like, some of the other recovery has been, frankly,
more dramatic than I think many of us would have even predicted.
One thing—I have got two issues I want to raise in my short
time, and I will try to be quick about it because I want to follow
up on Senator Bennet’s question. But before I get there, one of the
things I think, and hopefully we will have a wise way to avoid a
Government shutdown right now, but I do think at times within
the public, there is some confusion between these issues around
shutdown and an issue that we will have to address in the next few
months around the debt ceiling limit. And as we have heard from
your testimony, and I absolutely believe we need to put in place a
long-term plan to deal with our debt and deficit and I am proud
of the bipartisan work that is being done on that.
But as we are still kind of in this hopefully strengthening recovery, can you, in as plain of language as a central banker can, make
clear what the ramifications would be, maybe to an average American or to our economic recovery, if we were to default and not
raise that debt ceiling limit and the ramifications that would have
toward our recovery to an average American family, two or three
examples.

29
Mr. BERNANKE. Well, it would be an extremely dangerous and
very likely recovery-ending event. First, it would almost certainly
create a new financial crisis as firms that rely on receiving their
interest and principal do not receive it and they are unable to
make payments, and so that problem would cascade through the financial markets. Then there would be a massive loss of confidence
in the U.S. Treasury securities, which are the deepest, most liquid
market in the world. Interest rates would spike, and that would,
in turn, affect many other assets, as well as Treasuries.
So the near-term effect would almost certainly be a very sharp
resumption of the kinds of instabilities we saw in 2008. Even if we
were able to avoid those kinds of effects, the interest rate that
lenders would demand of the U.S. to finance our debt going forward would be higher, reflecting the greater riskiness and uncertainty associated with funding the U.S. Government, and that
would make our fiscal problems all the more severe because interest payments are part of the deficit. So it means that cuts would
have to be sharper and tax increases larger and those things themselves would also be a negative for the recovery.
So, broadly speaking, it would be, a very, very bad outcome for
the U.S. economy.
Senator WARNER. So it would be safe to say that 2 years of extraordinary actions, many of them politically unpopular, could all
be washed away and whatever recovery we have got could all be
put in jeopardy if we, as Members of Congress and the American
public, does not realize that there is a major distinction between
the questions around the debt ceiling limit and equally important
questions around Government shutdown. But Government shutdown compared to messing with the debt ceiling limit could have
dramatically different ramifications.
Mr. BERNANKE. We have never had a failure to raise the debt
limit. We have had a number of Government shutdowns and they
have created problems, but they have not been as destructive as a
debt limit failure would be.
Senator WARNER. All right. Well, being sensitive to those of us
on the end who have been waiting a while, I will try to get my last
question in and observe the time limit. One of the things I know,
as much as Senator Bennet tried to pin you down on the Deficit
Commission report, you will not go on the specifics, but I would
like to ask, because there are many folks here who feel that we can
solve this crisis simply on the spending side. There are some on our
side that want to do it only on the revenue side, or revenue side
with the exclusion of entitlements.
But the nature and size of this challenge is so great, do you believe that we can really get there without having an open mind on
both sides of the balance sheet?
Mr. BERNANKE. Well, I hope there will be an open mind. I hope
there will be plenty of discussion about all possible ways forward.
So certainly, I cannot disagree with that.
Senator WARNER. But both spending and revenues have to be
part of this discussion if we are going to be able——
Mr. BERNANKE. I hope there will be an open mind and that there
will be discussion of all options, including reforms of the tax code,
including restructuring of spending and the like, yes.

30
Senator WARNER. I wish I had had another 30 seconds.
Chairman JOHNSON. Senator Moran.
Senator MORAN. Mr. Chairman, thank you very much. Chairman
Bernanke, thank you for the opportunity to question and make
comments.
Mr. Menendez asked earlier about, I think, at least from my perspective, the crux of his point was that despite significant monetary policy changes designed to put additional dollars into the
banking system, loans are not being made. Credit is not being extended to the degree that we need to increase the economy. And
I am interested in knowing whether that is accurate. Are we still
trying to—I assume our goal is still try to increase loan demand.
And do you think that the regulatory environment that particularly
community banks face has a consequence in the fact that credit is
not being extended and is there something we should do?
Mr. BERNANKE. Well, first, the QE2 is not intended to work primarily through banks. It is intended to work through broader markets and we have seen, very open corporate bond markets, in part
because of the monetary policy actions we have taken. So that is
not the direct object of the QE2 and what we have seen is easier,
broader credit conditions as opposed to bank lending specifically.
We have tried to address the bank lending issues in different
ways from a supervisory perspective, and I do not want to take all
your time, but we have a long list of steps we have taken in terms
of guidance, in terms of examiner trading, in terms of outreach, to
try to make banks appreciate and make our own examiners appreciate that what we are looking for here is an appropriate balance.
On the one hand, we do not want banks making bad loans, but on
the other hand, it is good for everybody if they make loans to creditworthy borrowers, and we are encouraging that and encouraging
our examiners to encourage that.
My sense is that although credit conditions are still tight, that
they are improving. I mentioned that in my testimony. We have
seen in our surveys of banks that terms and conditions have
stopped tightening and in some cases have begun to loosen a bit.
Many banks have introduced new programs like second-look programs for looking at small business loans. My sense is that this
year will see some improvement, not anything like what we saw
before the crisis, and that is, in fact, probably a good thing, but we
will see some improvement in bank lending and we are going to
continue to follow that carefully. It is a very high priority for us.
Senator MORAN. I raised this topic in your last appearance with
other regulators before our Committee and I again would tell you
that bankers continue to suggest that the ability to make loans is
significantly hampered by the regulatory environment, and in most
instances, the suggestion, at least, is that those regulations are not
keeping them from making bad loans. They are keeping them from
making good loans. And so again, I would encourage the Fed to
pursue what you outline as your current course of action in a more
significant or strenuous way.
Often, your policy is criticized on QE2, and in doing so, the comparison is made to Japan, and I would like to know your thoughts
about the correlation between what has occurred in the Japanese
economy and its central bank’s response and yours in our economy.

31
And then you indicated earlier that, long-term, our deficits are
not sustainable, and you have had some conversation with my colleagues here on the Committee about not extending the debt ceiling, for example. What are the precipitating factors that you are
concerned about? I know every central banker has got to portray
confidence, but what are the things that are out there that may
make this, when you say long term not sustainable, that long term
becomes a significantly a shorter term? What are the things in the
world economy that we ought to keep our eye on that may change
the timeframe in which we have to operate?
Mr. BERNANKE. First, let me say on your bank issue that we do
have an ombudsman, and I would encourage any bank that has
concerns about Federal Reserve examiners to get in touch with us
and we will try to follow through on that.
Senator MORAN. Thank you.
Mr. BERNANKE. On Japan, the Japanese did a lot of things earlier because they had a bubble and a collapse earlier than we did,
but, one important difference is that, instead of simply focusing on
bank reserves, which have not been lent out very much, we do not
want it to be excessively lent out in the sense that we want it to
be controlled. Otherwise, it would tend to create higher money supply and pose an inflation risk. What we have done instead is focus
on longer-term securities, taking duration out of the market, and
that has the effect of pushing investors into other types of investments and, again, making the corporate bond market more attractive, making the stock market stronger, and the like.
So our approach has been somewhat different than what the Japanese took, but we have faced the same concern that following a
financial crisis, recovery can be quite slow and deflation can be a
risk, and we saw those things happening last summer and that is
why we decided to take additional steps as we have.
On terms of what could bring the fiscal crisis into the present,
it is very hard to know. There is no way, to judge when markets
will change their mind. Currently, 10-year bonds are still 3.5 percent, and currently, they seem to still have the confidence of the
bond markets.
I think what would be a real problem would be if investors saw
not so much the economic capacity, but the political capacity of the
United States as being inadequate to address these problems. If it
became clear that these problems were not going to be adequately
addressed because we were just in a perpetual gridlock, I think
that would raise significant concerns and would risk bringing these
problems forward into the present.
Senator MORAN. Mr. Chairman, thank you. I think we often in
Congress tend to criticize the Fed when so much of this, as you
said earlier, is determined by decisions made here on spending,
deficits, and revenues. Thank you, Mr. Chairman.
Mr. BERNANKE. Thank you.
Chairman JOHNSON. Senator Schumer.
Senator SCHUMER. Thank you, Mr. Chairman, and thank you,
Mr. Chairman.
My first question relates to concentration limits in competitive in
your role as a member of the FSOC group. Section 622 prohibits
any firms whose total liabilities are greater than 10 percent of all

32
financial firms’ liabilities from merging with or acquiring another
company. I am concerned, the way those numbers are calculated
could put U.S. companies at a competitive disadvantage. That is
because for U.S. companies, the number in the numerator includes
all their liabilities worldwide, but for non-U.S. companies, only
their U.S. liabilities. That means if a U.S. company and a Swiss
company simultaneously bought a Brazilian bank, the concentration ratio for the U.S. company would go up and the ratio for the
Swiss company would go down. As I understand it, the FSOC committee has the ability to change that and make it fairer. What are
your thoughts, and what should FSOC do?
Mr. BERNANKE. Well, I fully agree with your concern. It is unfair
in the sense that a foreign bank that has operations in the U.S.
could purchase a domestic U.S. bank where a U.S. bank of the
same size could not buy that bank, and that is an issue——
Senator SCHUMER. Or a foreign bank of the same size.
Mr. BERNANKE. Or a foreign bank. I may be mistaken, but my
understanding is that we did not have discretion——
Senator SCHUMER. You do.
Mr. BERNANKE. Well, I will look at that——
Senator SCHUMER. OK. Good.
Mr. BERNANKE. ——because I do think it is a problem.
Senator SCHUMER. OK. The FSOC the statute says FSOC can, A,
take competitiveness into account, and B, that any rules are subject to the recommendations of FSOC. So you have some discretion
and I hope you will.
Second issue, you have persistently, wisely, in my view, you defer
to Congress on taxing and spending, but I want to ask you a more
general question about the ‘‘when’’ of deficit reduction rather than
the ‘‘how,’’ about the timing of our efforts to reduce the deficit. Last
month when you were testifying before the House Budget Committee, you said the following, and I am quoting, ‘‘This very moment is not time to radically reduce our spending or raise our taxes
because the economy is still in a recovery mode and needs that
support.’’
Now, private economists seem to agree. Mark Zandi yesterday in
his report said too much cutting too soon would be counterproductive and would be taking an unnecessary chance with recovery. Do you agree with those sentiments?
Mr. BERNANKE. Yes, if I may add a small qualification, only
that——
Senator SCHUMER. No, do not do that.
[Laughter.]
Mr. BERNANKE. Thank you, Senator. Only that it is important to
be showing progress, and therefore, I hope that we will take a longterm perspective and do things that will be persuasive to the market, and that over time——
Senator SCHUMER. Yes.
Mr. BERNANKE. ——we are committed to——
Senator SCHUMER. I do not disagree with that caveat, at all. I
mean, that is a fair caveat. But in the short term, we had better
be careful not to snuff out this nascent recovery by doing too much
cutting, in the words of Zandi. That is correct, in your opinion?
Mr. BERNANKE. Yes.

33
Senator SCHUMER. OK. Do you also agree—he said that cuts, significant cuts could cause job loss. Those cuts would create job loss.
I do not mean overall job loss, macro, but those cuts could. Do you
agree with that?
Mr. BERNANKE. That cuts would presumably lower overall demand in the economy, would have some effect on growth and employment.
Senator SCHUMER. Good. So the answer is yes?
Mr. BERNANKE. Yes.
Senator SCHUMER. Thank you, Mr. Chairman.
Chairman JOHNSON. Senator Kirk.
Senator KIRK. Thank you, Mr. Chairman.
I would just like to briefly comment for you on the work, This
Time is Different, by Reinhart and Rogoff. What do you think?
Mr. BERNANKE. Well, Ken Rogoff is one of my long-term colleagues and friends and I have great respect for both him and for
Ms. Reinhart and I think it is a very interesting piece of work. It
is particularly instructive because it uses a lot of historical episodes, data, as opposed to a purely theoretical approach to the
problem.
Senator KIRK. I think it is an important piece of work. You were
effusive in your praise, at least on Amazon, I saw, and I thought
it was—the title is important, because every central banker or economic official says, this time is different, and yet the basic themes
of debasing a currency, inflation, lack of spending discipline,
Reinhart and Rogoff highlight the similarity of poor action by bankers and governments to destroy their economy through a lack of
discipline, and it is an important lesson for us.
We have a report from the National Council of State Legislators
that talk about financial stress now in 12 American States. Just recently, the State of Illinois borrowed another $3.7 billion, paying 50
basis points more to borrow than corporate debt at the lowest investment grade.
You and I talked earlier about the potential of States posing a
systemic risk to our economy. Do you feel that they could pose a
systemic risk?
Mr. BERNANKE. It is possible, but currently, while States are facing very tough financial conditions, at least as long as the recovery
continues, they are seeing higher tax revenues and that will at
least be helpful to some of them in trying to address these problems. But obviously this is something we have to watch carefully.
Senator KIRK. Certainly a panic in the State and municipal bond
market could trigger a systemic risk, in your view?
Mr. BERNANKE. If it was sufficiently severe, yes.
Senator KIRK. Yes. You have expressed opposition to any Federal
bailout of the States, is that correct?
Mr. BERNANKE. I think that it is a Congressional, Federal matter. It is not a Federal Reserve matter. The Federal Reserve is not
going to be involved in that. If Congress wants to address it, that
is——
Senator KIRK. What would your view be to accelerate Federal
borrowing to give money to the States?

34
Mr. BERNANKE. Again, I think that is a Congressional decision.
If you are going to be increasing borrowing, obviously, that bears
its own risks.
Senator KIRK. Right, I think tremendous. Would you regard the
proposal to defer State payments of principal and debt on loans
made from the Federal Government as a State bailout?
Mr. BERNANKE. Well, to some extent, it has fiscal implications for
the Federal Government.
Senator KIRK. I would think so. Also, maybe we could use language that is more clear. In your testimony on page five, you
talked about we are considering providing additional monetary accommodation through further asset purchases. In November, the
committee announced that it intended to purchase an additional
$600 billion in longer-term Treasury securities in the middle of this
year. In more layman’s terms, you are talking about lending money
to the U.S. Government, correct?
Mr. BERNANKE. Well, not exactly, because we are buying these
securities on the secondary market. So somebody has already lent
the money directly, but yes, we are holding Government debt.
Senator KIRK. Yes, my point exactly. Section 14 of the Federal
Reserve Act legally prevents you from—well, this would say from
buying newly issued securities, which in a more layman’s term
would be lending directly to the U.S. Government.
Mr. BERNANKE. And that is why we are not doing that.
Senator KIRK. Right. But instead, what you do is others lend to
the U.S. Government and then you buy their loans.
Mr. BERNANKE. Well, we do that all the time, even in most normal conditions.
Senator KIRK. Correct. The CRS says, in modern times, the Fed
has always held Treasury securities as part of normal operations,
but now under QE2, it is a $600 billion commitment.
But the CRS goes on to say, nonetheless, the effect of the Fed’s
purchase of Treasury securities on the Federal budget is similar to
monetization, whether the Fed buys securities on the secondary
market or directly from Treasury. When the Fed holds Treasury securities, Treasury must pay interest to the Fed as it would to any
private investor. These interest payments after expenses become
part of the profits of the Fed. The Fed, in turn, remits 95 percent
of the profits to the Treasury, where it is added to the general revenues. CRS concludes, in essence, the Fed has made an interest-free
loan to the Treasury because almost all of the interest paid by the
Treasury to the Fed is subsequently sent back to the Treasury.
Would you agree with that?
Mr. BERNANKE. Yes, we have remitted $125 billion to the Treasury in the last 2 years. So it is important to understand that what
we are doing is not fiscal spending. It is, in fact, purchasing securities which we will then sell back to the market.
Senator KIRK. So because of Section 14 of the Act, maybe the
simple way of saying it is others are lending money to the Federal
Government. You are purchasing those loans, and then the interest
payments being made to you because you are now the holder of
the—or you are the official maker of the loan—are then remitted
back to the Treasury. So maybe in layman’s terms, this is one part
of the Government lending another part of the Government money,

35
which would not lead to long-term confidence once the American
people understood the basics a little bit better.
Mr. BERNANKE. Well, it should be added that we also have a
funding cost, and as interest rates go up, we will have a liability
cost as well as an asset cost. So it may or may not be a return to
the Treasury.
Monetary policy, even in most normal times, as the CRS says, involves buying and selling Treasury securities. We could not have
currency outstanding if we did not have securities to back them up.
Senator KIRK. Although I would say, we had a currency for many
parts of our history without any Federal debt.
Mr. BERNANKE. When was that?
Senator KIRK. Under the Jackson administration.
Mr. BERNANKE. So this was before the Civil War. This was during the period where individual banks issued currency. We did not
have a national currency.
Senator KIRK. I just might say that it is possible for a country
to have a currency without a trillion-dollar debt.
Mr. BERNANKE. Yes.
Senator KIRK. Thank you.
Chairman JOHNSON. Senator Kohl.
Senator KOHL. Thank you, Mr. Chairman.
Chairman Bernanke, I would like to ask you two questions. The
first question will be about rising oil prices. The second question
will be about interchange fees. First, Mr. Chairman, we all agree
that the rising price of oil will slow the economic recovery. To me,
one of the most anticompetitive forces in the world, which raises
the price of oil, are the price-fixing activities of the 12 member nations of OPEC oil cartel.
I have a bill, Mr. Chairman, called NOPEC that would, for the
first time, make the actions of OPEC subject to U.S. antitrust law.
This bipartisan bill passed the Senate 4 years ago with 70 votes.
Mr. Chairman, if this price-fixing cartel did not exist, wouldn’t the
market function better and wouldn’t oil prices be lower? I would
like your comment after I make my second question to you.
Interchange fees. The issue of interchange fees is very controversial, as you know. In the recent Wall Street Reform Bill, Congress
exempted small banks and credit unions so that they would not be
impacted by any attempt to regulate interchange fees. But small
banks are still worried that they will be discriminated against.
Now, you and your staff are smart people, so can you see that
the interests of small banks and credit unions are protected when
you write the interchange rule?
Mr. BERNANKE. Senator, on the first one, on OPEC, it is difficult
to tell how much impact on the price OPEC has. It is a global market and there are non-OPEC producers. What OPEC does try to do
is set production quotas, that are restrictive, but they are violated
to some extent, you know, because it is very hard to monitor them.
So I do not honestly know how big an affect OPEC has on oil
prices.
On the interchange fees, we are following the law and we are
certainly exempting the small banks and credit unions from the
limits and other restrictions on the interchange fees that they can

36
charge. Whether or not there will be any effect on the interchange
fees charged by small banks remains to be seem.
There are really, two issues. One is whether the networks, which
are not required to differentiate in their payments to small banks
and to others, whether they do have a two-tier pricing system or
whether they find it, for one reason or another, inconvenient or uneconomic to do so.
The other factor which may affect the interchange fees for smaller institutions is the fact that with the route with the network
competition that is required by the bill, there may be some general
downward pressure on interchange fees just coming from the fact
that there is more competition in the marketplace and that may affect small banks to some extent.
So I think there are some things we cannot fully control. That
being said, we are certainly trying to write the rule in a way that
will achieve Congress’ intention and provide exemptions for banks
under 10 billion and for the other kinds of debit cards that receive
the exemption.
Senator KOHL. Can you say to us that that goal that you are trying to hard to achieve when you write the rule is something that
you are going to exert tremendous effort and energy on in order to
see to it that you do meet that goal?
Mr. BERNANKE. We will do everything we can, but there are certain areas where we do not have control. For example, we cannot
dictate the pricing policies of the networks, and it was part of the
goal of the bill to put competitive pressure on interchange fees in
general, and Congress chose not to exempt smaller institutions
from that particular provision. So they are still subject to the competitive pressures arising from multiple networks.
But again, we understand the intent of Congress and we will do
everything that has been given to us via the statute to try to
achieve that objective.
Senator KOHL. Thank you so much. Thank you, Mr. Chairman.
Chairman JOHNSON. Senator DeMint.
Senator DEMINT. Thank you, Mr. Chairman.
Mr. Chairman, thank you for being here. Just a quick follow-up
on Senator Kirk’s question. Can you tell us absolutely that there
will be no quantitative easing for States and no buying of State
debt by the Federal Reserve?
Mr. BERNANKE. I can say that, yes.
Senator DEMINT. OK, good. Thank you. There are a lot of different economic and political philosophies here in the Congress,
and I think oftentimes, we may look to you to help provide some
consensus, so I have got a couple of just general questions.
Do you generally agree that the private sector is a more efficient
allocator of resources than the Government?
Mr. BERNANKE. In most spheres. There are a few areas where
the Government plays an important role, like defense.
Senator DEMINT. Sure. But so generally, a dollar left in the private sector provides a greater economic multiplier than a dollar
taken by Government and spent?
Mr. BERNANKE. Again, there are some areas where the Government plays an important role.

37
Senator DEMINT. Sure. But just generally, could we generally
conclude that the Government taxing and spending is not as an effective stimulus to the economy as money that is kept and spent
and invested in the private sector?
Mr. BERNANKE. It sounds like the conclusion of your argument
is that taxes should be zero and I would not argue that.
Senator DEMINT. No, no, but generally, as far as—I mean, I am
not talking about essential services like military, but as we are
looking at raising taxes versus cutting spending in the debates we
are going through now, I mean, I think a basic underlying economic philosophy is the private is the more efficient allocator of resources. Building a consensus here is very difficult and we are
often talking about effects rather than true causes. But I will move
on from there just to ask a couple of other questions.
Government spending and debt and borrowing obviously tightens
credit, and that brings about—forces your hand to some degree
with the quantitative easing. Is that a simple way to explain it? If
we were not in debt, you would not need to do the QE, right?
Mr. BERNANKE. I am not sure about that. The recession was tied
primarily to the financial crisis, which drove the economy into a
deep recession, and that in turn led to inflation falling toward the
deflation zone, and the weakness of the economy and the deflation
risk were the things that motivated us.
Senator DEMINT. But if there was no debt problem, then you
would be looking at other ways to stimulate the economy than actually buying Federal Reserve notes; is that right? I mean, excuse
me, Treasury notes.
Mr. BERNANKE. Well, if there were no debt to buy, we would
have to find some other way to do it.
Senator DEMINT. Right. What I am trying to get at is, when is
enough enough as far as what the Federal Reserve will do with
quantitative easing in the future? If we continue on our path, or
even cut the projected deficits in half, do you expect to continue to
buy more and more Treasury notes?
Mr. BERNANKE. Well, first, if you were able to do that, I think
it would be helpful for the economy. It would probably lower interest rates. It would probably increase confidence. So I urge you to
continue to address the fiscal issue. Our quantitative easing policy,
which is just another form of monetary policy, is trying to address
the recovery of the economy right now, which is still underway.
As I said in my testimony, it looks like a self-sustaining recovery
is beginning to take place, so that is encouraging. But what we will
be looking at is the state of the economy. Our mandate from Congress is to look at inflation and employment, so those are the
things that we will be looking at as we determine how to withdraw
or maintain our policy.
Senator DEMINT. The quantitative easing, monetizing of debt, or
however we term that, has caused some concern about our currency, the long-term value of our currency, and it has caused a lot
of us to look at ways to create a more substantial or more soundness and stability to our monetary policy. In 1981, former Chairman Greenspan, wrote in the Wall Street Journal about an idea of
using 5-year notes payable in gold that the Federal Reserve would
issue—excuse me—the Treasury Department, payable in gold or

38
dollars to create some standard, as just a test. A lot of folks are
talking about some form of standard, some way to create some
boundaries for our monetary policy.
Have you given any thought to the idea of a gold standard or
ways like that, issuing bonds payable in gold that would begin to
create some standard for our currency?
Mr. BERNANKE. Well, first, I would just say that the Federal Reserve is not debasing the currency; that the dollar’s value is roughly the same as it was before the crisis in foreign exchange markets;
that inflation is low and that is the buying power of the dollar. So
I think those concerns are somewhat overstated, in fact, way overstated.
On the gold standard, I have done a lot of study of that and it
did deliver price stability over very long periods of time, but over
shorter periods of time, it caused wide swings in prices related to
changes in demand or supply of gold. So I do not think it is a panacea. And there are also other practical problems like the fact that
we do not have enough gold to support our money supply.
Senator DEMINT. The question is about just the bond. That is
what Greenspan was talking about. Is that something that you
have given any thought to?
Mr. BERNANKE. I really have not analyzed that, that particular
point. I do not think that a full-fledged gold standard would be
practical at this point.
Senator DEMINT. OK. I realize I am out of time. I apologize, Mr.
Chairman. Thank you.
Chairman JOHNSON. Senator Toomey.
Senator TOOMEY. Thank you, Mr. Chairman, and thank you,
Chairman Bernanke, for your patience. I think I am last, so that
must be a bit of a relief.
I would like to very briefly, if we could, go back to this discussion
that we had earlier about the debt limit, because I think it is a
huge mistake and factually incorrect for some to suggest that failure to immediately raise the debt limit is equal to a default on our
debt. I am not accusing you of saying that, but I know others have.
I am sure that you are well aware that the total fraction of projected Government spending next year that would be necessary to
service our debt is about 6 percent. Even if the debt limit were not
raised, ongoing tax revenue amounts to nearly 70 percent of the
projected spending.
So as much as I acknowledge that it would be extremely disruptive, and so I am hoping that we will have an appropriate and
timely increase in the debt limit, given that there is so vastly much
more in revenue than what is necessary to honor our debt obligations, it seems to me that a Treasure Secretary would have to willfully choose to default on our bonds. It is unfathomable to me that
any Treasury Secretary would make such an imprudent decision.
And so, I guess my brief question, if I could—I’d like to get on
to monetary policy is, would you acknowledge that markets understand the difference between an unfortunate and temporary delay
in a payment to a vendor, which they have seen before, on the one
hand, versus failure to make an interest or a principal payment on
our Treasury securities, which we have never done before?

39
Mr. BERNANKE. My concern is not necessarily just a question of
willful decision. There are technical problems associated with making payments, including the fact that notwithstanding the facts,
the data that you gave, that on a day-to-day basis, the amount of
principal and interest which is due might exceed the free cash that
the Treasury has. So I am worried about this. I am worried about
the assurance that we would not risk failing to pay the debt.
Senator TOOMEY. Well, I want to get back to this point, but as
a former bond trader who earned a living trading fixed income securities and derivatives, I have to tell you, the market knows the
difference between delaying a payment to the guys who cut the
grass on the Mall, and failure to make a bond payment. It is a
huge difference and I really do not think we should be even pretending that there is any equivalence between those two.
On the QE2, and let me just preface by saying, I thought that
many of the extraordinary measures that you guys took in 2008,
did not agree with all of them, but I felt that—I did agree with
many and I recognize that they were decisions being made during
a crisis.
But we are not in a financial crisis now. We are in a subpar economic recovery, way subpar in terms of job growth, and we are all
disappointed by it. But what concerns me is that the problems that
I perceive affecting our economy are not fundamentally monetary
in nature. It does not seem to me that we have a lack of money
supply, that we have a lack of liquidity that is driving the biggest
problems that we have.
And when I look at some of the conventional ways of looking at
monetary policy, whether you look at the Taylor Rule or whether
you look at growth by some measures of money supply, or whether
you look at commodity prices, the breadth and scope of which has
been, I think, stunning, you look at all of these things and many
of them suggest that at a minimum, we are planting the seeds of
serious inflation down the road.
I also worry that excessive expansion of the money supply creates the illusion of growth, but not real growth. So I guess my concern is, if the economy remains weak, are there any—you know,
what measures of inflation? Are there any changes in asset prices
that would cause you to decide that despite a weak economy, we
need to pull back on this quantitative ease?
Mr. BERNANKE. Well, first, I think that many of the monetary or
nominal indicators that somebody like Milton Friedman would look
at did suggest the need for more monetary stimulus. For example,
nominal GDP has grown very slowly. I am not talking about the
reserves held by banks, which are basically idle, but if you look at
M–1 and M–2, those have grown pretty slowly.
The Taylor Rule suggests that we should be, way below zero in
our interest rate, and therefore, we need some method other than
just normal interest rate changes to——
Senator TOOMEY. Do you know if Mr. Taylor believes that?
Mr. BERNANKE. Well, there are different versions of the Taylor
Rule, and there is no particular reason to pick the one he picked
in 1993. In fact, he preferred a different one in 1999, which if you
use that one, gives you a much different answer.

40
Senator TOOMEY. My understanding is that his view of his own
rule is that it would call for a higher Fed funds rates than what
we have now.
Mr. BERNANKE. There are many ways of looking at that rule, and
I think that ones that look at history, ones that are justified by
modeling analysis, many of them suggest that we should be well
below zero, and I just would disagree that that is the only way to
look at it. But anyway, I think there is some basis for doing that.
I am sorry. The last part of your question was?
Senator TOOMEY. Whether there are——
Mr. BERNANKE. Yeah, I am sorry.
Senator TOOMEY. What, in a context of even unfortunately slow
economy growth should that persist? What kind of inflation indication would cause you to——
Mr. BERNANKE. Sir, we are committed. A few economists have
suggested temporarily raising inflation above normal levels as a
way of trying to stimulate the economy. We have rejected that approach and we are committed to not letting inflation go above sort
of the normal level of around 2 percent in the medium term.
So we are looking very carefully at indicators of inflation, including actual inflation, including commodity prices, including the
spreads between nominal and index bonds, which is a measure of
inflation compensation, looking at surveys, business pricing plans,
household inflation expectations. We look at a whole variety of
things and I just want to assure you, we take the inflation issue
very, very seriously and we do not have the illusion that allowing
inflation to get high is, in any way, a constructive thing to do and
we are not going to do that.
Senator TOOMEY. I see my time is expired. Thank you, Mr.
Chairman.
Chairman JOHNSON. Thank you. Senator Shelby has a couple additional questions.
Senator SHELBY. Thank you for your indulgence, Mr. Chairman.
In a recent article, Dr. Martin Feldstein, who is well known,
former president of the National Bureau of Economic Research,
asked an important question about QE. And he says, Does the artificial support for the bond market, inequities from QE2 mean that
we are looking at asset price bubbles that may come to an end before the year is over?
Chairman Bernanke, what data do you examine to calculate the
risk of creating asset bubbles within QE2? Is that a real concern?
Mr. BERNANKE. It is something, Senator, that we pay a great
deal of attention to. We have created a new office called the Office
of Financial Stability——
Senator SHELBY. OK.
Mr. BERNANKE. ——which is providing regular reports and data
to the FOMC as well as to the supervisors. If you look at most indicators of equity markets, bond markets, and the like, while of
course nobody can know for sure, there seems little evidence of any
significant bubbles. Where there have been concerns, a few people
have noted the increase in farmland prices.
We have been following that carefully and we have been in substantial contact with the agricultural banks that lend to the farmers to make sure that they are appropriately managing that risk.

41
So we are very attentive to that and I do not believe that there is
a dangerous bubble in U.S. financial markets.
Senator SHELBY. Shifting over to Basel 3 capital standards, your
counterpart at the Bank of England, Governor Mervyn King, recently gave a speech in which he stated that the new Basel 3 capital standards are, quote, insufficient to prevent another crisis. He
went on to say that capital requirements should be several orders
of magnitude higher.
Do you agree with Governor King’s view that the Basel 3 capital
standards are insufficient to prevent another crisis, or do we not
know yet?
Mr. BERNANKE. Several orders of magnitude would mean 700
percent capital.
Senator SHELBY. It would be a lot.
Mr. BERNANKE. The capital under Basel 3 is a multiple of what
it was under Basel 2 and also of higher quality, because it is common equity.
Senator SHELBY. It is a big improvement, isn’t it?
Mr. BERNANKE. It is a substantial improvement. In addition, the
risk weights against which capital is calculated on the assets held
by the banks are much more sensitive to risk and less liberal than
in the earlier version of Basel.
So there has been a substantial improvement in the amount of
capital and quality of capital that banks have. In addition, as required both by the Basel agreement and by Dodd-Frank, to have
additional capital for systemically significant banks, and we are
looking at how best to do that.
We agreed with the consensus of about 7 percent high quality
capital in Basel based on looking at worst case losses to banks over
the last 50 years, and it was our assessment that that amount of
capital would have prevented any banks from failing in the crisis
that we just suffered through.
So although there is more to be done in terms of adding some
additional capital to the most systemically significant banks, I do
think that we have made a lot of progress and I do not agree with
the view that this is likely to lead to another crisis.
Senator SHELBY. Do you believe that it is very important for—
and you are a regulator, too—that any bank with strong regulators,
strong capital, and good strong management will generally survive?
Mr. BERNANKE. Yes, except in the worst economic conditions. We
have also, I should add, we have added a leverage ratio which will
now be international, not just for the United States.
Senator SHELBY. How would that work?
Mr. BERNANKE. Well, there is a leverage ratio which will apply
to risk weighted assets and it is currently in an observation period.
But the previous situation was one in which only United States
banks were required to have a minimum amount of capital as a
fraction of total assets, and now all banks, including European and
other competitors, will have to have that.
The other thing we are doing is adding liquidity requirements.
In the crisis, a lot of the problems arose when banks that were
technically solvent were unable to meet their short-term liquidity
demands and we want to address that as well. So I think these will
be much stronger than we had before overall.

42
Senator SHELBY. Thank you, Mr. Chairman.
Chairman JOHNSON. Thanks again to my colleagues and Chairman Bernanke for being here today. Economic growth is one of this
Committee’s top priorities and we will do all we can to formulate
policies that help support us——
Senator Corker, do you have additional questions?
Senator CORKER. Are you wrapping it up? I will submit it in
writing.
Chairman JOHNSON. ——that helps us support a sustainable economic recovery. I will remind my colleagues that we will leave the
record open for the next 7 days for Members to submit their questions for Chairman Bernanke. This hearing is adjourned.
Mr. BERNANKE. Thank you.
[Whereupon, at 12:26 p.m., the hearing was adjourned.]
[Prepared statements, responses to written questions, and additional material supplied for the record follow:]

43
PREPARED STATEMENT OF BEN S. BERNANKE
CHAIRMAN, BOARD

OF

GOVERNORS

OF THE

FEDERAL RESERVE SYSTEM

MARCH 1, 2011
Chairman Johnson, Ranking Member Shelby, and other Members of the Committee, I am pleased to present the Federal Reserve’s semiannual Monetary Policy
Report to the Congress. I will begin with a discussion of economic conditions and
the outlook before turning to monetary policy.
The Economic Outlook
Following the stabilization of economic activity in mid-2009, the U.S. economy is
now in its seventh quarter of growth; last quarter, for the first time in this expansion, our Nation’s real gross domestic product (GDP) matched its precrisis peak.
Nevertheless, job growth remains relatively weak and the unemployment rate is
still high.
In its early stages, the economic recovery was largely attributable to the stabilization of the financial system, the effects of expansionary monetary and fiscal policies,
and a strong boost to production from businesses rebuilding their depleted inventories. Economic growth slowed significantly in the spring and early summer of
2010, as the impetus from inventory building and fiscal stimulus diminished and
as Europe’s debt problems roiled global financial markets. More recently, however,
we have seen increased evidence that a self-sustaining recovery in consumer and
business spending may be taking hold. Notably, real consumer spending has grown
at a solid pace since last fall, and business investment in new equipment and software has continued to expand. Stronger demand, both domestic and foreign, has
supported steady gains in U.S. manufacturing output.
The combination of rising household and business confidence, accommodative
monetary policy, and improving credit conditions seems likely to lead to a somewhat
more rapid pace of economic recovery in 2011 than we saw last year. The most recent economic projections by Federal Reserve Board members and Reserve Bank
presidents, prepared in conjunction with the Federal Open Market Committee
(FOMC) meeting in late January, are for real GDP to increase 31⁄2 to 4 percent in
2011, about one-half percentage point higher than our projections made in November. 1 Private forecasters’ projections for 2011 are broadly consistent with those of
the FOMC participants and have also moved up in recent months. 2
While indicators of spending and production have been encouraging on balance,
the job market has improved only slowly. Following the loss of about 83⁄4 million
jobs from early 2008 through 2009, private-sector employment expanded by only a
little more than 1 million during 2010, a gain barely sufficient to accommodate the
inflow of recent graduates and other entrants to the labor force. We do see some
grounds for optimism about the job market over the next few quarters, including
notable declines in the unemployment rate in December and January, a drop in new
claims for unemployment insurance, and an improvement in firms’ hiring plans.
Even so, if the rate of economic growth remains moderate, as projected, it could be
several years before the unemployment rate has returned to a more normal level.
Indeed, FOMC participants generally see the unemployment rate still in the range
of 71⁄2 to 8 percent at the end of 2012. Until we see a sustained period of stronger
job creation, we cannot consider the recovery to be truly established.
Likewise, the housing sector remains exceptionally weak. The overhang of vacant
and foreclosed houses is still weighing heavily on prices of new and existing homes,
and sales and construction of new single-family homes remain depressed. Although
1 Forecast ranges here and below refer to the central tendencies of the projections of FOMC
participants, as presented in the ‘‘Summary of Economic Projections’’ released with the minutes
of the January FOMC meeting, available at www.federalreserve.gov/monetarypolicy/
fomcminutes20110126ep.htm.
2 For example, both the Survey of Professional Forecasters (see, the first quarter 2011 survey
released by the Federal Reserve Bank of Philadelphia on February 11, available at
www.philadelphiafed.org/research-and-data/real-time-center/survey-of-professional-forecasters)
and the Blue Chip forecasting panel (see, the February 10, 2010, issue of Blue Chip Economic
Indicators (New York: Aspen Publishers)) now project real GDP growth of about 31⁄2 percent
from the fourth quarter of 2010 to the fourth quarter of 2011, about one-half percentage point
higher than the corresponding projections made in August. Looking further ahead, most FOMC
participants project that economic growth will pick up a bit more in 2012 and 2013, whereas
private forecasters tend to see the expansion proceeding fairly steadily over the next few years.
(Note: Blue Chip Economic Indicators and Blue Chip Financial Forecasts are publications owned
by Aspen Publishers. Copyright © 2009 by Aspen Publishers, Inc. All rights reserved;
www.aspenpublishers.com.)

44
mortgage rates are low and house prices have reached more affordable levels, many
potential homebuyers are still finding mortgages difficult to obtain and remain concerned about possible further declines in home values.
Inflation has declined, on balance, since the onset of the financial crisis, reflecting
high levels of resource slack and stable longer-term inflation expectations. Indeed,
over the 12 months ending in January, prices for all of the goods and services consumed by households (as measured by the price index for personal consumption expenditures (PCE)) increased by only 1.2 percent, down from 2.5 percent in the yearearlier period. Wage growth has slowed as well, with average hourly earnings increasing only 1.9 percent over the year ending in January. In combination with productivity increases, slow wage growth has implied very tight restraint on labor costs
per unit of output.
FOMC participants see inflation remaining low; most project that overall inflation
will be about 11⁄4 to 13⁄4 percent this year and in the range of 1 to 2 percent next
year and in 2013. Private-sector forecasters generally also anticipate subdued inflation over the next few years. 3 Measures of medium- and long-term inflation compensation derived from inflation-indexed Treasury bonds appear broadly consistent
with these forecasts. Surveys of households suggest that the public’s longer-term inflation expectations also remain stable.
Although overall inflation is low, since summer we have seen significant increases
in some highly visible prices, including those of gasoline and other commodities. Notably, in the past few weeks, concerns about unrest in the Middle East and North
Africa and the possible effects on global oil supplies have led oil and gasoline prices
to rise further. More broadly, the increases in commodity prices in recent months
have largely reflected rising global demand for raw materials, particularly in some
fast-growing emerging market economies, coupled with constraints on global supply
in some cases. Commodity prices have risen significantly in terms of all major currencies, suggesting that changes in the foreign exchange value of the dollar are unlikely to have been an important driver of the increases seen in recent months.
The rate of pass-through from commodity price increases to broad indexes of U.S.
consumer prices has been quite low in recent decades, partly reflecting the relatively
small weight of materials inputs in total production costs as well as the stability
of longer-term inflation expectations. Currently, the cost pressures from higher commodity prices are also being offset by the stability in unit labor costs. Thus, the
most likely outcome is that the recent rise in commodity prices will lead to, at most,
a temporary and relatively modest increase in U.S. consumer price inflation—an
outlook consistent with the projections of both FOMC participants and most private
forecasters. That said, sustained rises in the prices of oil or other commodities would
represent a threat both to economic growth and to overall price stability, particularly if they were to cause inflation expectations to become less well anchored. We
will continue to monitor these developments closely and are prepared to respond as
necessary to best support the ongoing recovery in a context of price stability.
Monetary Policy
As I noted earlier, the pace of recovery slowed last spring—to a rate that, if sustained, would have been insufficient to make meaningful progress against unemployment. With job creation stalling, concerns about the sustainability of the recovery increased. At the same time, inflation—already at very low levels—continued to
drift downward, and market-based measures of inflation compensation moved lower
as investors appeared to become more concerned about the possibility of deflation,
or falling prices. 4
Under such conditions, the Federal Reserve would normally ease monetary policy
by reducing the target for its short-term policy interest rate, the Federal funds rate.
However, the target range for the Federal funds rate has been near zero since December 2008, and the Federal Reserve has indicated that economic conditions are
likely to warrant an exceptionally low target rate for an extended period. Consequently, another means of providing monetary accommodation has been necessary
since that time. In particular, over the past 2 years the Federal Reserve has eased
monetary conditions by purchasing longer-term Treasury securities, agency debt,
and agency mortgage-backed securities (MBS) on the open market. The largest program of purchases, which lasted from December 2008 through March 2010, appears
3 The Survey of Professional Forecasters projects PCE inflation to run at about 11⁄2 percent
in 2011 and to subsequently rise gradually to nearly 2 percent by 2013. The corresponding projections from the Survey of Professional Forecasters for Consumer Price Index (CPI) inflation
are about 13⁄4 percent this year and about 2 percent next year and in 2013. Blue Chip forecasts
for CPI inflation stand at about 2 percent for both 2011 and 2012.
4 For example, deflation probabilities inferred from prices of certain inflation-indexed bonds
increased during this period.

45
to have contributed to an improvement in financial conditions and a strengthening
of the recovery. Notably, the substantial expansion of the program announced in
March 2009 was followed by financial and economic stabilization and a significant
pickup in the growth of economic activity in the second half of that year.
In August 2010, in response to the already-mentioned concerns about the sustainability of the recovery and the continuing declines in inflation to very low levels,
the FOMC authorized a policy of reinvesting principal payments on our holdings of
agency debt and agency MBS into longer-term Treasury securities. By reinvesting
agency securities, rather than allowing them to continue to run off as our previous
policy had dictated, the FOMC ensured that a high level of monetary accommodation would be maintained. Over subsequent weeks, Federal Reserve officials noted
in public remarks that we were considering providing additional monetary accommodation through further asset purchases. In November, the Committee announced
that it intended to purchase an additional $600 billion in longer-term Treasury securities by the middle of this year.
Large-scale purchases of longer-term securities are a less familiar means of providing monetary policy stimulus than reducing the Federal funds rate, but the two
approaches affect the economy in similar ways. Conventional monetary policy easing
works by lowering market expectations for the future path of short-term interest
rates, which, in turn, reduces the current level of longer-term interest rates and contributes to both lower borrowing costs and higher asset prices. This easing in financial conditions bolsters household and business spending and thus increases economic activity. By comparison, the Federal Reserve’s purchases of longer-term securities, by lowering term premiums, put downward pressure directly on longer-term
interest rates. By easing conditions in credit and financial markets, these actions
encourage spending by households and businesses through essentially the same
channels as conventional monetary policy.
A wide range of market indicators supports the view that the Federal Reserve’s
recent actions have been effective. For example, since August, when we announced
our policy of reinvesting principal payments on agency debt and agency MBS and
indicated that we were considering more securities purchases, equity prices have
risen significantly, volatility in the equity market has fallen, corporate bond spreads
have narrowed, and inflation compensation as measured in the market for inflationindexed securities has risen to historically more normal levels. Yields on 5- to 10year nominal Treasury securities initially declined markedly as markets priced in
prospective Fed purchases; these yields subsequently rose, however, as investors became more optimistic about economic growth and as traders scaled back their expectations of future securities purchases. All of these developments are what one would
expect to see when monetary policy becomes more accommodative, whether through
conventional or less conventional means. Interestingly, these market responses are
almost identical to those that occurred during the earlier episode of policy easing,
notably in the months following our March 2009 announcement. In addition, as I
already noted, most forecasters see the economic outlook as having improved since
our actions in August; downside risks to the recovery have receded, and the risk
of deflation has become negligible. Of course, it is too early to make any firm judgment about how much of the recent improvement in the outlook can be attributed
to monetary policy, but these developments are consistent with it having had a beneficial effect.
My colleagues and I continue to regularly review the asset purchase program in
light of incoming information, and we will adjust it as needed to promote the
achievement of our mandate from the Congress of maximum employment and stable
prices. We also continue to plan for the eventual exit from unusually accommodative
monetary policies and the normalization of the Federal Reserve’s balance sheet. We
have all the tools we need to achieve a smooth and effective exit at the appropriate
time. Currently, because the Federal Reserve’s asset purchases are settled through
the banking system, depository institutions hold a very high level of reserve balances with the Federal Reserve. Even if bank reserves remain high, however, our
ability to pay interest on reserve balances will allow us to put upward pressure on
short-term market interest rates and thus to tighten monetary policy when required. Moreover, we have developed and tested additional tools that will allow us
to drain or immobilize bank reserves to the extent needed to tighten the relationship between the interest rate paid on reserves and other short-term interest rates. 5
5 These tools include the ability to execute term reverse repurchase agreements with the primary dealers and other counterparties, which drains reserves from the banking system; and the
issuance of term deposits to depository institutions, which immobilizes bank reserves for the period of the deposit.

46
If necessary, the Federal Reserve can also drain reserves by ceasing the reinvestment of principal payments on the securities it holds or by selling some of those
securities in the open market. The FOMC remains unwaveringly committed to price
stability and, in particular, to achieving a rate of inflation in the medium term that
is consistent with the Federal Reserve’s mandate.
Federal Reserve Transparency
The Congress established the Federal Reserve, set its monetary policy objectives,
and provided it with operational independence to pursue those objectives. The Federal Reserve’s operational independence is critical, as it allows the FOMC to make
monetary policy decisions based solely on the longer-term needs of the economy, not
in response to short-term political pressures. Considerable evidence supports the
view that countries with independent central banks enjoy better economic performance over time. 6
However, in our democratic society, the Federal Reserve’s independence brings
with it the obligation to be accountable and transparent. The Congress and the public must have all the information needed to understand our decisions, to be assured
of the integrity of our operations, and to be confident that our actions are consistent
with the mandate given to us by the Congress.
On matters related to the conduct of monetary policy, the Federal Reserve is one
of the most transparent central banks in the world, making available extensive
records and materials to explain its policy decisions. For example, beyond the semiannual Monetary Policy Report I am presenting today, the FOMC provides a
postmeeting statement, a detailed set of minutes 3 weeks after each policy meeting,
quarterly economic projections together with an accompanying narrative, and, with
a 5-year lag, a transcript of each meeting and its supporting materials. In addition,
FOMC participants often discuss the economy and monetary policy in public forums,
and Board members testify frequently before the Congress.
In recent years the Federal Reserve has also substantially increased the information it provides about its operations and its balance sheet. In particular, for some
time the Federal Reserve has been voluntarily providing extensive financial and
operational information regarding the special credit and liquidity facilities put in
place during the financial crisis, including full descriptions of the terms and conditions of each facility; monthly reports on, among other things, the types of collateral
posted and the mix of participants using each facility; weekly updates about borrowings and repayments at each facility; and many other details. 7 Further, on December 1, as provided by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, the Federal Reserve Board posted on its public Web site the details
of more than 21,000 individual credit and other transactions conducted to stabilize
markets and support the economic recovery during the crisis. This transaction-level
information demonstrated the breadth of these operations and the care that was
taken to protect the interests of the taxpayer; indeed, despite the scope of these actions, the Federal Reserve has incurred no credit losses to date on any of the programs and expects no credit losses in any of the few programs that still have loans
outstanding. Moreover, we are fully confident that independent assessments of these
programs will show that they were highly effective in helping to stabilize financial
markets, thus strengthening the economy. Overall, the operational effectiveness of
the programs was recently supported as part of a comprehensive review of six lending facilities by the Board’s independent Office of Inspector General. 8 In addition,
we have been working closely with the Government Accountability Office, the Office
of the Special Inspector General for the Troubled Asset Relief Program, the Congressional Oversight Panel, the Congress, and private-sector auditors on reviews of
these facilities as well as a range of matters relating to the Federal Reserve’s oper6 See, for example, Alberto Alesina and Lawrence H. Summers (1993), ‘‘Central Bank Independence and Macroeconomic Performance: Some Comparative Evidence’’, Journal of Money,
Credit and Banking, vol. 25 (May), pp. 151–162; or, more recently, Christopher Crowe and Ellen
E. Meade (2008), ‘‘Central Bank Independence and Transparency: Evolution and Effectiveness’’,
European Journal of Political Economy, vol. 24 (December), pp. 763–777. See, Ben S. Bernanke
(2010), ‘‘Central Bank Independence, Transparency, and Accountability’’, at the Institute for
Monetary and Economic Studies International Conference, Bank of Japan, Tokyo (May 25), for
further discussion and references.
7 See, the reports available on the Board’s webpage, ‘‘Credit and Liquidity Programs and the
Balance Sheet’’, at www.federalreserve.gov/monetarypolicy/bstlreports.htm.
8 See, Board of Governors of the Federal Reserve System, Office of Inspector General (2010),
‘‘The Federal Reserve’s Section 13(3) Lending Facilities To Support Overall Market Liquidity:
Function, Status, and Risk Management’’ (Washington: Board of Governors OIG, November),
www.federalreserve.gov/oig/files/FRSlLendinglFacilitieslReportlfinal-11-23-10lweb.pdf.

47
ations and governance. We will continue to seek ways of enhancing our transparency without compromising our ability to conduct policy in the public interest.
Thank you. I would be pleased to take your questions.

48
RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN JOHNSON
FROM BEN S. BERNANKE

Q.1. Recognizing the critical need to reduce our structural deficit
to avert the problems you were discussing with Senator Bennet,
and given the importance of continuing to make selective investments in R&D, education and infrastructure, would defunding
those areas now hurt the recovery and damage long term U.S.
growth?
A.1. The costs and risks to the U.S. economy will rise if the Federal
budget persistently runs large structural deficits. If global financial
market participants were to lose confidence in the United States’
ability to manage its fiscal policy, the historical experience of countries that have faced fiscal crises should warn us that interest rates
could increase suddenly and quickly, which would impose substantial costs on our economy. The threat from our currently
unsustainable fiscal policies is real and growing, which should be
sufficient reason to put in place a credible plan to place fiscal policy
on a sustainable path over the medium and longer term. Acting
now to develop a credible program to reduce future structural deficits would not only enhance economic growth in the longer run,
these policy actions would likely also yield near-term economic benefits from lower long-term interest rates and increased consumer
and business confidence. Moreover, the sooner a credible fiscal plan
is established, the more time affected individuals would have to adjust to the necessary policy changes, which would probably make
those changes less painful and more politically feasible.
That said, economic growth is affected not only by the levels of
spending and taxes, but also by their composition and structure.
Changes in the Government’s tax policies and spending priorities
could be made that not only reduce the deficit but also enhance the
long-term growth potential of the economy—for example, by reducing disincentives to work and to save, by encouraging investment
in the skills of our workforce as well as new machinery and equipment, by promoting research and development, and by encouraging
and providing necessary infrastructure. In the current fiscal environment, policy makers will want to intensively review the effectiveness of all spending and tax policies and be willing to make
changes in order to provide necessary programs more efficiently
and at lower cost. These policy choices will certainly be difficult
and will require tradeoffs to be made, but a more productive economy will ease the tradeoffs that we face.
Q.2. Following up on Senator Moran’s question to you at the hearing, what can the Federal Reserve do to help encourage, or direct
banks to, increase lending to small businesses on Main Street that
are responsible for so much job growth?
A.2. During the past few years, we have frequently received reports
that small businesses are facing difficulty in obtaining credit. We
share the Senator’s concerns about the effect that tight credit conditions can have on Main Street and in response have taken several steps to foster access to loans by creditworthy businesses.
Early in the crisis, the Federal Reserve and the other banking
agencies recognized the possibility that bankers and examiners
could overcorrect for underwriting standards that had become too

49
lax and issued guidance to instruct examiners to take a measured
and balanced approach to reviews of banking organizations and to
encourage efforts by these institutions to work constructively with
existing borrowers that are experiencing financial difficulties. The
Federal Reserve subsequently conducted significant training for its
examiners on this guidance to ensure that it was carefully implemented. In addition, we continue to strongly reinforce the guidance
with our examiners and are focusing on evaluating compliance with
the guidance as part of our regular monitoring of the examination
process, which includes local management vettings of examination
findings in the district Reserve Banks, review of a sample of examination reports in Washington, and investigation of any specific instances of possible undue regulatory constraints reported by members of the public.
Our monitoring to date suggests that examiners are appropriately considering the guidance in evaluating supervised institutions. However, to the extent that a banking organization is concerned about supervisory restrictions imposed by Federal Reserve
examiners, we have encouraged them to discuss their concerns with
Reserve Bank or Federal Reserve Board supervisory staff. Bankers
also have been advised that they can confidentially discuss these
concerns with the Federal Reserve Board’s Ombudsman, who
works with bankers and supervisory staff to resolve such issues.
In addition to our efforts to encourage careful implementation of
the interagency guidance, the Federal Reserve last year also completed a series of more than 40 meetings with community leaders
from across the country to gather information to help the Federal
Reserve and others better respond to the credit needs of small businesses. Emerging themes, best practices, and common challenges
identified by the meeting series were discussed and shared at a
conference held at the Federal Reserve Board in Washington in
early July and are described in a summary report posted on the
Federal Reserve’s Web site at: http://www.federalreserve.gov/
events/conferences/12010/sbc/downloads/
smalllbusinesslsummary.pdf The agenda for this meeting and
remarks that address our plans for following-up on our findings are
also available on the Federal Reserve’s Web site.
More recently, the Federal Reserve has been working with staff
at the U.S. Treasury and the other banking agencies to implement
the Small Business Lending Fund created by the Small Business
Jobs Act of 2010. This fund is intended to facilitate lending to creditworthy borrowers by providing affordable capital support to community banks that lend to small businesses.
Q.3. We also want to ensure that individuals have appropriate access to credit. Is the Federal Reserve considering how its policies
(both regulatory and monetary) impact consumer access to credit?
If there is a negative impact on access to credit, what steps will
the Federal Reserve take?
A.3. In the context of both monetary and regulatory or supervisory
policy, the Federal Reserve regularly analyzes data and other information about the availability of credit to consumers. The availability of credit is a key factor pertaining to the outlook for consumer spending, which is, itself, a major component of aggregate

50
demand in the U.S. economy. Therefore, when determining the appropriate stance of monetary policy, the Federal Open Market
Committee considers consumers’ access to credit along with many
other factors that shape the macroeconomic outlook.
The Federal Reserve also considers the potential effects of its
regulatory or supervisory policies on the availability of consumer
credit. A recent example of this is the Comprehensive Capital Analysis and Review (CCAR) that was completed by the Federal Reserve on March 18, 2011. One element of the study of the capital
plans of the 19 largest bank holding companies in the CCAR was
to ascertain each firm’s ability to hold sufficient capital to maintain
access to funding, to continue to serve as credit intermediaries, to
meet their obligations to creditors and counterparties, and to continue operations, even in an adverse macroeconomic environment.
In other words, a key element of the review was to evaluate the
capital plans of large bank holding companies in the context of
their ability to support lending to consumers, even in an adverse
macroeconomic environment.
RESPONSES TO WRITTEN QUESTIONS OF SENATOR REED
FROM BEN S. BERNANKE

Q.1. In your testimony you described an apparent willingness on
the part of banks to lend. However, we continue to hear that small
businesses are still having trouble obtaining needed lending. Considering that small businesses take the leading role in job creation,
what are you doing to ensure that creditworthy small businesses
have access to lending?
A.1. We are also aware of reports that some small businesses are
facing difficulty in obtaining loans and are concerned about the impact on job creation. As a result, we have taken a number of steps
to try to improve small businesses’ access to credit in the time
since the recent financial crisis began. Initially, the Federal Reserve and the other banking agencies recognized the possibility
that bankers and examiners could overcorrect for underwriting
standards that had become too lax in the run-up to the crisis and
unnecessarily constrain access to credit by creditworthy borrowers.
In order to address this possibility, they issued guidance to instruct
examiners to take a measured and balanced approach to reviews
of banking organizations and to encourage efforts by these institutions to work constructively with existing borrowers that are experiencing financial difficulties. The Federal Reserve subsequently
conducted significant training for its examiners on this guidance to
ensure that it was carefully implemented. Currently, we continue
to strongly reinforce the guidance with our examiners and are focusing on evaluating compliance with the guidance as part of our
regular monitoring of the examination process.
Our monitoring to date suggests that examiners have been appropriately considering the guidance in evaluating supervised institutions. However, to the extent that a banking organization is concerned about supervisory restrictions imposed by Federal Reserve
examiners, we have encouraged them to discuss their concerns with
Reserve Bank or Federal Reserve Board supervisory staff or, if they
prefer to raise their concerns confidentially, to raise them with the

51
Board’s Ombudsman, who works with bankers and supervisory
staff to resolve such issues. In addition, last year the Federal Reserve conducted a series of more than 40 meetings with community
leaders from across the country to gather information to help the
Federal Reserve and others better respond to the credit needs of
small businesses. Emerging themes, best practices, and common
challenges identified by the meeting series were discussed and
shared at a conference held at the Federal Reserve Board in Washington in early July 2010 and are described in a summary report
posted on the Federal Reserve’s Web site at: http://
www.federalreserve.gov/events/conferences/2010/sbc/downloads/
smalllbusinesslsummary.pdf.
There are several initiatives currently underway to address
issues identified through these meetings. Most recently, the Federal Reserve has been working with staff at the U.S. Treasury and
the other banking agencies to implement the Small Business Lending Fund created by the Small Business Jobs Act of 2010. This
fund is intended to facilitate lending to creditworthy borrowers by
providing affordable capital support to community banks that lend
to small businesses.
Q.2. During this economic crisis the length of time workers have
remained unemployed has increased substantially. The longer
someone remains outside the workforce, the harder it becomes to
find employment and contribute to economic growth. What can policy makers do to get people back to work as soon as possible? What
actions can be taken to help the long-term unemployed so we can
make sure they do not lose the ability to reenter the workforce?
A.2. Although the economy recovery appears to be on firmer footing, unemployment remains a significant concern in the United
States. The recent declines in the unemployment rate are encouraging, but the level of unemployment is still very high, and it is
likely to be some time before the unemployment rate returns to a
more normal level. In addition, more than 40 percent of the unemployed have been out of work for 6 months or more. As you indicate, long-term unemployment is a particularly serious problem because it erodes the skills of those workers and may cause lasting
damage to their future employment and earnings prospects.
Given the current situation in which unemployment is high and
inflation is low, the Federal Open Market Committee has maintained the target range for the Federal funds rate at 0 to 1⁄4 percent. In addition, the Committee decided in November 2010 to expand its holdings of securities, with the intention of purchasing
$600 billion of Treasury securities by the end of the second quarter
of 2011. The Committee believes that its policies will promote a
stronger pace of economic recovery and anticipates a gradual return to higher levels of resource utilization in a context of price stability. The Federal Reserve also continues to provide guidance to
banks to ensure that creditworthy borrowers, including small businesses and other potential employers, have access to credit. Finally, as I indicated in my recent testimony, I believe that efforts
to address the Nation’s longer-run fiscal challenges could also help
to promote the economic recovery. In particular, the adoption of a
credible program to reduce future deficits would not only enhance

52
economic growth and stability in the long run, but could also yield
substantial near-term benefits in terms of lower long-term interest
rates and increased consumer and business confidence. All of these
policies should help to reduce unemployment over time.
With regard to other actions that might be taken to help the
long-term unemployed, it seems to me that policies targeted towards providing those workers with the resources they need to upgrade their skills and find new jobs as the economy continues to
recovery can be helpful. For example, community college and other
adult education programs have been effective in helping workers
who have lost their jobs to obtain new skills that strengthen their
qualifications for available jobs. Similarly, innovative workforce development programs can play an important role in anticipating future job market demands, and it might be fruitful to couple these
programs with job search assistance that channeled search and
training toward the most promising areas. Unfortunately, however,
long-term unemployment is a complex problem and there are no
simple or guaranteed solutions.
Q.3. What steps is the Federal Reserve taking toward establishing
macroprudential tools that will assist it in identifying and responding to future asset bubbles that have the potential of igniting another financial crisis?
A.3. The Federal Reserve is taking steps to identify and respond
to emerging asset bubbles. Macrostress tests of financial institutions—such as those recently performed by Federal Reserve as part
of the Comprehensive Capital Analysis and Review (CCAR) of large
bank
holding
companies
(BHCs
)—are
an
important
macroprudential tool. The macro stress tests help to identify the
threats to financial stability from BHCs that would be posed by adverse economic conditions and large falls in asset prices. In addition, enhanced supervision and prudential standards required
under the Dodd-Frank Act will make large BHCs and nonbank institutions determined to be systemically important subject to more
stringent requirements on capital, leverage, and liquidity, as well
as tighter limitations on their single-counterparty credit exposures.
These enhanced standards should help to make the financial sector
more resilient to asset price adjustments and thus would diminish
the cost to the real economy. Finally, the Federal Reserve is working closely with other member agencies of the Financial Stability
Oversight Council (FSOC) to identify threats to the financial stability of the United States, which could include emerging asset bubbles, and, moreover, to respond preemptively to such threats. Because the FSOC’s mandate is to focus on the stability of the U.S.
financial system as a whole, this focus should reduce the possibility
of undetected regulatory gaps which could, left unmonitored, fuel
asset bubbles.
Q.4. In a recent speech you explained the role played by global imbalances in encouraging the asset bubbles that led to the financial
crisis. If this was a contributing factor to the crisis, what actions
should be taken to address these global imbalances so that they do
not destabilize the global financial system again in the future?
A.4. The primary cause of the boom and bust in the housing market was the poor performance of the financial system and financial

53
regulation, including misaligned incentives in mortgage origination,
underwriting, and securitization; risk-management deficiencies
among financial institutions; conflicts of interest at credit rating
agencies; weaknesses in the capitalization and incentive structures
of the Government-sponsored enterprises; gaps and weaknesses in
the financial regulatory structure; and supervisory failures. Global
imbalances and the capital flows associated with them likely
played a role in helping to finance the housing bubble and thus setting the stage for its subsequent bust. But it was the interaction
between strong capital inflows and weaknesses in the domestic financial system that proved so injurious to financial stability.
The appropriate response to the concerns posed by global imbalances is not to try to reverse financial globalization, which has conferred considerable benefits overall. Rather, we need to pursue reforms that promote financial stability in the context of an increasingly globalized financial arena. First, countries must work together to create an international system that more effectively supports the pursuit of internal and external balance: Countries with
excessive and unsustainable trade surpluses will need to allow
their exchange rates to better reflect market fundamentals and increase their reliance on domestic demand, while countries with
large trade deficits must encourage higher national saving, including by strengthening their fiscal positions. Second, the United
States must continue to work with its international partners to increase the efficiency, transparency, and resiliency of our national financial systems and to strengthen financial regulation and oversight.
RESPONSES TO WRITTEN QUESTIONS OF SENATOR AKAKA
FROM BEN S. BERNANKE

Q.1. Chairman Bernanke, as you know, I am most concerned with
the well-being of consumers. In the current economic climate, consumers are confronted with difficult financial decisions. This is the
case in Hawaii, where many homeowners face possible foreclosure
and the average credit card debt of a resident is the second highest
in the country.
Last week was America Saves Week. We highlighted the importance of personal savings and teach consumers how to increase
their financial security through better money management. By saving, individuals can help protect themselves during economic
downturns and unforeseen life events.
And yet, we also know that our slow economic recovery is partially due to low consumption or consumer spending.
Chairman Bernanke, my question to you is about these two different motivations. How can we continue our efforts to promote economic recovery? And, how do we at the same time encourage responsible consumer behavior and financial decision making?
A.1. The Federal Reserve System is strongly committed to promoting consumer financial education through research, community
outreach and a wide range of information on issues related to personal finance that we make available to the public. One objective
of our consumer and community activities is to foster informed and
prudent financial decision making of the type promoted by the

54
America Saves campaign. Indeed, the Federal Reserve Board is a
member of the America Saves National Advisory Committee.
The exercise of sound judgment in personal financial affairs is
not inconsistent with a healthy growing economy. Quite the contrary. As the events of the past several years have shown, outsized
debt accumulation can leave many households vulnerable to great
distress if collateral values drop sharply or income is disrupted,
which leads to cutbacks in aggregate demand, production and employment. These cutbacks can lead to further financial distress and
income disruptions and associated declines in production and employment. However, sound household decision making can lay the
foundations for sustainable economic growth. Looking forward, a
combination of rising business confidence, accommodative monetary
policy, and improving credit conditions seems likely to lead to continued gains in production and employment. These gains, in turn,
should boost incomes and provide the wherewithal for households
to increase their spending without taking on excessive debt, which
helps to further support increases in production and employment
in a virtuous cycle.
Q.2. Chairman Bernanke, because of the high number of recent
foreclosures, an alarming number of Americans face the extremely
difficult task of placing themselves back on sound financial footing.
They are especially vulnerable to nontraditional and predatory financial products and services.
What can be done to help these individuals overcome foreclosure
and restore their financial well-being?
A.2. The Federal Reserve has been working at various levels to
support consumers and communities struggling with the impact of
the foreclosure crisis since 2007. Through the 12 Federal Reserve
Banks, the System works with financial institutions, local leaders,
and community groups to provide relevant research, and data
through a broad range of programs and activities. The Board of
Governors provides guidance and support to the Reserve Banks’ efforts, offering a national perspective on various policy issues and
programs that help provide further understanding of the mortgage
market and the options available to stabilize neighborhoods and assist borrowers struggling with the impacts of foreclosure. A comprehensive overview of these efforts undertaken by the Federal Reserve in response to the foreclosure crisis is provided in ‘‘Addressing the Impact of the Foreclosure Crisis: Federal Reserve Mortgage
Outreach and Research Efforts.’’ This report is available online. 1
The Federal Reserve also has a centralized call center, the Federal Reserve Consumer Help (FRCH), to accept consumer complaints against financial institutions, including consumers experiencing difficulty with their mortgages or who experience communication issues with the financial institution regarding their mortgage. Consumers can contact FRCH for assistance and information. 2 Complaint specialists are trained in responding to consumers’ mortgage and foreclosure issues and to direct them to addi1 For ‘‘Addressing the Impact of the Foreclosure Crisis . . . ’’ report, see www.chicagofed.org/
digital assets/others/inlfocus/foreclosurelresourcelcenter/morelreportlfinal.pdf.
2 For additional information about the Federal Reserve Consumer Help center, see
www.federalreserveconsumerhelp.gov/index.cfm.

55
tional assistance as their circumstances require. The FRCH Web
site provides one-stop shopping for resources and links to Government and nonprofit organizations that offer foreclosure assistance.
In addition, each of the Federal Reserve banks and the Board of
Governors has established a Web site where consumers can access
online Federal and local resources designed to help homeowners
with foreclosure prevention and assist their efforts to recover from
financial difficulties. 3 For example, the Federal Reserve Bank of
St. Louis’ Foreclosure Resource Center includes a ‘‘Foreclosure
Mitigation ToolKit’’ that identifies steps that community leaders
can take to address foreclosures in their neighborhoods, including
outreach to those consumers at risk of losing their homes and for
developing postforeclosure support systems. 4
The Board has also issued a number of supervisory guidances to
the banks on policies and procedures that are essential to ensuring
they work with consumers struggling with their mortgages and
comply with appropriate consumer protection laws and regulations
that relate to foreclosure and loss mitigation. In 2007, the Board,
in concert with other banking supervisory agencies, issued guidance letters specifically related to working with borrowers struggling with their mortgages, as well as guidance in 2009 on tenants’
rights when landlords fall into foreclosure. 5 Most recently, the
Board announced formal enforcement actions requiring 10 banking
organizations to address patterns of misconduct and negligence related to deficient practices in residential mortgage loan servicing
and foreclosure processing. A copy of the press release and the accompanying publication that documents the supervisory agencies’
findings, Interagency Review of Foreclosure Policies and Practices,
can be found online on the Board of Governors’ public Web site. 6
Q.3. Chairman Bernanke, I know that we share an interest in remittances. During difficult economic times, individuals who normally remit money to their relatives overseas are under greater financial pressure. At the same time, they also are under greater
pressure to provide assistance to their families abroad.
I know that the Federal Reserve is working hard to implement
the remittance protection provisions of the Dodd-Frank Act. It requires more meaningful disclosures for remittance transactions. It
also establishes an error resolution process for consumers.
Please update us on what progress has been made to implement
the remittance protections in the Dodd-Frank Act.
A.3. On May 12, 2011, the Federal Reserve Board requested public
comment on a proposed rule that would create new protections for
consumers who send remittance transfers to recipients located in a
3 Board
of Governors, Consumer Information web page, www.federalreserve.gov/
consumerinfo/foreclosure.htm.
4 For additional information, see Federal Reserve Bank of St. Louis, Community Development,
Foreclosure Resource Center at www.stlouisfed.org/communityl development/foreclosure/mitigation-l.cfm.
5 Federal Reserve Board, Supervision, Consumer Affairs Letters, 2007, CA 07-01, ‘‘Working
with Mortgage Borrowers’’, and ‘‘Statement on Loss Mitigation Strategies for Servicers of Residential Mortgages’’. In 2009, CA 09-05, ‘‘Information and Examination Procedures for the ‘Protecting Tenants at Foreclosure Act of 2009’ ’’ and CA-13,‘‘Mortgage Loan Modifications and Regulation B’s Adverse Action Requirement’’.
6 For the Board of Governors’ enforcement actions and the report, ‘‘Interagency Review of
Foreclosure Policies and Practices’’, see http://www.federalreserve.gov/newsevents/press/enforcement/20110413a.htm.

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foreign country. The press release and related information can be
found on the Board’s public Web site at: www.federalreserve.gov/
newsevents/press/bcreg/20110512a.htm.
The proposed rule would require that remittance transfer providers make certain disclosures to senders of remittance transfers,
including information about fees and the exchange rate, as applicable, and the amount of currency to be received by the recipient. In
addition, the proposed rule would provide error resolution and cancellation rights for senders of remittance transfers. The proposed
model disclosure forms were developed with the use of extensive
consumer testing to ensure that they presented the information
that consumers of remittance products need to make informed decisions regarding fees and features across providers.
The public comment period will end on July 22, 2011, and all
comment letters will be transferred to the Consumer Financial Protection Bureau which will have responsibility for issuing the final
rules.
RESPONSES TO WRITTEN QUESTIONS OF SENATOR MERKLEY
FROM BEN S. BERNANKE

Q.1. Federal Reserve Audit. During the debate over the Dodd-Frank
Act, the Federal Reserve argued that revealing the names of borrowers from its emergency lending facilities would imperil the financial institutions and other borrowers and chill the use of those
emergency facilities that may be necessary to stabilize the economy. Yet, as mandated by the Dodd-Frank Act, the Federal Reserve on December 1, 2010 revealed the names of many of the borrowers from its emergency lending facilities during the 2008 financial crisis.
What lessons can be drawn from this experience? Does this experience suggest that the Federal Reserve can be more transparent
regarding its borrowers during or soon after a crisis?
A.1. As you note, the Federal Reserve published the names of the
borrowers from its emergency lending facilities, as well as details
on the loans extended, on December 1, 2010. The publications
added to the large volume of information that the Federal Reserve
had made available in weekly and monthly reports on its emergency lending throughout the financial crisis. In addition, as required by the Dodd-Frank Act, any borrowers at future emergency
credit facilities would be identified 1 year after the emergency facility was closed, and borrowers at the Federal Reserve’s normal discount window would be identified 2 years after borrowing. It is difficult to assess the effect of these disclosures on the effectiveness
of Federal Reserve lending programs that may put in place to address a future financial crisis and support credit availability to U.S.
businesses and households. Financial firms may be less willing to
participate in such programs because they will anticipate that their
names will be disclosed and will remain concerned about the possible effects of that disclosure on the behavior of their creditors and
counterparties in some circumstances. Indeed, some firms have
publicly stated that they no longer intend to access the discount
window.

57
We think that an effective discount window can be an important
source of backup liquidity for the banking system, and we will
monitor carefully the discount window borrowing of depository institutions.
Q.2. Commodities. Financial experts have noted that speculative
booms in commodities, especially oil, tend to immediately precede
recessions in the U.S. Are you concerned at all that commodities
are getting out of hand? If monetary policy ought to be focused on
the big risks to the U.S., such as from housing, are there other
tools that can be applied to the commodities markets to ensure we
don’t have a speculative bubble and bust? For example, both the
U.S. and European financial regulators have new authorities to impose position limits. Please share your views regarding the use of
these.
A.2. The prices of oil and other commodities can have important
implications for U.S. economic growth and price stability. Accordingly, the Federal Reserve closely monitors developments in these
markets. Broad movements in commodity prices have been in line
with developments in the global economy. These prices rose
throughout most of the past decade while global growth was strong
and supply was constrained, they collapsed with the onset of the
global recession, and they subsequently rebounded amid the economic recovery. The increases in commodity prices in recent
months have largely reflected rising global demand, particularly in
some fast-growing emerging market economies, coupled with constraints on global supply in some cases. In particular, political unrest in the Middle East and North Africa has led to further increases in oil prices, and adverse weather has boosted prices of
some important food commodities.
Some have argued that speculative activities on the part of financial investors have been responsible for the extreme swings in commodity prices. Notwithstanding considerable study, however, conclusive evidence of the role of speculators remains elusive. If conclusive evidence emerged that commodity markets were not performing their price discovery and allocative role effectively, changes
in regulatory policies might be appropriate. Policy makers should
be cautious and careful in proposing changes to the regulation of
commodity markets, so as to not excessively shrink market liquidity, impede the price discovery process, or interfere with the ability
of commodity producers and consumers to manage their risks.
Q.3. Foreign Exchange. We have heard some argue that foreign exchange markets performed well during the crisis, that those markets did not need to be bailed out, and that as a result ‘‘foreign exchange swaps’’ ought to be exempt from Dodd-Frank swaps regulation (as permitted if the Secretary of the Treasury makes the finding required under Dodd-Frank Act). Please refresh the Committee
on how the foreign exchange markets, especially the markets in
these foreign exchange swaps, performed during the crisis.
• Did they freeze up at any point such that firms would not
enter into transactions with each other?

58
• Did some firms place trades betting that currencies would decline and then suffer losses when their counterparties were unable to repay?
• What role did the Federal Reserve’s central bank foreign exchange swap lines—which in December of 2008 reached nearly
$600 billion in outstanding lending, or 25 percent of the Fed’s
assets—play in those ensuring the functioning of these ‘‘foreign
exchange swap’’ markets?
A.3. All financial markets experienced some stress during the crisis. However, foreign exchange markets were arguably more resilient than many other wholesale money markets. In particular, unlike some dollar funding markets—such as markets for commercial
paper, asset-backed commercial paper, repurchase agreements, and
Eurodollars—which essentially seized up during the crisis, the foreign exchange market continued to function. Liquidity in the market for spot foreign exchange was only slightly impaired. The market for dollar-related foreign exchange swaps, which is used by
some financial institutions to acquire dollar funding, exhibited
more strains because of its tighter links with dollar funding markets more generally. However, trading in the foreign exchange
swap market for dollars was not affected as much as trading in
some of the other market segments. And nondollar foreign exchange swap markets were relatively unaffected.
Some firms may have taken directional positions in currencies
during the crisis, as part of their standard business activity, but we
did not hear of any significant troubles with failures to repay in the
swap or forward market for foreign exchange.
The Federal Reserve’s swap operations were not done in the private market with private-market counterparties. They were done
with other central banks, so there was no direct support provided
by these operations to the foreign exchange swap market. The Federal Reserve’s swap operations with other central banks provided
the other central banks with dollar liquidity that they in turn could
lend to private financial institutions in their jurisdictions. The dollar transactions of the foreign central banks in their local markets
were nearly all in the form of repurchase agreements or other
collateralized lending operations. Such operations were not in direct support of the market for foreign exchange swaps. Nonetheless, because the operations of the foreign central banks did help
relieve pressures in dollar funding markets more generally, these
operations had an indirect impact on the functioning of the dollar
foreign exchange swap market, too.
Q.4. Housing Risks. The Case-Schiller housing price index fell by
3.9 percent from November to December 2010, and was down 4.1
percent year on year. As you know, declining housing prices in the
U.S. expose families and financial institutions to a great deal of
hardship and risk. And while employment appears to be improving
in some places, many people continue to be out of work, especially
in my home State of Oregon.
What risk to the economy do you see from falling or stagnant
housing market, with an inventory of distressed properties constituting a large proportion of the homes for sale? What monetary or

59
supervisory tools does the Federal Reserve have to manage such
risks? What role can fiscal and other Government policy play?
A.4. In many markets across the country, housing activity remains
weak and home prices remain depressed. Weakness in real estate
markets is an important headwind for economic growth and represents a key risk to macroeconomic performance in the period
ahead.
Against this backdrop and in the context of low overall rates of
resource utilization, subdued inflation trends, and stable inflation
expectations, earlier this month, the Federal Open Market Committee has maintained the target range for the federal funds rate
at the historically low level of 0 to 1⁄4 percent and continued its existing policy of reinvesting principal payments from its securities
holdings and of purchasing additional longer-term Treasury securities through the end of the second quarter of 2011. Should the
Committee determine it to be necessary, the overall size and pace
of the Federal Reserve’s asset-purchase program can be adjusted as
needed to best foster maximum employment and price stability.
The Federal Reserve also has a variety of supervisory tools at its
disposal to help manage risks stemming from weakness in real estate markets. Indeed, to improve both the Federal Reserve’s consolidated supervision and our ability to identify potential risks to
the financial system, such as those posed by weakness in housing
markets, we have made substantial changes to our supervisory
framework. In particular, we have augmented our traditional approach to supervision, which focuses on examinations of individual
firms in isolation, with greater use of horizontal reviews that simultaneously examine risks across a group of firms, to identify
common sources of risks and best practices for managing those
risks. To supplement information gathered by examiners in the
field, we have also enhanced our quantitative surveillance program
to use data analysis and modeling to help identify vulnerabilities
at both the firm level and for the financial sector as a whole.
A recent example of this improved supervisory framework is the
Comprehensive Capital Analysis and Review (CCAR) that was completed by the Federal Reserve on March 18, 2011. One element of
the forward-looking evaluation of the internal capital planning
processes of the large, complex banking organizations in the CCAR
was to ascertain each firm’s ability to hold sufficient capital to
maintain access to funding, to continue to serve as credit intermediaries, to meet their obligations to creditors and counterparties,
and to continue operations, even in an adverse macroeconomic environment. The ‘‘supervisory stress scenario’’ that was part of the
CCAR included a deterioration in real estate markets resulting in
a significant further decrease in home prices nationwide.
Regarding fiscal policy and other governmental policy, the Congress could, in principle, decide to pursue a range of responses to
weakness in housing markets. However, the Congress would, of
course, have to weigh the potential benefits of such policy responses in the context of the overall Federal budget situation and
a number of competing demands on scarce resources.

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RESPONSES TO WRITTEN QUESTIONS OF SENATOR VITTER
FROM BEN S. BERNANKE

Q.1. When are you going to get out of the ultra-low interest rates
policies of near zero interest rates? What specific metrics will guide
your decision? What will you look at in terms of factors that will
influence your decision as to when to increase rates off of zero?
A.1. The Federal Reserve conducts monetary policy to foster its
statutory objectives of maximum employment and stable prices.
Consistent with these objectives, the Federal Reserve eased monetary policy aggressively over the course of 2008 in response to the
financial crisis and the associated steep economic downturn. By
late 2008, the Federal Open Market Committee (FOMC) had reduced its target for the Federal funds rate to a range of 0 to 1⁄4
percent. It also had begun large-scale purchases of agency debt and
agency-guaranteed mortgage-backed securities in order to provide
additional monetary policy accommodation. Subsequently, the Federal Reserve also purchased longer-term Treasury securities with
the same objective. As the FOMC noted in its most recent statement, recent data suggest that the economic recovery is proceeding
at a moderate pace and labor market conditions are improving
gradually. Nonetheless, the unemployment rate remains elevated,
and measures of underlying inflation continue to be somewhat low,
relative to levels that the FOMC judges to be consistent, over the
longer run, with its dual mandate. Based on this outlook, the
FOMC decided at its most recent meeting that it was appropriate
to maintain its accommodative stance of monetary policy.
As the economy recovers further, the FOMC will eventually need
to remove the current degree of policy accommodation so that the
stance of monetary policy remains consistent with the FOMC’s dual
mandate. The FOMC monitors a wide range of indicators in order
to assess progress toward its dual objectives and hence the appropriate stance of policy. In particular, the FOMC has noted factors
that are important in its assessment of the appropriate level of the
Federal funds rate in the current environment including low rates
of resource utilization, subdued inflation trends, and stable inflation expectations.
Q.2. Mr. Chairman, as you are well aware, since the Federal Reserve lowered the Federal Funds rate to ‘‘0 to 1⁄4 percent’’ the
FOMC statement has included the following statement, the Fed
‘‘continues to anticipate economic conditions . . . are likely to warrant exceptionally low levels of the federal funds rate for an extended period of time.’’
As I’m sure you are aware Kansas City Federal Reserve Bank
President Hoenig cast dissenting votes on the Federal Open Market
Committee 8 times throughout 2010 because he felt that ‘‘continuing to express the expectation of exceptionally low levels of the
Federal funds rate for an extended period was no longer warranted
because it could lead to the buildup of financial imbalances and increase risks to longer-runmacroeconomic and financial stability.’’
At what point, Mr. Chairman, would it be warranted not to increase the Federal funds rate, but to simply remove that phrase:
‘‘likely to warrant exceptionally low levels of the Federal funds rate
for an extended period of time?’’ Can you give this Committee a

61
time frame on when that might happen? If not, can you describe
the metrics you will use to make that decision?
A.2. The FOMC regularly evaluates all aspects of the current
stance of policy and its statement in light of the evolution of the
economic outlook. The phrase noted is intended to provide market
participants with greater clarity about the FOMC’s expectations for
the path of the Federal funds rate given its assessment of the economic outlook. Importantly, this so-called ‘‘forward guidance’’ for
the funds rate is explicitly conditional on the economic outlook. As
a result, any changes in the forward guidance will depend on the
evolution of the outlook for economic activity and inflation. As the
economy continues to recover, policy accommodation will eventually
need to be removed so that the stance of monetary policy remains
consistent with the Federal Reserve’s dual mandate to foster maximum employment and stable prices. The FOMC monitors a wide
range of indicators in order to assess progress toward its dual objectives and hence the appropriate stance of policy. The FOMC has
noted some of the important metrics that form the basis for its current forward guidance regarding the funds rate target. In particular, the FOMC statement notes that low rates of resource utilization, subdued inflation trends, and stable inflation expectations
are some of the key factors supporting its judgment that exceptionally low levels of the funds rate are likely to be warranted for an
extended period.
Q.3. In a speech last year, Mr. Hoenig advocated a policy that remains accommodative but slowly firms as the economy itself expands and moves toward more balance. He advocated dropping the
‘‘extended period’’ language from the FOMC’s statement and removing its guarantee of low rates. This tells the market that it
must again accept risks and lend if it wishes to earn a return. The
FOMC would announce that its policy rate will move to 1 percent
by a certain date, subject to current conditions. At 1 percent, the
FOMC would pause to give the economy time to adjust and to gain
confidence that the recovery remains on a reasonable growth path.
At the appropriate time, rates would be moved further up toward
2 percent, after which the nominal Fed funds rate will depend on
how well the economy is doing. Are you aware of this proposal?
Have you considered it?
A.3. The FOMC reviews its policy stance at every FOMC meeting,
and meeting participants regularly offer their views about a range
of policy options. President Hoenig expressed his views at FOMC
meetings, and they were noted in the minutes of the meetings.
(See, for example, the minutes to the September 2010 meeting at
http://www.federalreserve.gov/monetarypolicy/
fomcminutes20100921.htm.)
As noted above, the FOMC will eventually need to remove policy
accommodation in order to maintain an overall stance of monetary
policy that is consistent with the statutory objectives of maximum
employment and stable prices. Currently, the unemployment rate
remains elevated, and measures of underlying inflation continue to
be somewhat low, relative to levels that the FOMC judges to be
consistent, over the longer run, with its dual mandate. At its most
recent meeting, the FOMC again judged that it was appropriate to

62
maintain the current 0 to 1⁄4 percent target range for the Federal
funds rate to foster its dual mandate. In addition, the FOMC again
continued to anticipate that economic conditions—including low
rates of resource utilization, subdued inflation trends, and stable
inflation expectations—were likely to warrant exceptionally low
levels for the Federal funds rate for an extended period.
Q.4. What specific metrics will guide your decision for ending QE2?
A.4. The FOMC’s decision last fall to undertake a second round of
large scale asset purchases reflected its judgment that, while the
economic recovery was continuing, progress toward meeting the
FOMC’s dual mandate of maximum employment and price stability
had been disappointingly slow. Moreover, members generally
thought that such progress was likely to remain slow. While incoming economic and financial data since that time has suggested some
improvement in the economic outlook, that improvement has been
fairly gradual, and the FOMC has judged that the current program
of purchases remains appropriate.
The FOMC regularly reviews the pace of its securities purchases
and the overall size of the asset purchase program in light of incoming information and will adjust the program as needed to best
foster its statutory goals of maximum employment and price stability. In considering the appropriate stance of policy, including the
decision for ending the asset purchase program, the FOMC must
be forward-looking because changes in monetary policy affect the
economy with a lag. In making its assessment of the likely trajectory for the economy and the risks around that trajectory, the
FOMC monitors a wide range of economic and financial indicators,
including measures of spending and production in various sectors
of the economy, labor market indicators across sectors and regions,
measures of price and wage developments, and financial variables
that shed light on the financing conditions faced by businesses and
households, as well as overall conditions in the financial system.
Q.5. Mr. Chairman, you and the Federal Reserve have said repeatedly that QE2 related purchase will end in June. Do you still plan
for that to be the case—for QE2 to definitely end in June? What
factors would dissuade you from pursuing that course?
A.5. Yes, at its most recent meeting, the FOMC announced that the
Federal Reserve will complete purchases of $600 billion of longerterm Treasury securities by the end of the current quarter. Of
course, going forward, the FOMC will continue to monitor a wide
range of economic and financial indicators and assess their likely
implications for the achievement of its objectives.
Q.6. There are long term risks and short term benefits associated
with the policy of QE2. How do you appropriately balance the short
term benefits the long term risk?
A.6. The main benefit the FOMC saw to the new asset purchase
program was that by providing additional monetary accommodation, the purchases would help to support the attainment of the
Federal Reserve’s statutory goals of maximum employment and
price stability. As I noted earlier, the FOMC’s decision last fall to
undertake a second round of large scale asset purchases reflected
its judgment that, while the economic recovery was continuing,

63
progress toward meeting the FOMC’s dual mandate of maximum
employment and price stability had been disappointingly slow.
Moreover, in the absence of additional policy stimulus, there was
a risk that further adverse shocks to the economy could lead to deflation—that is, to falling prices and wages—and a protracted period of economic weakness.
However, as you note, the benefits of the asset purchase program
need to be weighed against the associated risks. One risk was that,
given our relative lack of experience with this policy tool, we did
not have very precise knowledge of the quantitative effect of
changes in our holdings of longer-term securities on financial conditions and on the economy. This uncertainty about the quantitative
effect of securities purchases increased the difficulty of calibrating
and communicating the policy response, and it made a flexible, conditional approach to the new purchases attractive. As a result, the
FOMC, while noting its intent to purchase $600 billion of Treasury
securities by the end of the second quarter of 2011, emphasized
that it would regularly review the pace of its securities purchases
and the overall size of the asset purchase program in light of incoming information and adjust the program as needed to best foster its statutory goals of maximum employment and price stability.
Ultimately, the FOMC decided to complete the program as originally announced.
Another concern associated with our securities purchases is that
substantial further expansion of the Federal Reserve’s balance
sheet might reduce public confidence in the ability of the Federal
Reserve to execute a smooth exit from its accommodative policies
at the appropriate time. Even if unjustified, such a reduction in
confidence might lead to an undesired increase in inflation expectations. However, the Federal Reserve has expended considerable effort in developing the tools needed to ensure that the exit from
highly accommodative policies can be smoothly accomplished when
appropriate, and I am confident that those tools are ready for use
when needed. By providing clarity to the public about the methods
by which the FOMC will exit its highly accommodative policy
stance—which we have done through speeches and testimonies by
FOMC members—the Federal Reserve can help to anchor inflation
expectations and so help to foster our dual mandate.
Q.7. One thing that I am deeply concerned about is how the Federal Reserve will deal with inflationary pressure. The Fed’s extraordinary response to the financial crisis has exposed itself to potential losses that would be exacerbated by any attempt of the Federal Reserve to fight inflation—with the average cost of gas already
on the rise ($3.19/gallon last week)—is something you will have to
address in the very short term. How do you, Mr. Chairman, plan
to fight inflation without increasing the losses you would take on
interest rate sensitive assets the Fed now owns because of your
previous actions?
A.7. The Federal Reserve is unwaveringly committed to carrying
out its dual mandate to promote price stability and maximum employment. Although increases in energy prices over recent months
have boosted headline inflation in the near term, inflation is likely
to moderate substantially over the intermediate term given that

64
measures of underlying inflation are subdued and long-run inflation expectations remain stable. At the same time, the unemployment rate is quite high and seems likely to return to a more normal level at a very gradual pace. Based on this outlook, the FOMC
decided at its most recent meeting that it was appropriate to maintain its very accommodative stance of monetary policy. However, if
the inflation outlook were to worsen appreciably, the Federal Reserve has the will and the tools to remove monetary accommodation as needed on a timely basis. As discussed in more detail below
in response to Question 10, the removal of policy accommodation
could result in some losses on sales of securities. However, we expect that any such losses would be more than offset by interest income generated by the Federal Reserve’s securities portfolio. In all
cases, the Federal Reserve’s monetary policy decisions will be guided solely by its statutory mandate to foster maximum employment
and price stability.
Q.8. On January 6, 2011, the Federal Reserve quietly announced
a significant change to its accounting rules. Reuters reported that
rule change ‘‘was tucked quietly into the Fed’s weekly report on its
balance sheet and phrased in such technical terms that it was not
even reported by the financial media when originally announced on
January 6.’’
The change itself was buried in footnote 15 of supplemental table
number 10. The footnote states: ‘‘15. Represents the estimated
weekly remittances to the U.S. Treasury as interest on the Federal
Reserve Notes or, in those cases where the Reserve Bank’s net
earnings are not sufficient to equate surplus to capital paid-in, the
deferred asset for interest on Federal Reserve notes. The amount
of any deferred asset, which is presented as a negative amount in
this line, represents the amount of the Federal Reserve Bank’s
earnings that must be retained before remittances to the U.S.
Treasury resume. The amounts on this line are calculated in accordance with the Board of Governors policy, which requires the
Federal Reserve Banks to remit residual earnings to the U.S.
Treasury as interest on Federal Reserve notes after providing for
the costs of operations, payment of dividends, and the amount necessary to equate surplus with capital paid-in.’’
Does accounting change mean that Treasury, and therefore the
U.S. taxpayer, is now in a first-loss position should the Fed become
book-value insolvent as a result of potential losses that might be
incurred on asset sales as part of its efforts to absorb the excess
liquidity the Federal Reserve has injected into the financial system?
A.8. The financial relationship between the Federal Reserve and
U.S. Treasury was not affected by this accounting change. Instead,
the accounting change was made to present that financial relationship in the weekly release more clearly and similarly to how it is
presented in the Federal Reserve Banks’ annual audited financial
statements.
As noted in the footnote to which your question refers, the Board
requires the Reserve Banks to remit excess earnings to the Treasury as interest on Federal Reserve notes after providing for the
costs of operations, payment of dividends, and reservation of an

65
amount necessary to equate surplus with capital paid-in. This practice has been in effect since 1964 and has not changed. The Board
requires these remittances to be made by each Reserve Bank weekly unless that Reserve Bank’s earnings are less than the total of
these three elements. In those cases, remittances are suspended
until earnings again exceed the three elements. The U.S. Treasury
and the taxpayer have always been the beneficiaries of Reserve
Bank earnings.
The accounting change implemented in January essentially requires Reserve Banks to record their obligation to remit excess
earnings to the U.S. Treasury as a liability each day, rather than
only at year-end. This accounting treatment is consistent with generally accepted accounting principles and more clearly presents
each Reserve Bank’s obligation to remit earnings to the Treasury.
Previously, unremitted earnings were reflected on the Reserve
Bank balance sheets as ‘‘other capital’’ pending ultimate reclassification at year-end to the appropriate surplus and liability accounts. The accounting change ensures that the Reserve Banks’
weekly balance sheets clearly reflect the capital position of each
Reserve Bank and the amount of that ReserveBank’s earnings yet
to be remitted to the Treasury.
Your question related to the possibility that a Reserve Bank’s liability for remittances to the Treasury would be negative and represented as a deferred asset. This occurs when earnings are less
than the three elements noted above and remittances have been
suspended. Just as Reserve Bank earnings above those elements
create a liability for the amount to be remitted, earnings less than
those elements create a deferred asset for the amount of future
earnings that will be retained before remittances will resume.
Q.9. Do these accounting changes really prevent the Federal Reserve from being bankrupt? Is it appropriate that the Federal Reserve is allowed to make this sort of dramatic change to how it
keeps its book without any oversight or approval from anyone?
A.9. The accounting changes have no bearing on the fundamental
financial condition or solvency of the Reserve Banks. As stated previously, the accounting change made in January aligned our weekly
accounting practices with our year-end accounting practices and
generally accepted accounting principles. The Reserve Banks continue to receive clean annual audit opinions from the external auditors. The accounting for the distribution of excess earnings is designed to be transparent and show clearly the economic substance
of the distribution policy each week. The change has no impact on
the financial operations of the Reserve Banks.
Q.10. Mr. Chairman, were these changes made because of the increasingly significant exposure to interest rate risk, through the acquisition of mortgage-backed-securities and long-term Treasuries
due to Fed actions during the financial crisis and QE2?
A.10. No. The changes to Federal Reserve accounting policy were
made to provide greater transparency regarding Federal Reserve
income and remittances to the U.S. Treasury. Regarding the Federal Reserve’s interest rate risk, the Federal Reserve’s System
Open Market Account (SOMA) portfolio currently has an overall
unrealized gain position of about $70 billion. An increase in inter-

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est rates and a decline in the market value of the securities in the
portfolio could result in unrealized losses for the portfolio. However, the Federal Reserve does not realize losses on its portfolio unless a security is sold. As a result, even if the securities in the
SOMA portfolio were to decline in value, there would be no implication for Federal Reserve earnings unless the assets are sold. Moreover, we currently expect that any realized losses on any potential
sales of securities would be more than offset by the substantial interest income that the Federal Reserve earns, and is expected to
continue to earn, on the SOMA portfolio. If interest rates were to
rise more than is implied by current market rates, or if the Federal
Reserve were to sell assets relatively rapidly, realized losses would
be higher than expected, reducing the Federal Reserve’s net income. While there may be scenarios in which asset sales could lead
to realized losses that exceed net interest income, those scenarios
seem very unlikely. Moreover, any reduction in Federal Reserve net
income resulting from realized losses on securities holdings would
most appropriately be viewed in the context of the very sizable Reserve Banks remittances to the Treasury over the past few years,
much of which reflects the large-scale asset purchases that have
been pursued by the FOMC to foster the goals of monetary policy.
Q.11. Mr. Chairman, this time last year you were asked about your
thoughts about the GSEs—Fannie Mae and Freddie Mac—and
what sort of time frame we [Congress] should try to come up with
a solution—6 months? 9 months? End of the year?
In response, you said, ‘‘Well, the sooner you get some clarity
about where the ultimate objective is, the better.’’
Here we are a year later and the administration has just released its plan—which is more of a menu of options than a plan.
Do you think the lack of clarity from Congress on the future direction of the economy is having an adverse impact on the housing finance market?
A.11. Greater clarity from the Congress on the direction of housing
finance in the United States would have a positive effect on mortgage markets. Market participants would be better able to plan for
the future if they knew what institutions and policies were likely
to be important in coming years.
Q.12. As you know between FHA and Fannie Mae and Freddie Mac
the Government is originating roughly 95 percent of new loans in
the market today. Do you think Congressional action on GSE reform could help reinvigorate the private mortgage lending sector?
A.12. Congressional action on GSE reform could help reinvigorate
the private mortgage lending sector. As described in the recent Department of the Treasury Report to the Congress on ‘‘Reforming
America’s Housing Finance Market,’’ the Administration lays out
three options for moving forward with the reform of Fannie Mae
and Freddie Mac. These options are reasonable and feasible approaches for reforming mortgage finance. By presenting these options, the report appropriately leaves to Congress the question of
the extent of Government involvement in mortgage markets. By
settling on an approach for managing future Government involvement in mortgage markets, Congress would also provide the pri-

67
vate mortgage sector with important information about its future
role in housing finance.
Q.13. Some have criticized the Obama administration for suggesting that the Government should be completely removed from
the housing finance market. One industry group (the National Association of Realtors) has said, ‘‘The Obama administration and
some members of Congress want to turn the clock back on the
housing market to the 1930s, turning us into a Nation of renters
and making home ownership something that only the rich can afford.’’ Do you think that is a fair criticism or is that hyperbole from
people who are addicted to the current system of subsidy for housing?
A.13. The Administration’s housing finance reform proposal rejects
privatization of the housing markets. As its states, ‘‘Complete privatization would limit access to, and increase the cost of, mortgages
for most Americans too dramatically and leave the Government
with very little it can do to ensure liquidity during a crisis’’ (page
26). Instead, the Administration proposes three options that have
less Government involvement in mortgage markets than in the
past, but still have a significant role for Government. The options
presented in the Administration’s proposal strike a balance between access to mortgage credit, incentives for housing investment,
taxpayer protection, and financial stability.
Q.14. Given the fact that jumbo 30-year fixed-rate mortgages existed before the crisis, don’t you think it’s likely that a strictly private housing finance market would offer a 30-year fixed-rate product, though maybe at a slightly higher priced than in the past?
A.14. A strictly private market is likely to offer a 30-year mortgage
that is somewhat more costly than such mortgages in the past, but
such mortgages may only be available during good economic times.
Fannie Mae and Freddie Mac did not dominate the mortgage markets until the late 1980s, but the 30-year mortgage was offered to
mortgage borrowers prior to that time. Moreover, the 30-year fixedrate mortgage is currently offered to borrowers in the jumbo mortgage market (without Fannie Mae or Freddie Mac guarantees).
Therefore, some evidence strongly suggests that the 30-year mortgage is a product that can be provided by the private sector. However, it seems unlikely that the 30-year fixed-rate mortgages would
be available even at somewhat higher prices under all economic
conditions. The implicit Government backing of Fannie Mae and
Freddie Mac likely provides them with some significant advantages
in funding and in hedging the interest rate risks associated with
such mortgages, particularly during times of financial market turmoil. Jumbo mortgages were not available during the worst times
of the most recent financial crisis, and when they became available
in the latter part of the crisis, such mortgages were priced at very
high spreads relative to Treasury yields. Thus, as suggested by the
Treasury’s recent white paper, some form of Government backing
may be needed to maintain reasonable 30-year fixed-rate mortgage
rates and a steady supply of mortgage credit during times of substantial financial stress.
Q.15. First, does he support age discrimination?

68
A.15. No. The Board complies with the Age Discrimination in Employment Act of 1967 (ADEA). The ADEA and the implementing
regulations of the EEOC authorize employers to impose mandatory
retirement based on age in limited circumstances and the Board
policy referred to below complies with the ADEA. (See 29 USC
§631(c) and 29 CFR §1625.12.)
Q.16. Why does the Board of Governors require the regional Feds
to have a mandatory retirement age?
A.16. The Reserve Banks are private entities for purposes of the
ADEA. Accordingly, as is the case in many private firms, the Reserve Banks follow a policy of mandatory retirement of the type
that is expressly permitted under the ADEA, as passed by Congress. (See 29 USC §631(c).) The ADEA permits private employers
to require the retirement of any employee who has attained 65
years of age, and who, for the 2-year period immediately before retirement, is employed in a bona fide executive or higher policymaking position, if such employee is entitled to an immediate nonforfeitable annual retirement benefit from a pension, profit-sharing,
savings, or deferred compensation plan, or any combination of such
plans, of the employer of such employee which equals, in the aggregate, at least $44,000. An employee within this exemption can lawfully be required to retire at age 65 or above.
The mandatory retirement policy adopted by the Board applies
only to the two most high level officers at the Federal Reserve
Banks, the President and the First Vice President, and meets all
of the conditions for mandatory retirement under the ADEA, as
noted above. The Board’s mandatory retirement policy is intended
to enable successors to move into these positions at an earlier age
than might have been the case without the policy. Moreover, when
successors have come from within the organization, earlier turnover at the top has meant earlier advancement, as well as the possibility of increased advancement opportunities for other officers
whom the Federal Reserve needs to retain. On the other hand, a
fixed mandatory retirement age without due regard for tenure may,
on balance, require a frequency of turnover that may be more disruptive than beneficial, and may require an individual to retire
when he or she is becoming able to make the greatest contribution.
As a result, Board policy requires Reserve Bank presidents and
first vice presidents to retire at age 65 or after 10 years in their
positions, whichever is later, up to age 75.
Q.17. Is there a similar age restriction on the Board of Governors?
A.17. No. Tenure of service on the Board of Governors is governed
by the terms set by Congress in the Federal Reserve Act. Members
of the Board are limited in how long they may serve. Under the
Federal Reserve Act, both the Chairman and Vice Chairman of the
Board serve in this position for a term of 4 years and may only continue as Chairman/Vice Chairman if the then sitting President renominates them for office and the Senate confirms the appointment. All Members, including the Chairman and the Vice Chairman, are appointed to complete fixed terms of 14 years, which start
and expire in staggered fashion. Upon the expiration of their terms,
Members may continue to serve until their successors are appointed and have qualified.

69
Q.18. Do you support the mandatory retirement age for regional
Feds?
A.18. Yes. The Board’s mandatory retirement policy for Presidents
and First Vice Presidents of Federal Reserve Banks has provided
a beneficial balance between tenured policy makers and incoming
executives with new perspectives, while providing for reasonable
advancement opportunities for others within the organization. As
noted above, the Board’s policy complies with the terms of the
ADEA as enacted by Congress and the EEOC’s implementing regulations.
Q.19. Do you support giving Federal Reserve Board of Governors
their own staff?
A.19. All staff of the Board of Governors report to, and perform
work for, all members of the Board, and any Board staff may be
called upon by any Member to perform work for them in furtherance of official Board functions. In addition, the Board has established delegations of authority which assign responsibility for
Board operations to various Members of the Board. Staff who work
within these areas of responsibility report directly to the Member
who has oversight responsibility for the relevant Board function.
Members determine the performance ratings of high level staff
within their oversight area and are able to request additional resources for their areas of responsibility if they consider such resources necessary to carrying out the function. Final determinations on staffing and funding levels are voted on by the full Board,
with each Member having an equal vote on the ultimate outcome.
Q.20. How can other Governors exercise independent judgment
when they have to rely on information fed to them by your staff?
A.20. As noted above, Board staff do not work solely for the Chairman. Board staff report to, and perform work for, all members of
the Board based on the duties the Board member performs for the
Board.
Q.21. Don’t you think, in a crisis such as the one the Federal Reserve just dealt with, that you would have been better served if the
other Governors had additional resources with which to make their
decisions?
A.21. The Members of the Board worked collaboratively, creatively,
and diligently, to address the issues raised by the financial crisis.
In addition, staff of the board worked with all Board Members to
identify and address concerns. The result, in my estimation, led to
a very successful series of policy decisions. All Members of the
Board have an equal vote on the Board’s budget, which is what determines the level of resources available to carry out the Board’s
functions.
RESPONSES TO WRITTEN QUESTIONS OF SENATOR WICKER
FROM BEN S. BERNANKE

Section 1
Q.1. The Federal Reserve is the primary regulator for the largest
U.S. banks and one of the regulators most concerned about
securitization, which affects not only the health of those banks but

70
the U.S. financial system in general. I am very concerned that the
mortgage backed securities (MBS) market has no standards and no
real working structure, and these problems affect not just financial
institutions’ ability to monitor and value the MBS they hold but
also regulators’ ability to understand what is happening with the
institutions they are regulating.
In your earlier testimony, you mentioned the steps that regulators are taking to make sure that mortgages are better underwritten, such as the ‘‘qualified residential mortgage’’ definition, national servicing standards, and possible improvements to credit rating agencies’ performance. However, I would like you to focus on
potential problems with the securities and not the underwriting of
mortgages in response to my questions.
Each set of securities has its own pooling and servicing agreements, its own definitions of such fundamental concepts of delinquency and default, and its own internal plumbing mechanisms as
to how cash flows work. Can you describe the challenges banks
have in placing values on their MBS holdings when it is difficult
to compare to other MBS holdings that have different standards?
A.1. MBS valuation has two important components: the projection
of cash flows and the identification of appropriate discount rates
based on portfolio and market information. Banks investing in
MBS should analyze the terms and conditions of Pooling and Servicing Agreements (PSAs) governing the transactions in order to understand the cash flow waterfall and other factors that affect the
value of these securities. While there is a greater degree of standardization in PSAs for securities issued by the Government sponsored entities (GSEs), thereby facilitating the valuation of these securities, there is less standardization in the private label MBS
market, thereby making the valuation of private label MBS somewhat more complex. These differences include potential loss mitigation strategies and payment advance requirements for delinquent
loans as well as other items that give the service some level of discretion in the private label MBS market. Additionally, the underlying representations and warranties and requirements for originators to repurchase mortgage loans not meeting the representations
and warranties may vary widely among private label MBS deals.
These differences are more acute in private label deals than in
issuances involving the GSEs. Further, there can be significant
structural differences between issuances of private label MBS that
need to be considered such as the number of junior classes and the
amount of subordination.
There are a number of challenges in projecting cash flows, including but not limited to mortgage prepayment speeds, uncertainty about housing values, the willingness of borrowers without
significant equity to continue to service their mortgage debt, resolution of documentation issues around the foreclosure process, and
differences in the quality of servicer data and servicer practices.
Q.2. When there are no standard classifications of mortgages into
basic categories such as ‘‘prime,’’ ‘‘subprime,’’ and ‘‘alt-A,’’ how can
banks, investors, and regulators be sure about what kind of mortgages are in these securities? Without standards, is it possible for

71
the underwriters to throw the poorest quality mortgages into securities with good marketing labels?
A.2. The Federal Reserve Board staff agrees that these classifications for mortgages are often subject to interpretation and there is
a lack of clear specifications for different mortgage credit classifications. MBS materials and transactional documents should contain
clear definitions and detailed disclosures regarding the credit quality of underlying mortgage loans to help protect against potential
abuses from mortgage underwriters and MBS issuers. In addition,
loan data should be provided far enough in advance of offering
dates to give investors adequate time to analyze the credit risk of
the portfolio. (This issue has been partially addressed by the Securities and Exchange Commission (Commission) through, for example, its Regulation AB.) While the use of standardized classifications for mortgage credit quality may be a partial solution, additional disclosure regarding the credit quality of the underlying
loans would enhance the ability of investors to make a more granular and independent assessment of risk.
Q.3. Is it true that there is no loan-level data on MBS generally
available to banks, investors, and regulators who purchase MBS?
A.3. PSAs generally do not require servicers to provide monthly
loan-level data to investors in MBS. Servicers usually provide a
monthly cash flow report to investors that summarizes the performance of the underlying mortgage pools. These monthly investor
reports include information on the total amount of principal and interest collected on the portfolio, delinquent loans, including the severity of delinquencies, servicing and other fees charged by the
servicer, and other information. However, such reports may not always contain all relevant data, and investors often utilize information from third party data providers to analyze the performance of
MBS. Implementation of revisions to Regulation AB by the Commission should also help improve the amount and standardization
of performance data available to investors.
Q.4. Is it true that most MBS are sold through private placements
rather than public offerings, which means that important legal documents for MBS are not generally available to banks, investors,
regulators, and the public, making it impossible for anyone except
the underwriter and the original purchaser of the securities to completely understand the assets making up the MBS?
A.4. Prior to the mortgage crisis, the vast majority of private label
MBS were issued using publicly registered shelves. Very few issues
were privately placed. However, the private placements issued during that time posed problems for investors. Most investors who initially purchased the offering did not receive the private placement
memo until after the trade date. Also, monthly loan performance
data is generally not available to new investors after a private
placement. Under the terms of private placements, investors are
not entitled to the data unless they own the securities, thereby
complicating the purchase and sale of these securities in the secondary market. The Commission’s proposed enhancements to Regulation AB are designed to address this problem by requiring issuers
to provide investors in both public deals and private placements
with better access to monthly loan performance data.

72
Q.5. Without information and good analysis as to what these securities are worth, how can regulators have confidence that the banks
with MBS holdings are able to value them correctly?
A.5. A holder of actively traded MBS has access to market bid and
ask prices to value these investments. As part of the examination
process, regulators assess the processes and methods banks use to
value their securities relative to the prices for these securities in
the marketplace. The absence of adequate monthly data and the
sometimes imprecise terms of PSAs create uncertainty in valuing
less liquid assets, particularly where bid and ask prices are not
readily available in the market. Banks and other investors employ
cash flow models to estimate the expected cash flows from these securities in order to determine the present value and price of the securities. Examiners evaluate the assumptions and have the ability
to challenge or change the assumptions, if necessary.
Q.6. Is it true that Fannie Mae and Freddie Mac already have
standard legal documents—like pooling and servicing agreements—
for the MBS that they guarantee? Has this contributed to these entities sponsoring the only MBS that investors are buying right
now? Should the private MBS market have similar standard legal
documents and structures?
A.6. Fannie Mae and Freddie Mac have standardized terms for the
pooling and servicing agreements for the mortgages they guarantee. Minor variations exist among servicers. However, this standardization in the pooling and servicing agreements is not likely a
rationale for investors to purchase GSE-issued MBS. Investors purchase GSE securities because of the Government guarantee as well
as the absence of private label mortgage backed securities in the
market currently. The private label market would benefit from
standardized pooling and servicing agreements once that market
restarts.
Section 2
Q.1. The banks and investors that buy MBS rely on the representations and warranties on the underlying mortgage loans being met
and for servicers and trustees to enforce remedies for banks and investors if they are not met.
Is it true that the servicers of MBS mortgage pools are responsible for detecting breaches of these representations and warranties
and for putting loans that do not meet them back to originators,
who often are the servicers’ affiliates? Is this a fundamental conflict of interest?
A.1. Under most existing PSAs, servicers do not have the responsibility to review every loan file for violations of representations and
warranties or to put the loans that violate representations and
warranties back to the originator. However, servicers do have the
responsibility to report loans found in violation of representations
and warranties in the normal course of business to the bond trustee and the originator. When notified, the originator has the obligation to repurchase the loan or cure the violation. Investors in private label MBS have filed a number of lawsuits alleging, among
other claims, that the underlying loans contain breaches of representations and warranties and that the servicers have breached

73
their fiduciary duty to require originators to repurchase these
loans. Much of this litigation is still in its early stages, and at this
time, it is difficult to predict its ultimate impact.
Q.2. Is it true that the trustees of MBS mortgage pools provide little to no protection for the banks you regulate that invest in MBS,
as the trustees are selected and paid by the underwriter, generally
insist on being indemnified for everything, and are generally required to do very little when the mortgage pool is not being serviced properly?
A.2. Federal Reserve Board staff understands that there have been
complaints from MBS investors regarding trustees and the terms
of trust agreements. Existing agreements can often provide broad
indemnifications to trustees. Additionally, trustees are generally
not obligated to initiate broad investigations of loan files for
breaches of representations or warranties under these agreements,
unless a substantial number of investors petition the trustee. The
industry will need to come to agreement on any appropriate
changes to trust and PSA agreements in order to address investors’
concerns.
Q.3. Do you believe that Congress should consider requiring legally
and financially meaningful protections for the banks you regulate,
and for investors, when they buy MBS and the underlying mortgage quality is not as it was represented by the underwriter?
A.3. The Federal financial industry regulators are discussing the
content and extent of guidance on mortgage servicing standards
that can help address issues that have arisen in the mortgage and
MBS markets as a result of the recent financial crisis. The group
may develop solutions that could be implemented through banking
supervision and regulation. In circumstances where the scope of
bank regulatory authority is limited, the agencies may make recommendations to Congress for further action, if appropriate.
Q.4a. What do you believe the implications would be for the private
mortgage finance market as the Government pulls back from its
support?
A.4a. Federal Reserve Board staff can see the benefit of standardized guidelines for certain types of mortgages eligible for
securitizations. However, these guidelines would need to be one
component of an overall housing finance strategy in the United
States. The final determination of the role of Freddie Mac and
Fannie Mae as well as FHA in the MBS market will determine the
course of the private label MBS market. As you may know, a number of standardization efforts are under way. The American
Securitization Forum (ASF), through its Project Restart, has a goal
to standardize the PSA agreements. The Commission has proposed
changes to Regulation AB as noted above.
Q.4b. Mandated standardization of mortgage categories for
securitization and of the legal documents that govern MBS.
A.4b. Generally, transparency and disclosure about the financial
contracts is helpful for improving the operation of markets for financial assets. However, mandating the details of contracts among
private market participants may or may not be helpful depending
on the circumstances. For example, standardization can at times be

74
helpful and improve the market liquidity of some financial assets.
At other times, however, standardization may impede financial innovation and hinder market liquidity if the standards are too inflexible or not designed to meet new or evolving market changes.
Thus, the details of any particular approach to financial market
transactions or contracts have to be known and studied to know if
such actions help or hurt financial market performance. Such details are also important for helping to define the appropriate role
for GSEs in such markets.
Q.4c. Better disclosure of MBS data and the legal documents.
A.4c. The Federal Reserve Board supports greater transparency
and disclosure of MBS data and legal documents. For example, investors need other avenues to access monthly mortgage loan data
other than Bloomberg and Loan Performance. In addition, the Federal banking agencies, the Commission, the Federal Housing Finance Authority, and the Department of Housing and Urban Development are working together on issuing proposed rules to require
that a securitizer retain an economic interest in a material portion
of the credit risk for any asset that it transfers, sells, or conveys
to a third party. These rules would require certain mandatory disclosure requirements in securitizations transactions involving MBS
that are designed to enhance the information available to investors.
Q.4d. Meaningful remedies for banks and investors of MBS if the
underlying mortgage quality is worse than was originally as promised.
A.4d. Securitization documents should provide a framework that
permits investors to access loan files so that they can confirm completeness and compliance with the representations and warranties.
The Federal Reserve Board supports a securitization framework
that would ensure effective oversight of compliance with
securitizers’ representations and warranties.

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ADDITIONAL MATERIAL SUPPLIED

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