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S. HRG. 110-855
FEDERAL RESERVE'S SECOND MONETARY POLICY
REPORT FOR 2008
HEARING
BEFORE THE
COMMITTEE ON
BANKING, HOUSING, AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED TENTH CONGRESS
SECOND SESSION
ON
OVERSIGHT ON THE MONETARY POLICY REPORT TO CONGRESS PURSUANT TO THE FULL EMPLOYMENT AND BALANCED GROWTH ACT OF 1978
JULY 15, 2008
Printed for the use of the Committee on Banking, Housing, and Urban Affairs
Available at: http://www.access.gpo.gov/congress/senate/senate05sh.html
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
CHRISTOPHER J. DODD, Connecticut, Chairman
RICHARD C. SHELBY, Alabama
TIM JOHNSON, South Dakota
ROBERT F. BENNETT, Utah
JACK REED, Rhode Island
WAYNE ALLARD, Colorado
CHARLES E. SCHUMER, New York
MICHAEL B. ENZI, Wyoming
EVAN BAYH, Indiana
CHUCK HAGEL, Nebraska
THOMAS R. CARPER, Delaware
JIM BUNNING, Kentucky
ROBERT MENENDEZ, New Jersey
MIKE CRAPO, Idaho
DANIEL K. AKAKA, Hawaii
ELIZABETH DOLE, North Carolina
SHERROD BROWN, Ohio
MEL MARTINEZ, Florida
ROBERT P. CASEY, Pennsylvania
BOB CORKER, Tennessee
JON TESTER, Montana
SHAWN MAHER, Staff Director
WILLIAM D. DUHNKE, Republican Staff Director and Counsel
ROGER HOLLINGSWORTH, Deputy Staff
Director
AMY FRIEND, Chief Counsel
DEAN V. SHAHINIAN, Senior
J E N N I F E R FOGEL-BUBLICK,
Counsel
Counsel
JULIE CHON, Counsel
AARON K L E I N , Chief
Economist
JONATHAN MILLER, Professional Staff Member
COLIN McGlNNIS, Professional Staff Member
NEAL ORRINGER, Professional Staff Member
DREW COLBERT, Legislative
Assistant
BRIAN FlLIPOWICH, Legislative
Assistant
MARK OESTERLE, Republican Chief Counsel
JlM JOHNSON, Republican
Counsel
PEGGY KUHN, Republican Senior Financial
Economist
ANDREW OLMEM, Republican Professional Staff Member
MARK CALABRIA, Republican Professional Staff Member
BRANDON BARFORD, Republican Legislative
Assistant
DAWN RATLIFF, Chief Clerk
DEVIN HARTLEY, Hearing Clerk
SHELVIN SIMMONS, IT Director
JIM CROWELL, Editor
(ID
C O N T E N T S
TUESDAY, JULY 15, 2008
Page
Opening statement of Chairman Dodd
Opening statements, comments, or prepared statements of:
Senator Shelby
1
3
WITNESS
Ben S. Bernanke, Chairman, Board of Governors of the Federal Reserve
System
Prepared statement
Response to written questions of:
Senator Shelby
Senator Bunning
4
38
42
44
ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD
Monetary Policy Report to the Congress dated July 15, 2008
(III)
46
FEDERAL RESERVE'S SECOND MONETARY
POLICY REPORT FOR 2008
TUESDAY, JULY 15, 2008
U.S. SENATE,
COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS,
Washington, DC.
The Committee met at 10:09 a.m., in room SR—325, Russell Senate Office Building, Senator Christopher J. Dodd (Chairman of the
Committee) presiding.
OPENING STATEMENT OF CHAIRMAN CHRISTOPHER J. DODD
Chairman DODD. Well, good morning. Let me welcome my colleagues and others to this very important hearing this morning. I
want to thank the Chairman of the Federal Reserve.
Today we are meeting in the most unusual and extraordinary
moments in many ways in the recent history of our country. Let
me tell you how we are going to proceed this morning.
This is, of course, a scheduled hearing with the Chairman of the
Federal Reserve on Humphrey-Hawkins and dealing with monetary
policy, and over the next hour or so, we are going to focus on that
and give the Chairman an opportunity to give us his statement this
morning on that statutorily mandated requirement to appear before the Committee and share his thoughts on this issue. And then,
as I understand it, we are due to have a vote around 11 o'clock,
and my hope would be that we would recess for a few minutes for
that vote, and when we come back, the Secretary of the Treasury,
Hank Paulson, and Christopher Cox, the Chairman of the Securities and Exchange Commission, will be with us to engage in a discussion of the financial services issues that are before us.
I want to thank Senator Shelby and my colleagues here for
waiving the normal requirements of having several days of notice
before we actually have a hearing like this. But I think all of us
recognize the significance of the issues that are going on in our
country at this moment and the importance of having the Secretary
of the Treasury and the Chairman of the SEC as well as the Chairman of the Federal Reserve to be with us this morning. So I am
very grateful to you and to the Secretary of the Treasury and Chris
Cox.
So the first hearing will be to receive the Semiannual Monetary
Policy Report from the Federal Reserve as previously scheduled,
and after the conclusion of that hearing, we will convene a second
hearing on Recent Developments in U.S. Financial Markets and
Regulatory Responses to Them. The second hearing was noticed
yesterday with the consent of Senator Shelby—and, again, I am
(l)
grateful to him—due to the special and exigent circumstances in
our Nation's financial markets.
I want to thank Chairman Bernanke for testifying at both hearings. I also thank Secretary Paulson and Chairman Cox for agreeing to appear on very short notice at the second hearing. In deference to them and the importance of the matters at hand, I will
provide a brief opening statement. I will ask Senator Shelby to do
likewise. And then I would ask my fellow Members here if they
would reserve their question period to make their opening statements. All statements will be included in the record as if read so
that we can get to the statement by the Chairman of the Federal
Reserve and then get to the questions as quickly as we can.
In considering the state of our economy and, in particular, the
turmoil in recent days, it is important to distinguish between fear
and facts. In our markets today, far too many actions are being
driven by fear and ignoring crucial facts. One such fact is that
Fannie Mae and Freddie Mac have core strengths that are helping
them weather the stormy seas of today's financial markets. They
are adequately capitalized. They are able to access the debt markets. They have solid portfolios with relatively few risky subprime
mortgages. They are well regulated, and they have played a vital
role in maintaining the flow of affordable mortgage credit even during these volatile times.
Another fact is that the subprime lending fiasco was preventable.
In this Committee, 18 months of exhaustive hearings have documented what I have called a "pattern of regulatory neglect." The
previous leadership, along with other financial agency leaders appointed by this administration, in my view ignored the clear and
present danger posed by predatory lending to homeowners, to financial institutions, and to the economy as a whole. The result of
this neglect is that the American people are experiencing unprecedented hardships and uncertainties.
Foreclosure rates continue at record levels. Each and every day
in America, more than 8,000 families enter foreclosure. For those
lucky enough to keep their homes, the value of their homes has
dropped by the greatest amount in some cases since the Great Depression. Millions more are paying record-high prices for gasoline,
for health care, for education, and even for the food that they put
on their tables. They are watching the value of their pension funds
and 401(k)s plummet. And they want to know when will things
start to turn around, when will America get back on track.
Chairman Bernanke, you are to be commended, in my view, for
your efforts to bring greater stability to our financial system during
an unprecedented period of volatility. You also deserve credit for
your willingness to address some of the unsafe, unsound, and predatory practices that proliferated over the last several years in the
subprime mortgage market, as well as in the credit card lending.
And we look forward to hearing from you today about the outlook
for the Nation's economy and what can be done to improve it.
Certainly, this Committee has worked diligently in that regard.
On Friday evening, the Senate passed, with an overwhelming bipartisan majority, a bill that we believe will assist homeowners at
risk of foreclosure, establish a new, permanent affordable housing
fund, modernize the FHA, strengthen the regulation of the GSEs,
and help restore confidence to the mortgage markets as a whole.
It is certainly my view that this legislation deserves to be enacted
as soon as possible, and I hope that will occur.
In addition, we are all by now aware that the Treasury and the
SEC as well as the Fed made important policy announcements this
past weekend, which we intend to examine carefully in the hearing
later this morning with you, Mr. Chairman, Secretary Paulson, and
Chairman Cox.
I think I can speak for everyone, I hope, on this Committee in
saying that we all share a common desire to promote the common
good of our country, and I think we all certainly appreciate the
spirit in which the Fed, the SEC, and the Treasury Department
have acted. But we do them and the American people a disservice
if we do not examine very carefully the proposals that are being
put forward. That is particularly true of the Treasury proposals. It
is in many respects unprecedented. Although limited in duration,
these proposals would give the Treasury unlimited new authority
to purchase GSE debt and equity, it would exempt those purchases
from pay-as-you-go budget rules, and it would grant to the Federal
Reserve considerable new powers in relation to the regulation of
the GSEs. These new powers could have the effect of crippling the
efforts of virtually every Member of this Committee to create a true
world-class regulator for the GSEs.
These proposals raise serious questions—questions about the nature of the economic crisis facing our Nation, about the ability of
these proposals to address this crisis effectively, and about the burden to the American taxpayer potentially being asked to carry.
These questions deserve serious answers.
Above all, this is a time to act on the basis of fact and not fear,
as I said at the outset of these remarks. For too many years, leaders have shirked their duty, in my view, to protect the American
taxpayer and to promote the American economy. At this critical
moment, we must not flinch from our duty to do the same.
With that, let me turn to Senator Shelby.
STATEMENT OF SENATOR RICHARD C. SHELBY
Senator SHELBY. Mr. Chairman, I ask that my whole statement
be made part of the record.
Chairman DODD. Without objection, it will be.
Senator SHELBY. Chairman Bernanke, we again welcome you to
the Banking Committee. We know this is a stressful time for our
country, for our banking system, and perhaps for the Federal Reserve. We welcome you to deliver the Federal Reserve's Semiannual
Monetary Policy Report, as you are required by law to do.
I will keep my remarks brief and wait for Secretary Paulson and
also SEC Chairman Cox to join you. But we are all interested in
your views on the economy, where the economy is going to go, more
than the specter of inflation, but other issues, related issues, such
as the GSE situation.
A lot of us—and you have raised this issue, your Chairman
raised this issue over 5 years ago in this Committee. A lot of us
realized that the GSEs were not properly regulated and were thinly
capitalized. We have seen this come home now. They were fears
that we hoped would not come, but they are here today.
I guess the situation is some said always that the GSEs, because
of the implicit guarantee of the Government, with over $5 trillion
of debt, exceeding that of France and the U.K. combined, that it
was a ticking time bomb. Well, someone has started the fuse burning. I hope it is not too little or too late. But I believe this is an
opportune time to rein in the GSEs.
Senator Dodd has talked about this a lot: We realize they are important to our housing, they are important to our economy, but
they have to be capitalized well. They have got to be managed well,
and they have got to be regulated. And I hope later in the morning
we will get into that. I think that is one of the topics of the day
after your monetary policy report.
Thank you, Senator Dodd.
Chairman DODD. With that, Mr. Chairman, we welcome your
comments, and your statement in full will be included in the
record.
STATEMENT OF BEN S. BERNANKE, CHAIRMAN,
BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
Mr. BERNANKE. Chairman Dodd, Senator Shelby, and Members
of the Committee, I am pleased to present the Federal Reserve's
Monetary Policy Report to the Congress.
The U.S. economy and financial system has confronted some significant challenges thus far in 2008. The contraction in housing activity that began in 2006 and the associated deterioration in mortgage markets that became evident last year have led to sizable
losses at financial institutions and a sharp tightening in overall
credit conditions. The effects of the housing contraction and of the
financial head winds on spending and economic activity have been
compounded by rapid increases in the prices of energy and other
commodities which have sapped household purchasing power even
as they have boosted inflation.
Against this backdrop, economic activity has advanced at a sluggish pace during the first half of this year while inflation has remained elevated. Following a significant reduction in its policy rate
over the second half of 2007, the Federal Open Market Committee
eased policy considerably further through the spring to counter actual and expected weakness in economic growth and to mitigate
downside risk to economic activity. In addition, the Federal Reserve
expanded some of the special liquidity programs that were established last year and implemented additional facilities to support
the functioning of financial markets and foster financial stability.
Although these policy actions have had positive effects, the economy continues to face numerous difficulties, including ongoing
strains on financial markets, declining house prices, a softening
labor market, and rising prices of oil, food, and some other commodities.
Let me now turn to a more detailed discussion of some of these
key issues.
Developments in financial markets and their implications to the
macroeconomic outlook have been a focus of monetary policymakers
over the past year. In the second half of 2007, the deteriorating
performance of subprime mortgages in the United States triggered
turbulence in domestic and international financial markets as in-
vestors became markedly less willing to bear credit risks of any
type.
In the first quarter of 2008, reports of further losses and
writedowns by financial institutions intensified investor concerns
and resulted in further sharp reductions in market liquidity. By
March, many dealers and other institutions, even those that had
relied heavily on short-term secured financing, were facing much
more stringent borrowing conditions.
In mid-March, a major investment bank, the Bear Stearns Companies Incorporated, was pushed to the brink of failure after suddenly losing access to short-term financing markets. The Federal
Reserve judged that a disorderly failure of Bear Stearns would pose
a serious threat to overall financial stability and would most likely
have significant adverse implications for the U.S. economy. After
discussions with the Securities and Exchange Commission and in
consultation with the Treasury, we invoked emergency authorities
to provide special financing to facilitate the acquisition of Bear
Stearns by JPMorgan Chase and Company.
In addition, the Federal Reserve used emergency authorities to
establish two new facilities to provide backstop liquidity to primary
dealers, with the goals of stabilizing financial conditions and increasing the availability of credit to the broader economy.
We have also taken additional steps to address liquidity pressures in the banking system, including a further easing of the
terms for bank borrowing at the discount window and increases in
the amount of credit made available to banks through the Term
Auction Facility.
The FOMC also authorized expansion of its currency swap arrangements with the European Central Bank and the Swiss National Bank to facilitate increased dollar lending by those institutions to banks in their jurisdictions.
These steps to address liquidity pressures, coupled with monetary easing, seem to have been helpful in mitigating some market
strains. During the second quarter, credit spreads generally narrowed, liquidity pressures ebbed, and a number of financial institutions raised new capital. However, as events in recent weeks have
demonstrated, many financial markets and institutions remain
under considerable stress, in part because the outlook for the economy and, thus, for credit quality remains uncertain.
In recent days, investors became particularly concerned about
the financial condition of the Government-sponsored enterprises
Fannie Mae and Freddie Mac. In view of this development, and
given the importance of these firms to the mortgage market, the
Treasury announced the legislative proposal to bolster their capital,
access to liquidity, and regulatory oversight.
As a supplement to the Treasury's existing authority to lend to
the GSEs, and as a bridge to the time when the Congress decides
how to proceed on these matters, the Board of Governors authorized the Federal Reserve Bank of New York to lend to Fannie Mae
and Freddie Mac should that become necessary. Any lending would
be collateralized by U.S. Government and Federal agency securities. In general, healthy economic growth depends on well-functioning financial markets. Consequently, helping the financial mar-
kets to return to more normal functioning will continue to be a top
priority of the Federal Reserve.
I turn now to current economic developments and prospects. The
economy has continued to expand, but at a subdued pace. In the
labor market, private payroll employment has declined this year,
falling at an average pace of 94,000 jobs per month through June.
Employment in the construction and manufacturing sectors has
been particularly hard hit, although employment declines in a
number of other sectors are evident as well. The unemployment
rate has risen and now stands at 5.5 percent.
In the housing sector, activity continues to weaken. Although
sales of existing homes have been unchanged this year, sales of
new homes have continued to fall, and inventories of unsold new
homes remain high. In response, home builders continue to scale
back the pace of housing starts. Home prices are falling, particularly in regions that experienced the largest price increases earlier
this decade. The declines in home prices have contributed to the
rising tide of foreclosures. By adding to the stock of vacant homes
for sale, these foreclosures have in turn intensified the downward
pressure on home prices in some areas.
Personal consumption expenditures have advanced at a modest
pace so far this year, generally holding up somewhat better than
might have been expected given the array of forces weighing on
household finances and attitudes. In particular, with the labor
market softening and consumer price inflation elevated, real earnings have been stagnant so far this year. Declining values and equities in house have taken their toll on household balance sheets,
credit conditions have tightened, and indicators of consumer sentiment have fallen sharply. More positively, the fiscal stimulus package is providing some timely support to household incomes. Overall, consumption spending seems likely to be restrained over coming quarters.
In the business sector, real outlays for equipment and software
were about flat in the first quarter of the year, and construction
of nonresidential structures slowed appreciably. In the second
quarter, the available data suggests that business fixed investment
appears to have expanded moderately. Nevertheless, surveys of
capital spending plans indicate that firms remain concerned about
the economic and financial environment, including sharply rising
costs of inputs and indications of tightening credit, and they are
likely to be cautious with spending in the second half of the year.
However, strong export growth continues to be a significant boon
to many U.S. companies.
In conjunction with the June FOMC meeting, Board members
and reserve bank presidents prepared economic projections covering the years 2008 through 2010. On balance, most FOMC participants expected that, over the remainder of this year, output
would expand at a pace appreciably below its trend rate, primarily
because of continued weakness in housing markets, elevated energy prices, and tight credit conditions. Growth is projected to pick
up gradually over the next 2 years as residential construction bottoms out and begins a slow recovery and as credit conditions
gradually improve. However, FOMC participants indicated that
considerable uncertainty surrounded their outlook for economic
growth, and they viewed the risks to their forecast as skewed to
the downside.
Inflation has remained high, running at nearly a 3.5-percent annual rate over the first 5 months of this year, as measured by the
price index of personal consumption expenditures. And with gasoline and other consumer energy prices rising in recent weeks, inflation seems likely to move temporarily higher in the near term. The
elevated level of overall consumer inflation largely reflects a continued sharp run-up in the prices of many commodities, especially oil,
but also certain crops and metals. The spot price of West Texas intermediate crude oil soared about 60 percent in 2007 and thus far
this year has climbed an additional 50 percent or so.
The price of oil currently stands at about 5 times its level toward
the beginning of this decade. Our best judgment is that this surge
in prices has been driven predominantly by strong growth in underlying demand and tight supply conditions in global oil markets.
Over the past several years, the world economy has expanded at
its fastest pace in decades, leading to substantial increases in demand for oil. Moreover, growth has been concentrated in developed
and emerging market economies, where energy consumption has
been further stimulated by rapid industrialization and by government subsidies that hold down the price of energy faced by ultimate users.
On the supply side, despite sharp increases in prices, the production of oil has risen only slightly in the past few years. Much of
the subdued supply response reflects inadequate investment and
production shortfalls in politically volatile regions where large portions of the world's oil reserves are located. Additionally, many governments have been tightening their control over oil resources, impeding foreign investment and hindering efforts to boost capacity
and production. Finally, sustainable rates of production in some of
the more secure and accessible oil fields, such as those in the North
Sea, have been declining.
In view of these factors, estimates of long-term oil supplies have
been marked down in recent months. Long-dated oil future prices
have risen along with spot prices, suggesting that market participants also see oil supply conditions remaining tight for years to
come.
The decline in the foreign exchange value of the dollar has also
contributed somewhat to the increase in oil prices. The precise size
of this effect is difficult to ascertain as the causal relationships between oil prices and the dollar are complex and run in both directions. However, the price of oil has risen significantly in terms of
all major currencies, suggesting that factors other than the dollar—
notably, shifts in the underlying global demand for and supply of
oil—have been the principal drivers of these increases in prices.
Another concern that has been raised is that financial speculation has added markedly to upward pressure on oil prices. Certainly, investor interest in oil and other commodities has increased
substantially of late. However, if financial speculation is pushing
oil prices above the levels consistent with the fundamentals of supply and demand, we would expect inventories of crude oil and petroleum products to increase as supply rose and demand fell. But,
in fact, available data on oil inventories show notable declines over
the past year.
This is not to say that useful steps could not be taken to improve
the transparency and functioning of futures markets, only that
such steps are unlikely to substantially affect the prices of oil or
other commodities in the longer term.
Although the inflationary effect of rising oil and agricultural
commodity prices is evident in the retail prices of energy and food,
the extent to which the high prices of oil and other raw materials
have passed through to the prices of non-energy, non-food finished
goods and services seems thus far to have been limited. But with
businesses facing persistently higher input prices, they may attempt to pass through such costs into prices of final goods and
services more aggressively than they have done so far.
Moreover, as the foreign exchange value of the dollar has declined, rises in import prices have put greater upward pressure on
business costs and consumer prices. In their economic projections
for the June FOMC meeting, monetary policymakers marked up
their forecasts for inflation during 2008 as a whole. FOMC participants continue to expect inflation to moderate in 2009 and 2010 as
slower global growth leads to a pooling of commodity markets, as
pressures on resource utilization decline, and as longer-term inflation expectations remain reasonably well anchored. However, in
light of persistent escalation of commodity prices in recent quarters, FOMC participants view the inflation outlook as unusually
uncertain and cited the possibility that commodity prices will continue to rise as an important risk to the inflation forecast.
Moreover, the currently high level of inflation, if sustained,
might lead the public to revise up its expectations for longer-term
inflation. If that were to occur and those revised expectations were
to become embedded in the domestic wage- and price-setting process, we could see an unwelcome rise in actual inflation over the
longer term. A critical responsibility of monetary policymakers is to
prevent that process from taking hold.
At present, accurately assessing and appropriately balancing the
risks to the outlook for growth and inflation is a significant challenge for monetary policymakers. The possibility of higher energy
prices, tighter credit conditions, and a still deeper contraction in
housing markets all represent significant downside risks to the outlook for growth. At the same time, upside risks to the inflation outlook have intensified lately as the rising prices of energy and some
other commodities have led to a sharp pick-up in inflation, and
some measures of inflation expectations have moved higher.
Given the high degree of uncertainty, monetary policymakers
will need to carefully assess incoming information bearing on the
outlook for both inflation and growth. In light of the increase in upside inflation risk, we must be particularly alert to any indications,
such as erosion of longer-term inflation expectations, that the inflationary impulses from commodity prices are becoming embedded in
the domestic wage- and price-setting process.
I would like to conclude my remarks by providing a brief update
on some of the Federal Reserve's actions in the area of consumer
protection.
At the time of our report last February, I described the Board's
proposal to adopt comprehensive new regulations to prohibit unfair
or deceptive practices in the mortgage market using our authority
under the Home Ownership and Equity Protection Act of 1994.
After reviewing more than 4,500 comment letters we received on
these proposed rules, the Board approved the final rules yesterday.
The new rules apply to all types of mortgage lenders and will establish lending standards aimed at curbing abuses while preserving responsible subprime lending and sustainable homeownership.
The final rules prohibit lenders from making higher-priced loans
without due regard for consumers' ability to make the scheduled
payments and require lenders to verify the income and assets on
which they rely when making the credit decision. Also, for higherpriced loans, lenders now will be required to establish escrow accounts so that property taxes and insurance costs will be included
in consumers' regular monthly payments.
The final rules also prohibit prepayment penalties for higherpriced loans in cases in which the consumer's payment could increase during the first few years and restrict prepayment penalties
on other higher-priced loans. Other measures address the coercion
of appraisers' service or practices and other issues. We believe the
new rules will help to restore confidence in the mortgage market.
In May, working jointly with the Office of Thrift Supervision and
the National Credit Union Administration, the Board issued proposed rules under the Federal Trade Commission Act to address
unfair or deceptive practices for credit card accounts and overdraft
protection plans. Credit cards provide a convenient source of credit
for many consumers, but as the terms of credit card loans have become more complex, transparency has been reduced.
Our consumer testing has persuaded us that disclosures alone
cannot solve this problem. Thus, the Board's proposed rules will require card issuers to alter their practices in ways that will allow
consumers to better understand how their own decisions and actions will affect their costs. Card issuers would be prohibited from
increasing interest rates retroactively to cover prior purchases, except under very limited circumstances. For accounts having multiple interest rates, when consumers seek to pay down their balance by paying more than the minimum, card issuers would be prohibited from maximizing interest charges by applying excess payments to the lowest-rate balance first.
The proposed rules dealing with bank overdraft services seek to
give consumers greater control by ensuring that they have ample
opportunity to opt out of automatic payments of overdrafts. The
Board has already received more than 20,000 comment letters in
response to these proposed rules.
Thank you very much. I would be pleased to take your questions.
Chairman DODD. Well, thank you very much, Mr. Chairman. And
let me just briefly say I appreciate the efforts of the Fed regarding
both credit cards and the things dealing with predatory lending
practices. We welcome those rules, and we welcome the suggestions
in the credit card areas, and a future point here, we will maybe
have more discussion about that. But I wanted to at least reflect
10
my appreciation of what the Fed has done regarding those matters,
and we appreciate it very much.
I am going to put this clock on at 5 minutes so we can give everyone a chance to raise any questions they have on the monetary
policy issues. Some of the questions may overlap, and at the conclusion of that, Secretary Paulson and Chairman Cox will be here to
have a broader discussion about the proposals being made by
Treasury over the weekend.
Let me, if I can, jump to the economic projections for 2009, the
concerns about economic growth that you have raised in your statement here this morning. Given the fact that we have, as you point
out, acknowledged the risk to your forecast for economic growth are
skewed to the downside, to use your words, and given the fact that
the stimulus package is about to—the effects of it are going to run
out by the end of the year. The housing crisis continues, obviously,
as we all know painfully. Gasoline prices, as you point out, are at
record levels, costing consumers tremendously. The issues involving
the weakness in the labor market are significant, 94,000 jobs lost
every month for the last 6 months on a consistent basis. Inflation,
as you point out, while it may abate in the coming years, it certainly is going to be with us for some time.
What suggestions do you have for us in all of this? And I realize
you may want to reserve some final judgment on the effects of the
stimulus package and will not know the full effects of that until
maybe toward the end of the year. But as we look down the road
as policy setters here in the Congress looking at ideas, including
a possibly a second stimulus package, one of the suggestions we
made to increase productivity is to invest more heavily in infrastructure, the infrastructure needs of the country.
I wonder if you might just share with us your views as to what
ideas, as a menu of ideas, without necessarily embracing one or the
other, but what you would be planning to do rather than just sort
of waiting out the year and a new administration coming in, we
will be leaving here, adjourning in late September, early October,
maybe coming back, maybe not until after inauguration of the
President late in January, it seems to me this would be an opportune time for us to be considering very seriously policy considerations that would provide for greater economic growth and opportunity than what we are presently looking at.
Mr. BERNANKE. Mr. Chairman, I think that the central issue in
the economic situation right now is the housing market. It is the
continued uncertainty about house prices and housing activity
which is creating financial stress, is affecting consumer wealth and
consumer expectations and causing the stress we are seeing in the
economy. So my suggestion would be in the near term to focus on
issues related to housing. I understand that you have already
passed a bill that would address, for example, GSE reform. We
need the GSEs to continue to be active in supporting the mortgage
markets, as well as FHA modernization and other steps that Congress determines would strengthen and support mortgage finance
in the housing sector. I think that is the most critical central issue
we face.
On a second stimulus package, my own sense is that we are still
trying to assess the effects of the first round. It appears that it
11
does seem to be helping. But it might be a bit more time before we
fully understand the extent to which additional stimulus may or
may not be needed.
If additional stimulus is, in fact, invoked, it would be important
to find programs that would be, as in the first round, timely, temporary, and targeted, in particular, that would take place quickly
and would put money into the economy relatively quickly.
In the case of infrastructure, it is often well justified on its merits, but one would have to ask whether the flow of funding would
go into the economy in a relatively prompt way, or would there be
long delays associated with the planning process?
Chairman DODD. But your objections or concerns, they are not
about the effects of that in the longer term but more the near-term
benefits of it.
Mr. BERNANKE. Addressing the infrastructure issue in the United
States is very important since infrastructure is a critical part of the
economic underpinnings. But except for those cases where the infrastructure spending would have immediate impact on total
spending, I would suggest that those projects be evaluated on their
own merits in terms of their ability to contribute to the overall
strength of the economy in the longer term.
Chairman DODD. I have a last question for you dealing with gasoline prices, and, again, let me first of all commend you because
you did something different than your predecessor. In the past, we
have excluded in the consideration of inflation gasoline or energy
pricing and food. And if you do not drive a car, heat your home,
or put food on the table, I suppose that has some relevance here.
And I understand the macroeconomic value of excluding energy
and food. But for average Americans, excluding those two necessities hardly reflects real inflation. And so the fact that you are
now adding those to real inflation is very welcome, and I thank you
for it.
I wonder if you might comment briefly on the notion, how is it—
and I understand your points about demand in the country and
around the world and supply issues. But it strikes many of us here
in the speculation area, and you said the need to look at transparency issues and the like are warranted. But it seems to me in
1 year's time to go from $60 or $70 a barrel to this morning I think
it is hovering around $150 a barrel has to be explained in terms
other than just normal economic pressures that it created.
Does it concern you at all about margin requirements, for instance, in the area of speculation where the margin requirements
are somewhat different in the area of energy pricing than they are
for other commodities that there should be some leveling of the
playing field when it comes to margin requirements, as an example
of what might come as a response?
Mr. BERNANKE. I would just like to comment briefly that the
Federal Reserve and the CFTC are part of a task force which is
gathering data analyzing these issues and hope to bring some more
explicit recommendations to you later this summer or early fall.
Margin requirements serve two purposes. They can affect the
cost of credit, but they also are a very important part of the
counterparty risk management process for exchanges. And so we
need to be careful in changing margin requirements that we do not
12
interfere with these other important functions or that we do not
unnecessarily reduce the liquidity in those markets. But we are
certainly looking at these issues, and we hoped that they would
bring to you some ideas.
Chairman DODD. You will be looking at that one specifically, the
margin requirement issue. Is that
Mr. BERNANKE. We will be looking specifically at the whole range
of issues about transparency, practices, positions, and so on.
Chairman DODD. Thank you very much.
Senator Shelby.
Senator SHELBY. Mr. Chairman, I have a number of questions
that I would like to submit for the record dealing with monetary
policy.
Chairman DODD. That will all be done, by the way. Any questions people have and they do not feel they have enough time on
monetary policy, we will make sure the Chairman gets them.
Senator SHELBY. Chairman Bernanke, you are also a bank regulator, the Federal Reserve, and I know that you are not the primary regulator of IndyMac, which was the largest bank failure
since 1984, Continental Illinois. Why did that bank fail? And could
it have been prevented? What is your take on it? And is that just
the beginning of a number of bank failures that you should be concerned with and we should be concerned with in this country?
Mr. BERNANKE. Well, Senator, as you point out, we are not the
primary regulator of that institution, but we were involved in
Senator SHELBY. Absolutely.
Mr. BERNANKE.
because the Federal Reserve Bank of San
Francisco was attempting to assist in the wind down, and we certainly had extensive communication with the FDIC and the OTS
about that bank.
My assessment of IndyMac is that it was particularly weighted
down with low-quality mortgages, subprime and other exotic mortgages, and those losses created a capital hole that it was unable
to fill. So in that respect, I think its failure, barring acquisition by
another firm, which did not occur, was inevitable. So, again, I think
it was basically the asset quality of the bank that had that effect.
Of course, all banks are being challenged by credit conditions
now. The good news is that the banking system did come into this
episode extremely well capitalized, extremely profitable. I do not
have any forecast to make. I think Chairman Bair gave a good discussion yesterday about the pressures that banks are facing, and
she discussed her list of problem banks.
I suppose it is a bit of good news that most of the problem banks
that she had is a far smaller list than we have seen in some episodes in the past, in the 1990s, for example.
Senator SHELBY. Overall, looking at our banking system, could
you say today here in the Senate that you believe as Chairman of
the Federal Reserve that our banking system is stable and
capitally strong?
Mr. BERNANKE. Our banking system is well capitalized. They
came in with strong capital. We are watching the situation very
carefully. My concerns have turned less on the solvency of these institutions and more on their ability to extend the credit that our
13
economy needs to keep growing, because in many cases banks are
deleveraging or shrinking or are reluctant to raise the extra capital
needed to take advantage of business opportunities. So that is more
my concern than solvency concerns.
Senator SHELBY. Let's briefly, because I have just got a couple
of minutes, focus on the GSEs, and we will get into it more when
the Treasury Secretary gets here and the Chairman of the SEC. Is
this just a stopgap measure or is this a real approach to fundamentally reform the GSEs? A lot of us, you included, have been advocating that right here on this Committee for a long time. We did
not have a lot of help from certain people, some of our friends, and
Fannie Mae and Freddie Mac have some of the most powerful lobbyists, believe me, in Washington. And I do not believe that they
are going to like some of the things that I believe we have to come
forth with now. But is this just a piecemeal deal? Because we have
got systemic risk here. Where do we go? Will this do it, in other
words, or will this just be postponing the inevitable?
Mr. BERNANKE. Well, Senator, our goals at this point should be
to protect the financial system, to protect the taxpayer, and to
strengthen and support the housing market. There are a number
of steps that we need, but I think a critical step would be
Senator SHELBY. What are the three most important steps?
Mr. BERNANKE. The most important step will be to get a strong,
bank-like, world-class regulator that will be able to provide assurance to the public, to the taxpayer, and to the investors that these
firms will be well capitalized and able to maintain and support
their core mission, which is to support mortgage financing in the
United States. So I would say that is job one.
Then we need to think about what else is needed to make sure
that they are, in fact, strong enough financially and there is
enough confidence that they can, in fact, carry out their mission.
And, again, the taxpayers' interest must be protected.
Senator SHELBY. Thank you, Mr. Chairman.
Chairman DODD. Thank you.
Senator Menendez.
Senator MENENDEZ. Thank you, Mr. Chairman. Thank you,
Chairman Bernanke, for your testimony and your successful.
I want to visit with you on the housing issue. In March of 2007,
you said that, "The impact on the broader economy and financial
markets of the subprime market seems likely to be contained." And
I assume you would want to change that statement today somewhat, amend it, with the ability of 20/20 hindsight.
What do you think in the housing crisis, do you see it hitting
rock bottom this year? A year from now? Because this is one of the
significant challenges within the economy. What do you see on the
horizon?
Mr. BERNANKE. Well, first, of course, I would like to revise and
extend my remarks from March of 2007. The issue was that the
subprime crisis triggered a much broader retreat from credit and
risk taking, which has affected not just subprime lending but a
wide variety of credit instruments. And that is why it has become
a much bigger element in the situation than, frankly, I anticipated
at that time.
14
The housing market is still under considerable stress and construction is still declining. I do believe that we will start to see stabilization in the construction of new homes sometime later this
year or the beginning of next year, and that will be a benefit because the slowing construction pattern has been subtracting about
1 percentage point from the growth of the GDP going back now for
some time. So that will be a benefit.
House prices may continue to fall longer than that because of the
large inventories of unsold homes that we still face. And then I
would have to say that there is uncertainty about exactly what the
equilibrium level that house prices will reach is. Unfortunately, it
is that uncertainty, which is generating a lot of the stress and risk
aversion we are seeing in financial markets.
It is for that reason—the need to find a footing, to find stability
in the housing market—that I do think that action by this Congress to support the housing market through strengthening the
GSEs and FHA and so on is of vital importance.
Senator MENENDEZ. Let me talk about the other major driver,
then, of what is happening to our economy, and that is the whole
question of energy prices and oil. You know, I appreciate in your
answer to the Chairman and in your testimony, because we have
had testimony before the Congress by all executives who say that
the difference between supply and demand over the last 2 years
would largely lead us to a concern that, in fact, speculation may
have driven the price of oil up an additional $50 a barrel. You have
the view that that may not be the most significant thing in prices,
but you do take the view that useful steps can be taken to improve
the transparency and functioning of future markets.
Are you ready to say to the Committee today what some of those
useful steps are? Or are you still depending upon that Committee
that you are meeting with to look at that? Because we do not have
a lot of time here.
Mr. BERNANKE. Senator, this is really the CFTC's function and
responsibility. We are trying to assist them, and we are trying to
work as quickly as possible to gather information and try to make
some useful recommendations.
Senator MENENDEZ. Well, many of us believe we need to pursue
market speculation now as a critical element of helping to drive
down particularly gas prices. Let me ask you this: There is one
thing squarely within your realm, and that is the question of a
weaker dollar.
In 2000, we ran a budget surplus. Ever since then, the Federal
Government has been running up larger budget deficits. We added
to that a $1.6 trillion tax cut and a $700 billion war that would
generally contribute to a larger budget deficit. And if you look at
that and you look at the twin deficits of both trade and the budget
in combination, you have a low—with a low domestic savings rate,
you have all of the makings of a weakening dollar.
In 2002, the barrel of oil cost $23 and 23 euros. Now it costs—
well, the Chairman had even a higher figure than I had. I had
$145 and 90 euros. I am sure it just changed overnight.
Do you agree with the Commodity Futures Trading Commission
and others that the weakening dollar has contributed to the higher
price of oil as an elemental part of our challenge?
15
Mr. BERNANKE. I do agree, and I said so in my testimony. It
should be noted that the decline in the dollar from 2002 reversed
an appreciation of the dollar that had taken place from the early
1990s until that point. And it is related to the dynamics of our
trade deficit, as you alluded to.
In the late 1990s and early 2000s, strong capital inflows drove
the dollar up, but that made up less competitive and created a
trade deficit. Some of that has to be unwound to bring us back toward a better balance of trade, and, in fact, we had been seeing
considerable improvement in our balance of trade as the dollar reversed that increase. But we also import a lot of oil, and because
we import it, when oil prices rise, that also works in the other direction. It tends to hurt the dollar. So there is really causality
going in both directions.
Senator MENENDEZ. Thank you, Mr. Chairman.
Chairman DODD. Senator Bennett.
Senator BENNETT. Thank you very much, Mr. Chairman.
Welcome, Chairman Bernanke. I have the same kinds of questions everybody has with respect to the deal made over the weekend for Fannie and Freddie, but I will save those for the next
panel.
Let's talk about your forecast. The GDP for the first quarter was
originally forecast at six-tenths of 1 percent and then nine-tenths
of 1 percent and then at 1-percent growth. It has always been
raised as the data come in. We have had a bear signal on the Dow
theory. I don't know whether you follow that or not, but there has
been a lot of that in the newspapers, which I know you do follow
that. Whether you believe the Dow theory or not, you follow it. I
don't know whether you believe it or not. That is a separate issue.
But, nonetheless, we have got a bear signal that says we are now
in a bear market, which historically lasts for anywhere from 18 to
24, 30 months, something of that kind.
The blue chip forecast for the second half has always been for
growth—slow to be sure, relatively low to be sure, but for growth.
And in your previous appearances before the Committee in this
kind of a context, you have pretty much been in that same territory. Are you still there?
Mr. BERNANKE. Well, as your point about the first quarter makes
clear, even after the fact, it is sometimes hard to know exactly how
much growth there was. Yes, our forecast calls for growth in the
second half, but relatively weak. Part of what seems to have happened is that perhaps the fiscal stimulus or other factors—some of
the growth that we anticipated—has been pulled forward into the
second quarter, which looks to be doing somewhat better, frankly,
than we anticipated. So our forecast
Senator BENNETT. YOU mean pulled forward into the first quarter?
Mr. BERNANKE. NO. TO the second quarter, the current—the
quarter that just ended.
Senator BENNETT. Oh, yes. All right. I am second half so that
is—OK. Right.
Mr. BERNANKE. SO the second quarter appears to be actually better than expected, and, therefore, our forecast for the entire year
might actually be stronger than it was earlier. But with that
16
strength having been brought forward to some extent into the second quarter, we are looking at the remainder of the year as being
probably positive growth, but certainly not robust growth.
Senator BENNETT. The one thing the markets hate more than
anything else is uncertainty, and I have the feeling that that is
part of the problem with respect to oil prices and part of the problem with respect to the housing market.
Now, you have suggested that the housing market might stabilize over the next 6 to 12 months so that people will begin to say,
OK, we have now reached bottom and we are starting to build back
up again. Do you feel that the deal that was made over the weekend with Fannie and Freddie can help eliminate some of the uncertainty and cause people to have a greater degree of confidence that
the timeframe that we have been talking about will indeed come
to pass?
Mr. BERNANKE. Well, Senator, no deal was made. All that was
done was a proposal was made to bring to Congress
Senator BENNETT. I am using newspaper talk. I realize that is
always a mistake.
Mr. BERNANKE. But as I said earlier, I think the housing sector,
together to some extent with oil, is at the heart of the current uncertainty, the current situation. I think were it to happen that
there would become a general view that the housing situation had
stabilized, you would see actually a very strong bounce-back in the
economy and the financial markets, and it is the uncertainty about
when that happens that remains a problem.
Again, it is the Congress' prerogative to decide what to do about
the GSEs and other housing-related legislation. But as I tried to
indicate before, I think the best thing that we can do to remove
this uncertainty and to speed the recovery is to make sure that the
housing market and the mortgage finance markets are functioning
as well as possible.
Senator BENNETT. Yes, but very specifically, taking away the
word "deal"—and I agree with you that even though that is the
word we have seen in the press, that is probably not the right
word. But the structure that you have agreed to in terms of some
kind of a back-up for the GSEs, should they get in trouble, do you
have the feeling that the announcement of the terms of that structure should remove some of the uncertainty with respect to their
future?
Mr. BERNANKE. Yes. I think right now that, in fact, part of the
reaction in markets has to do with the uncertainty about exactly
what the deal, as you call it, might look like. So if there is clarity
which provides assurances that the GSEs will have the financial
strength they need to support the mortgage market, and, second,
as Senator Shelby emphasized, there is also a very strong regulator
that will protect the system and protect the taxpayer, the combination of those two things would be very constructive.
Senator BENNETT. I think we know about the regulator. It is the
other thing that people are waiting to find out about.
Mr. BERNANKE. I think so, Senator, because right now the GSEs
are a very big part of the U.S. mortgage market.
Senator BENNETT. Thank you very much.
Chairman DODD. Senator Casey.
17
Senator CASEY. Mr. Chairman, thank you very much, and, Chairman Bernanke, I want to thank you for your presence here today
and for your testimony.
We have had the opportunity to question you on a number of occasions, I probably more than most because not only am I Member
of this Committee but I am also a Member of the Joint Economic
Committee, and we are grateful, again, for your testimony today.
I wanted to review just some of the basic data, some of which you
were kind enough to put in your statement today in terms of where
we are economically in this country. It is, to use an old expression
from the 1970s, a "misery index," a "tale of woe," but I think it is
important to remind all of us kind of where we are.
You cited on page 3, I guess, of your testimony the average pace
of 94,000 jobs per month lost through June. If you look at it another way, just in terms of real GDP, the growth rate over the last
couple of years—I had not seen these numbers until recently—
2005, 3.1-percent growth, "only" I should say; 2006, 2.9; 2007, 2.2;
and then the first quarter of 2008, as was cited earlier, 1 percent.
The total job loss the last 6 months, 438,000. You look at the trade
deficit just with China alone, that went up even though the overall
trade deficit went down. Foreclosures, 8,400 to 8,500 families per
day, if you look at just weekdays, entering foreclosure. The projection by Treasury for foreclosures for 2008 is at some 2.5 million.
The prices report—there is a story today, a brief story in the New
York Times, I guess online, sales of retail goods and food grew just
0.1 percent in June. Consumers spent a large amount of money on
one product. Of course, gasoline we know, have heard an awful lot
about that. But outside of fuel, sales actually dropped last month
by 0.5 percent.
All of that is background, of course, to two basic questions I
wanted to ask you, one of which I have asked and you have answered over the course of many months in your appearances here.
The first question pertains to the difference between the real
world of the impact of this economic crisis on families versus the
economist's definition of "recession." And I think, frankly, the old
definition or the textbook definition of "recession" does not apply
when it comes to what families are up against.
And I think it was probably said best, not by a set of the data
points I just read and not by any economist, recently in a story in
the Centre Daily Times in Pennsylvania, in Centre County, Pennsylvania, "Tammy May, a single mother of two in Pleasant Gap,
Pennsylvania, probably said it best in just one line"—and I am
quoting her. She is a single mother of two. "Pretty much we have
reprioritized. The house payment is first, then day care, then we
worry about gas, then food." Food is number four.
So I would ask you, in light of that economic misery that I have
just highlighted, and in light of your own testimony, your own
work, and I think your own sensitivity to these issues, how do we
deal with this question of what is a recession and what it isn't, and
do we need some new definitions and some new terminology to better define what is happening to real families and real people?
Mr. BERNANKE. Well, there is a technical definition of recession
which has to do with behavior of employment and investor production and other things, and that is a determination that is made by
18
some economists after the fact. I don't know whether they will determine we have been in a recession or not according to these technical definitions, but I agree with you entirely that whether it is
a technical recession or not, the combination of declining wealth,
weak job market, rising food and energy prices, foreclosures, tight
credit—all those things are putting tremendous pressure on families and explain why consumer sentiment is very low. People are
very worried.
So I certainly would never make the claim that even if we were
not in a technical recession that it was not a serious situation. And
I just want to assure you that everything the Federal Reserve does
is intended to try to promote the welfare of the average American,
and that is our objective.
Senator CASEY. Thank you. I think I am out of time. I will go
to the next question on the second round.
Thank you.
Chairman DODD. I think Senator Bunning, I believe—no, excuse
me. Senator Allard. I apologize.
Senator ALLARD. Thank you, Mr. Chairman.
Welcome to the Committee. I always look forward to hearing
your comments, Chairman Bernanke. Business lending has—I
want to talk about that a little bit, and a big aspect of business
lending historically, I am told, has been that business plans and
their ability to execute those business plans has been a big factor
in assessing credit and whether they get a loan or not. I am told
that in recent history that has been minimized considerably.
First of all, I would like to know if that is true. And the other
question, if it is true, do you think we could help confidence if we
had provisions that somehow or the other brought more accountability to the business plan aspect when you apply for a loan?
Mr. BERNANKE. Well, there is a general tightening in credit and
tightening in underwriting standards, you know, related to this
pullback from credit risk in general. It has affected different groups
differentially. For example, prime corporate borrowers are still able
to access the bond market and the loan market pretty effectively.
Riskier firms, smaller firms, are having more difficulty accessing
credit.
I think that I would encourage banks to continue to make sound
loans, and we at the Federal Reserve will not penalize banks that
are making sound loans. We want them to extend credit. In assessing how to make a good loan to a business, certainly there are
many factors, including financials and personal relationships and
many other things, but the business plan is certainly an important
part and one that a good bank lender would look at.
Senator ALLARD. YOU have assumed, meaning the Fed has assumed, a great regulatory oversight authority recently here. Are
you comfortable with that? And do you anticipate that you may
even take on a greater regulatory role?
Mr. BERNANKE. We have begun to work with, as you know, the
Securities and Exchange Commission, who are the primary regulator. We have been working with them to help evaluate and oversee the four large investment banks and the other primary dealers.
That is because of the lending facility that we opened up after Bear
Stearns. We have a responsibility to protect our loans, and I be-
19
lieve that the SEC views our participation as helpful in trying to
make sure that these firms are sufficiently strong.
It remains to be seen how the Congress would like to think
through regulation going forward. I do think that the investment
banks need a consolidated supervisor, but have not proposed a particular agency to do that. The key issue is that they have strong
consolidated supervision. The only area in which I have raised the
possibility of additional powers for the Federal Reserve—in my testimony and in speeches—is in payment systems, which are systemically important and where in most countries central banks have
considerable oversight responsibility.
I think it would be useful for the Congress to review how payment and settlement systems are overseen and to ask whether,
from a systemic point of view, they are adequately regulated and
whether the Fed should have some additional role in that area.
Otherwise, we are going to have to do a lot of thinking, all of us,
and certainly the Congress, about how, if at all, the regulatory
structure should change based on what we have learned in the last
year.
Senator ALLARD. Some of the discussions I have been involved in
have said that if the Fed assumes a greater regulatory role, it could
affect your independence. And I would like to hear you comment
on that as acting in your current role.
Mr. BERNANKE. Well, the way Congress wants to organize the
regulatory structure is an important question that needs to be
worked out, and I am not asking for any change at this moment.
However, the Federal Reserve has a wide range of responsibilities,
including not only regulatory oversight but also consumer protection, payment systems, and other things. The independence, which
is critical, is the independence vis-a-vis monetary policy. And I
think we have been able to keep a good separation between monetary policy and these other areas. In these other areas, we are an
independent agency, but we have no stronger claimed independence than, say, the OCC would. It is only in monetary policy where
we need to maintain a strict independence, you know, in order to
make the right decisions.
Senator ALLARD. I noticed on some of the projections into 2009
that they seem pretty positive—that they are better than what we
are looking at this year, generally. What part of the economic sector do you see will continue to struggle? And where do you see that
growth to improve our economy as we move into 2009?
Mr. BERNANKE. Well, first of all, there are some factors which
have been positive and continue to be positive. Foreign trade exports have been a very positive factor and have contributed significantly to our growth, and as that continues, that will be a basis
to build on.
I mentioned already the home-building sector. That has already
declined quite substantially. It is very likely going to begin to level
out somewhere around the end of the year. That leveling out will
also provide additional strengths, at least in the sense of not subtracting from the GDP growth.
As the situation begins to stabilize and credit markets begin to
stabilize, then I think confidence will return to consumers, and we
will see the beginnings of a recovery. But as I noted and as every-
20
one has made allusion to, the uncertainties of the exact timing of
this are still great.
Senator ALLARD. Thank you, Mr. Chairman.
Chairman DODD. Thank you.
Senator Tester.
Senator TESTER. Thank you, Mr. Chairman. Thank you, Chairman Bernanke.
In your statement, you said the world economy was growing at
the fastest pace in decades. I believe that is what you said. Do you
anticipate that to continue or to decline?
Mr. BERNANKE. I think that this year and going into next year,
we probably will see some moderation but still healthy growth.
Senator TESTER. SO do you think that those impacts, if it backs
off some, will have positive or negative or no effect on our financial
situation?
Mr. BERNANKE. Well, it cuts two ways. On the one hand, it might
weaken to some extent the contribution of exports and trade to our
growth. But, on the other hand, if these other economies cool down,
it might reduce commodity prices or flatten out commodity prices,
which would be very beneficial.
Senator TESTER. DO you anticipate overall negative, positive, or
pretty static in its effect?
Mr. BERNANKE. Sorry?
Senator TESTER. I know it is a two-edged sword, but do you anticipate it will be positive, negative, or negligible?
Mr. BERNANKE. I think it will be probably positive if it contributes to a slowing in commodity prices.
Senator TESTER. YOU talked about the long-term oil supplies are
down. I believe that is what you said.
Mr. BERNANKE. Well, not rising.
Senator TESTER. IS that domestically, worldwide, or both?
Mr. BERNANKE. Well, certainly oil supplies are declining in the
United States. Worldwide, they have been relatively flat.
Senator TESTER. OK. Senator Menendez talked about the dollar
and the value it has on oil. Does the budget deficit have any effect
on the value of the dollar?
Mr. BERNANKE. Perhaps a weak effect, but I don't think it is a
first-order effect. The linkage between the budget deficit and the
trade deficit is there because the trade deficit does reflect our national savings and investment imbalance. But, empirically, the effect is relatively weak under most circumstances.
Senator TESTER. And the value of the dollar has devaluated by
about 40 percent—is that correct?—over the last 4 or 5 years.
Mr. BERNANKE. NO. I think it is more like 25 percent. And,
again, it has reversed a considerable appreciation prior to that
peak in 2002.
Senator TESTER. Are you comfortable with where the dollar's
value is now?
Mr. BERNANKE. I am looking for the economy to strengthen next
year, and as it does, I think that will support a strong dollar going
forward.
Senator TESTER. DO you anticipate it—OK. That is fine.
Is there anything that you see on the horizon that could impact
the credit rating for the Treasury?
21
Mr. BERNANKE. NO, I don't. In the very long term, or even the
medium term, we need to address these large issues of entitlements and the aging population, and there are tremendous challenges involved there. I don't think anything in the next short period of time, including issues related to the GSEs, for example,
would affect the credit rating. That is my understanding, for example, based on statements that some credit raters have made.
Senator TESTER. And we will get into this in the next panel, but
what you are saying is that even if we don't do anything with the
bill that is being proposed on the GSEs, you don't think that could
have any negative impact on the credit rating?
Mr. BERNANKE. If we don't do anything?
Senator TESTER. If we don't do anything, if we just let it play
out.
Mr. BERNANKE. NO, I don't think so. I don't think it would, no.
Senator TESTER. OK. You stated earlier in your testimony that
the housing is really kind of the root of what we are seeing, the
housing contraction. From my perspective, we have kind of gone
into a credit economy. Do you see that as being another part of this
equation that is kind of a boat anchor on our economy, that we are
making adjustments out of this? Or do you anticipate we are going
to be in this, what I would say is a credit economy, from now on?
Mr. BERNANKE. Well, a part of what has been happening—and
this goes back to Senator Menendez's question about the role of the
subprime crisis and so on—is that there was, if you will, a credit
boom or a credit bubble where there was an overextension of credit
in a lot of areas. There has been a big reversal of attitudes. Banks
and other financial institutions are scaling back on their credit
risk. They are deleveraging. They are raising capital. And that adjustment process is part of what is happening now that is creating
the drag on economic growth. So it is harder to get a mortgage, it
is harder to get a business loan. And until we come to a more stable situation where banks are comfortable with their credit standards and their balance sheets, the leveraging process is going to
continue and is part of what we are seeing here.
Senator TESTER. And very quickly, because my time is over, do
you—I mean, we have heard figures of 150 banks potentially going
down because, I assume, of this adjustment that you just talked
about. Do you guys have any projections on what kind of impact
banking institutions going down, how many there potentially could
be in the next year or do you not want to comment on that?
Mr. BERNANKE. I think I would just refer you to Chairman Bair's
list and discussion from the last couple of days. We don't have a
projection.
Senator TESTER. HOW many are on that list?
Mr. BERNANKE. About 95, as I recall. As I said, I think the banking system came into this episode with good capital basis and with
strong earnings.
Senator TESTER. OK. Thank you, Mr. Chairman. I appreciate
that. Thank you.
Chairman DODD. Thank you very much.
Senator Bunning.
Senator BUNNING. Thank you, Mr. Chairman. Since I did not
give an opening statement, I want to give an opening statement in
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all deference to Chairman Bernanke. I know we have a lot of
ground to cover today, but I want to say a few things on the topic
of this hearing and the next.
First, on monetary policy, I am deeply concerned about what the
Fed has done in the last year and in the last decade: Chairman
Greenspan's easy money in the late 1990s and then followed the
tech bust, inflated the housing bubble, and created the mess we are
in today. Chairman Bernanke's easy money in the last year has undermined the dollar and sent oil prices to a new high every day,
and an almost doubling since the rate cuts started. Inflation is here
and hurting us and the average American, and it was brought out
very clearly by the Senator from Pennsylvania.
Second, the Fed is asking for more power, but the Fed has proven they cannot be trusted with the power they have. They get it
wrong, do not use it, or stretch it farther than it was ever supposed
to go in the first place. As I said a moment ago, their monetary policy is the leading cause of the mess we are in. As regulators, it took
until yesterday to use the power we gave them in 1994 to regulate
all mortgage lenders. Then they stretched their authority by buying
$29 billion worth of Bear Stearns assets so JPMorgan could buy
Bear Stearns at a deep discount.
Now the Fed wants to be a systemic risk regulator, but the Fed
is a systemic risk. Giving the Fed more power is like giving a
neighborhood kid who broke a window playing baseball in the
street a bigger bat and thinking that will fix the problem.
I am not going to go along with that, and I will use every power
in my arsenal as a Senator to stop any new powers going to the
Fed. Instead, we should give them less to do so they can get it
right, either by taking their monetary responsibility away or by requiring them to focus only on inflation.
Third, and finally, since I expect we will try to get it right to
question the next hearing, let me say a few words about the GSE
bailout plan. When I picked up my newspaper yesterday, I thought
I woke up in France. But, no, it turned out it was socialism here
in the United States of America, and very well, going well. The
Treasury Secretary is now asking for a blank check to buy as much
Fannie and Freddie debt or equity as he wants. The Fed purchase
of Bear Stearns assets was amateur socialism compared to this.
And for this unprecedented intervention in our free markets, what
assurance do we get that it will not happen again? Absolutely none.
We are in the process of passing a strong regulator for the GSEs,
and that is important. But it allows them to continue in the current form. If they really do fail, we should let them go back to what
they were doing before? I doubt it.
I close with this question, Mr. Chairman. Given what the Fed
and Treasury did with Bear Stearns, and given what we are talking about here today, I have to wonder what the next Government
intervention into the private enterprise will be. More importantly,
where does it all stop?
Thank you.
Chairman DODD. Do you want to respond to that, Mr. Chairman?
[Laughter.]
23
Chairman DODD. Senator Bunning just does not have any strong
views on these matters. I wish he would be more clear in the future
when he speaks.
Mr. BERNANKE. Well, I think some of the problems with the
GSEs that you allude to were pre-existing. I mean, the moral hazard issue, the Government implicit guarantee, those
Senator BUNNING. We tried to pass a bill. We could not get it
Mr. BERNANKE. And I agreed with
Senator BUNNING. We passed it here.
Mr. BERNANKE. And I agree with you.
Senator BUNNING. And it got stuck between here and the floor
of the Senate.
Mr. BERNANKE. And I agree with you on that. As far as powers
are concerned, as I mentioned earlier, I think we ought to review
the payment system issue which is something that other central
banks have. But I have not asked for any other powers.
Thank you.
Chairman DODD. Very good.
Senator Reed.
Senator REED. Thank you, Mr. Chairman.
You indicated in your opening statement that in this economic
turmoil the banking system is approaching it with good capital levels. Your estimate is based upon not just their balance sheet, but
their off-balance-sheet arrangements. I understand there are new
anything rules that will shortly be enacted that will require much
more recognition of off-balance-sheet activities. Have you looked at
the fully diluted value of the balance sheets? And can you still
make that assessment?
Mr. BERNANKE. I don't think we have done a full assessment.
Those rules are yet to be clarified, and I think it may well be some
time before they are enacted. At such time we will obviously think
hard about how it affects those ratios.
Senator REED. But you are beginning to consider much more, I
hope, focus on some of these off-balance-sheet
Mr. BERNANKE. Oh, certainly. For a long time we have been
aware of those off-balance-sheet vehicles. There were some things
we did not appreciate. I think one of the issues we did not fully
appreciate was what is referred to sometimes as the moral recourse
issue, which is that off-balance-sheet vehicles, which are not technically owned by the bank, nevertheless the bank feels for
reputational reasons it needs to assume them in a difficult period.
We have been thinking about the capital requirements in those
kinds of contexts. But we have certainly been quite attentive to offbalance-sheet vehicles, very attentive in particular since this crisis
began in August.
Senator REED. Let me refer to another issue in your statement.
You indicated that one of the contributing factors to the present increase in oil prices is the lack of investment over the last several
years. Now with oil at extraordinarily high prices, one would think
in a simple market model that investment would be accelerating
rapidly.
Is investment in new drilling and new production and new refining, is that taking place?
24
Mr. BERNANKE. In some places, but not to the extent you might
think. Part of it is bottlenecks in the materials and manpower and
expertise that goes into drilling and development. Part of it is the
fact that a large share of the world's oil is controlled by national
governments who may not have the same immediate profit motives
as a private driller might have. In particular, some countries prohibit foreign technology or foreign investment in their oil production. So there are these political constraints as well that have been
affecting the supply as well as economic bottlenecks and other
problems.
Senator REED. IS there a lack of adequate fields to exploit worldwide? Is that one of the significant factors?
Mr. BERNANKE. Well, experts have some disagreement over this,
but in terms of proved reserves, there seems to be adequate oil in
the ground. It is really a question of exploiting it.
Senator REED. YOU indicated that in terms of speculation, that
was not a significant factor, but you are, with the CFTC, looking
into the issue of possible speculation. And I am getting into dangerous ground. You are an economist and I am not. But it would
seem to me this is a market that would be ripe for speculation. Demand is highly inelastic. Price signals are blunted in many countries because of subsidies. Is that your understanding of the market, that there is an opportunity at least for speculation in this
particular market for oil?
Mr. BERNANKE. Well, there is speculation, but speculation under
most circumstances is a positive thing. It provides liquidity and allows people to hedge their risks. It provides price discovery. It can
help allocate oil availability over time, depending on the pattern of
futures prices and so on.
What is really a concern—what the CFTC, for example, is concerned with would be manipulation as opposed to speculation.
Senator REED. Well, I will use the term "manipulation" in the
same situation.
Mr. BERNANKE. And as I said, you know, transparency and data
collection are important aspects of assuring there is no manipulation. But given the enormous size of this market, it is quite a difficult market—would be quite a difficult market, I would think, to
corner.
Senator REED. Thank you. My time is about to expire.
Thank you, Mr. Chairman.
Chairman DODD. Thank you very much, Senator.
Senator Dole.
Senator DOLE. Chairman Bernanke, in December of last year
Chairman DODD. Senator, would you just postpone for 1 second?
What I am going to do here with Members, by the way, is several
Members who have already asked questions have gone to vote, and
they will come right back. And this way we will try and keep going.
If there is going to be a minute or two before you get to question,
I suggest you go vote and come back. We are not going to interrupt.
I want to give everyone a chance to get one round in on this before
we move to our larger panel.
Senator Dole, please.
Senator DOLE. In December of last year, Attorney General
Cuomo of New York entered into an agreement with Fannie Mae,
25
Freddie Mac and OFHEO to create a mortgage appraiser code of
conduct. While everyone appreciates the goals of this agreement,
the code leans heavily toward inconsistent and potentially counterproductive regulation of the lending industry and, if implemented
poorly, could actually increase costs of obtaining appraisals and
slow down the process of obtaining appraisals.
Recognizing that the current settlement recommendations are inconsistent with current appraisal regulations and guidelines issued
by the FFIEC Subcommittee on Appraisals, what are you doing to
ensure that implementation of the code of conduct does not further
disrupt the current housing and mortgage crises on federally regulated banking institutions? What can you do?
Mr. BERNANKE. Senator, as I understand, the agreement requires
acceptance by the FFIEC, by the bank regulators, and so we are
currently looking at it, and we do want to make sure that it does
not prevent banks, for example, from using their own appraisers in
situations where they need that information to make a good appraisal. And we want to make sure it does not impose excessive
costs—there are already guidances by the regulators about how to
do appraisals which already exist for banks. And we think those
are pretty good, and we want to make sure there is no inconsistency. So we are looking at that, but we want to be particularly
careful about some of the issues that you have just raised.
Senator DOLE. AS you are aware, the FDIC gathers and monitors
various bank performance data for its member institutions as part
of its regulatory oversight, and this is on a quarterly basis, of
course. Ending with this most recent data collection period, the end
of the first quarter of 2008, the FDIC's data indicates that banks
in North Carolina are on fairly good footing relative to its peer
group nationally. But the report did show the number of unprofitable financial institutions with a market cap under $1 billion in my
home State increased from the previous quarter, while the national
numbers actually improved.
My question for you is whether the Fed currently reviews the
performance of smaller financial institutions such as community
banks as a proxy for the health of the local economy in which they
served. And if so, how does this information factor into Fed policy?
Mr. BERNANKE. Senator, we absolutely do look at community
banks. We have a regulatory responsibility for State member
banks, which include many, many small banks that we oversee in
conjunction with the State regulator or with the FDIC. There are
many benefits of our regulation of those banks in terms of what we
learn, but, in particular, as you point out, small banks have their
fingers on the pulse of the local economy, and they can provide us
a lot of useful information about what is happening. And for the
same reason, we are required to have bankers on the boards of the
reserve banks around the country so that we can gather information from them and benefit from their insights.
Senator DOLE. Thank you very much, Mr. Chairman.
Thank you.
Chairman DODD. Thank you, Senator Dole.
Senator Brown.
26
Senator BROWN. Thank you, Mr. Chairman. Chairman Bernanke,
thank you. Nice to see you again, and thank you for your public
service.
I appreciate the Fed has finalized its regulation for some prime
mortgage lending. In my view, as you know, this comes, especially
in a place like Ohio, several years too late. Hindsight, of course, is
near perfect, but there were lots of voices and warning signals trying to get the Fed to act both here in Washington, also at places
like the Cleveland Fed and elsewhere.
First of all, I appreciate the refreshingly different approach you
have to this job and to this issue than that of your predecessor. I
think that is very good for our country. But there is a certain cynicism in the public at large how, when Bear Stearns gets in trouble,
when Fannie and Freddie get in trouble, that you act, that Congress acts, the Treasury Department acts, but we do not act so
quickly, neither the regulatory system, the Fed, the Congress act
so quickly in protecting the public and the issues that Senator
Casey, the story Senator Casey brought up.
Tell me what steps we need to take, and you need to take especially, to get the same rapid response for consumers, for consumer
protection, that we have achieved, if you will, with Bear Stearns
and with Fannie and Freddie.
Mr. BERNANKE. Well, Senator, first, although I know it is not always easy to explain, our actions, as I said earlier, with respect to
Bear Stearns, with respect to Fannie and Freddie, with respect to
the financial system in general are based on our view that financial
stability is critical to economic stability. I think the benefit is more
obvious to the average person from Fannie and Freddie because
they, after all, are providing liquidity for mortgages, and people
want to be able to have access to mortgages. So I just do not accept
the distinction between helping Wall Street and helping Main
Street. The actions we have taken are aimed at supporting the
overall economy and helping the average American.
With respect to your question, I agree that there was a delay in
recognition of this issue. Once we undertook it, though, we had to
go through a regulatory process that involves developing regulations, putting them out for comment, re-evaluating them and so on.
There is a natural period of time. I think that is probably a good
thing in the sense that we want regulations to be well thought out
and so on. But to the extent that Congress wants to act more
quickly or is concerned about the constraints on the agency's powers given to them by their enabling legislation, Congress, of course,
can act very quickly if they need to.
Senator BROWN. While I do not oppose your actions on what we
are going to try to do with Fannie and Freddie, and I think we did
what we had to do with Bear Stearns, I think there is a perception,
and probably a reasonable perception, a deserved perception, that
our Government, whether it is regulatory process or the Congress,
is much more apt to move quickly on Wall Street when we do not
move so quickly on Main Street. Granted, you had to go through
a process, and as I say, I think you are refreshingly different from
your predecessor. But what can you do to speed that up so the public really can be assured that while it does make sense for the economy as a whole, which helps everyone on Main Street, too, doing
27
the right thing with Wall Street, but it is pretty clear that when—
and the Bush administration really did not seem to think there
was a subprime crisis until it spread to Wall Street. When it was
just Main Street, Mansfield, and Main Street, Zanesville, it did not
seem to be much of a problem.
Mr. BERNANKE. Well, we just have to do a better job, first of all,
monitoring what is going on. The Treasury Secretary had an interesting idea. The mortgage origination commission, I think it was
called, would be evaluating the quality of the State regulators to
make sure that State-regulated institutions were being adequately
supervised. So that is one possible suggestion. But in a way of
keeping better tabs on what is going on, we need to be more vigilant, and we need to be as effective and rapid as possible in promulgating good regulations. But, again, the legal process and our
responsibility to do a good job means that we cannot produce the
regulations in a month. It really does take some time for us to do
all the work, including one thing we have done at the Fed, which
is a lot of consumer testing, to make sure that people understand
disclosures, for example. We think we get more effective regulation
that way.
Senator BROWN. Does the Fed have a mechanism to listen better
to the regional—when the Cleveland Fed feeds you information
about a problem that may come to Cleveland before it comes to
New York or before it comes to Chicago or Los Angeles, do you feel
like the Fed here is listening to places like Cleveland the way that
you should?
Mr. BERNANKE. Absolutely. The 12 reserve banks around the
country were created to make sure that the Fed always had a national constituency, that it always listened to the concerns of the
whole country and not just the financial sector, and that works
very effectively. We do have a lot of input from reserve banks and
their boards, their advisory councils, their contacts. And related to
my reply to Senator Dole, those kinds of contacts are useful in a
macroeconomic monetary sense, but also in a regulatory sense as
well.
Senator CARPER [presiding]. The Senator's time has expired.
When Senator Martinez returns, it will be his time to ask questions, but until he does, I am going to ask a few of my own. Welcome, Mr. Chairman.
I was reflecting. How long have you been Federal Reserve Chairman now?
Mr. BERNANKE. Two-and-a-half years.
Senator CARPER. Does it seem that long?
[Laughter.]
Mr. BERNANKE. About that long.
Senator CARPER. Did you ever imagine in your wildest dreams
that the Federal Reserve would end up being called upon to do the
kinds of things you have done in recent months? I remember when
you were going through your confirmation hearing, we focused, as
I recall, on just what should be the right rate of inflation, kind of,
if you will, the window or the limits for the rate of inflation. I do
not think we ever asked you whether or not the discount window
should be made available to investment banks. I do not think we
ever asked you if the discount window should be made available to
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Fannie or to Freddie. I do not think we ever asked you about trying
to arrange the marriage, if you will, of JPMorgan Chase with Bear
Stearns.
All that stuff has just come along, and I want to commend you
and those with whom you serve, those who you lead, for the way
you have responded, and quickly, thinking outside the Box, and
trying to help us through all of this. I thought you said a great
truth in terms of where we want to position ourselves as we come
out of this fall. We have seen this drop in housing values, and I
think part of what is going on here in our economy today is the
loss of confidence you have alluded to. We have seen a loss of home
equity, and a lot of us in this country have treated the equity in
our home as a piggy bank, and the wealth effect that we derive
from that, and couple that with going up to the gas pump and
spending $80 or $90 to fill up the tank of our vehicles—I think the
two of those together has a dramatic negative effect on our confidence in this country and has sort of led to it.
One of the questions you were asked earlier—and I want to follow up on it—was: Where do we want to be when we bottom out?
Eventually, we will bottom out. There are a lot of people who are
renting today that are not buying, but eventually they are going to
want to get in. They are going to want to be homeowners. What
are the things that we need to be doing to make sure that when
they are ready to move, when they think that we have come to the
bottom and prices are starting to go back up? Just say again, how
do we want to plow the field, how do we want to prepare the field
in terms of a mortgage market and in terms of housing markets?
And you have said some of this already. I just want you to re-emphasize it, please?
Mr. BERNANKE. Well, of course, fundamentally the market will do
it. The free market will do it. But there are things that we can do.
The Federal Reserve has already tried to address, some of the regulatory aspects of high-cost mortgage lending. We and our fellow
regulators are also looking at the treatment of mortgages by banks
and other lenders in terms of their capital and how they manage
that. I think the banks and the private sector themselves are rethinking the standards, the underwriting standards, the loan-tovalue ratios, those sorts of things as they go forward.
So, I anticipate that we will have a healthy recovery in the housing market once we have gone through this necessary process. But
it will probably be less exuberant than we saw earlier with somewhat tougher underwriting standards, more investment due diligence, probably less use of securitization or complex securitized
products. But I am confident that, with the appropriate background—I probably include here the GSEs and FHA—the housing
market will recover, and it will help be part of the economy's return to growth.
Senator CARPER. One of my colleagues asked you earlier about
the drop in the value of the dollar and asked you quantify that. I
will not ask you to do that again. But we have seen the dollar drop,
whether it is 20 percent or 30 percent or some other number. We
have seen exports, conversely, rise, but yet we have seen a continued loss in manufacturing jobs in this country. I think the last
29
month I noticed maybe 30,000 or 40,000 additional manufacturing
jobs had been lost.
When do we see that turn around? And what do we need to do
to turn it around, the loss of manufacturing jobs, that is?
Mr. BERNANKE. Well, there has been an ongoing loss of manufacturing jobs even during periods of growth in production because the
U.S. manufacturing sector is enormously productive and its productivity has been growing more quickly than the rest of the economy.
And so even when output is growing—and we have some of the
best growth and the highest productivity growth in manufacturing
of any industrialized country—because of the high productivity
growth, you need fewer workers to make the same amount of output.
Now, one thing that has certainly been clear, and we have seen
in the U.S. manufacturing over the last few years, is an increasing
emphasis on sophisticated high-tech exports, including capital
goods and so on. And what I hear from manufacturers is that they
have plenty of low-skilled workers, but what they need are workers
with high skills—not necessarily a college degree, but with skills,
like welding and machine work and so on. And, in fact, the number
of skilled manufacturing workers has actually been rising, not falling.
So I think the future for us is to continue to go to more and more
sophisticated manufacturing products, but to support that and to
make sure there are good jobs associated with it, we need to have
the training and education that will provide the workforce that is
consistent with that.
Senator CARPER. The last question that I have deals with just to
follow up on the drop in the value of the dollar. The hearings that
we have had in this Committee and other committees that I have
participated in suggest there are three major factors driving up the
cost of oil. One of those is the laws of supply and demand. Nations
are pretty much holding their output level. Demand is rising. There
has been—we discussed the drop in the value of the dollar and the
effect that that has had. The third factor that we keep coming back
to is the role that speculation is playing. We touched on this at
least indirectly here today. Just give us some advice. I think we are
going to debate, seriously debate, probably before the beginning of
next month, legislation dealing with speculation to try to curb the
excesses that may be occurring there. If you could give us some advice, it would be timely and much appreciated.
Mr. BERNANKE. Well, as I said, based on the evidence that is
available, I would not estimate that speculation or particularly manipulation is a significant part of the rise in oil prices.
That said, the CFTC and others are looking at the data and trying to evaluate that. These are very difficult matters. We do not
want to do anything that will stop the futures markets from legitimate functions like providing liquidity and hedging. So, my advice
would be to go slow and carefully and to take the insights that you
get from the CFTC and others who are associated directly overseeing these activities.
Despite the concerns—and I fully understand the concerns about
high gas prices—I don't think it is likely that you can have a big
30
effect on gas prices with short-term moves in the futures markets.
And I would urge careful and deliberate action in this area.
Senator CARPER. All right. Thank you, Mr. Chairman.
Senator Martinez is next, and then followed by Senator Akaka.
Senator MARTINEZ. Thank you, Mr. Chairman.
Mr. Chairman, thank you very much for being with us today. I
wanted to focus on a couple of areas. One was your remarks during
your testimony regarding the fundamental issue in the energy situation which you identify one of supply and demand, which makes
sense to me. I wonder if you might dwell just for a moment on the
speculation side as to why you do not see that as a fundamental
part of the problem, but then also what we could do to be more
helpful in the area of transparency and oversight.
Mr. BERNANKE. Well, there are a number of pieces of evidence
against the view that speculation is a primary force. I mentioned
in my testimony the absence of hoarding or inventories that you
would expect to see if speculation was driving prices above the supply demand equilibrium. There are a number of studies which show
that there is little or no connection between the open interest taken
by non-commercial traders in futures markets and the subsequent
movements in prices.
It is also interesting to note that there are many commodities—
or at least some commodities—that are not even traded on futures
markets, like iron ore, for example, which have had very large increases in prices. So I think the evidence is fairly weak.
That said, I think that transparency in futures markets, information available to the overseer, the CFTC, is a positive thing. And
I expect that the CFTC will come forward with some suggestions
in that regard. But I just do not think it is going to be a magic
bullet to address this very difficult problem of high oil and commodity prices.
Senator MARTINEZ. In other words, well, it might be helpful and
useful to have more transparency ultimately. The supply and demand equilibrium is only going to be impacted by more supply or
less demand.
Mr. BERNANKE. I believe that to be true, yes.
Senator MARTINEZ. I want to commend you for the work you
have done in consumer protection. I noted in your testimony in a
couple of areas that I think are particularly important. I think that
it is terrific to prohibit lenders from making higher-priced loans
without due regard for a consumer's ability to make the scheduled
payments. And I also think it is great to also include the escrowing
of property taxes and insurance as an integral part of what we
need to do in order to keep homeowners in their home.
And, last, the area of credit cards as well, I think all those are
very, very good things for consumers, and particularly at stressful
times like this, it is good to have a reckoning of where we are and
where we are going and include that in that help to consumers.
I know in the next panel we will talk more about the GSE situation. I want to talk about regulatory reform, if I could. Your predecessor and I had an opportunity to discuss this when I was Secretary of HUD, and I recall also coming before this Committee and
testifying with Secretary Snow at that time, proposing a new regu-
31
latory framework for the GSEs. That was in 2003. I wish we might
have done that. But at the same time, we are where we are today.
We do have a piece of legislation moving its way through the
Congress, which includes the creation of a new affordable housing
trust fund. This affordable housing trust fund is funded by a fee
on the GSEs' new business purchases. So, in other words, as they
increase their book of business, this fund would grow at a percentage of that.
I wondered if you have a concern, which I certainly have, about
this provision, particularly at a time when the GSEs are suffering
such substantial losses and when we are, in fact, taking other Government action in order to ensure their sustainability.
Mr. BERNANKE. Senator, I think that is really a congressional
prerogative. I really have not gotten into that particular issue. I
think the really critical issue, as you alluded to, is that we have
a strong and robust regulator that will restore confidence in the
markets and will allow Fannie and Freddie to support the mortgage market in the way they are intended to do. That would be my
emphasis.
Senator MARTINEZ. Thank you, Mr. Chairman.
Chairman DODD. Thank you, Senator.
Senator Akaka.
Senator AKAKA. Thank you very much, Mr. Chairman. Let me
add my welcome to Chairman Bernanke for being here, and my
concerns in our country is to educate the people of America as well
as to protect them and empower them in our financial system.
Given the recent failures, I am concerned by the increasing lack
of trust that individuals have in the banking system. When large
numbers of depositors lose trust in their financial institution and
demand their money back, the bank can fail as a result, and we
know that.
In addition, distrust of the banking system causes many immigrants to miss out on savings, borrowing, and low-cost remittance
opportunities found at banks and credit unions.
My question to you is: What must be done to increase trust in
the banking system among depositors as well as among the
unbanked?
Mr. BERNANKE. Well, Senator, you point to a legitimate question,
which is that there are still many people, disproportionately immigrants, who do not have a checking account, do not have a savings
account, and these are the "unbanked," as the term goes. In not all
but in many cases, those people would be better off with a banking
relationship. They might be able to avoid high fees for remittances,
for example, or high fees for check cashing if they were associated
with a bank. To some extent, it is a cultural element. We encourage banks to reach out to communities, to have people who speak
the appropriate language.
On the other side, as you know—and this is one of your important issues that you have been a leader on—is to promote financial
literacy and to get folks to understand, how to manage their finances and how important having the right relationships with financial institutions can be.
So I think it is really on both sides. We have to get the banks
to reach out. We have to get the public to understand and reach
32
out. Where necessary, as in the case of home mortgages, disclosures and regulation may be necessary to keep the contracts, clear
enough that the public can make use of them. And in that respect,
I hope that, for example, our actions on mortgage lending will restore some confidence where there are people who feel that they got
burned taking out a subprime mortgage. Perhaps in the future,
they will see more clearly what the contract entails, and they will
be more confident in taking out a mortgage.
So it is a very important issue, and we can address it, I think,
from a number of different directions.
Senator AKAKA. Thank you. Working families, as you know, are
having trouble paying for increases today in gasoline, groceries,
and other daily living expenses while wages are not increasing fast
enough and affordable credit is becoming harder to obtain. I am
deeply concerned that too many working families are being exploited by the unscrupulous lenders who give payday loans, and
this is where protection, I think, is needed.
I have been impressed by the work of the National Credit Union
Administration, NCUA, due to a NCUA grant on the windward
side of the island of Oahu in Hawaii at the Community Federal
Credit Union at Kailua, and it has developed an affordable alternative to payday loans to help U.S. Marines and other members
they serve. We must further encourage the development of these
alternatives so that working families have access to affordable
small loans.
My question to you is: What must be done to protect consumers
from high-cost payday loans and encourage the development of affordable payday loan alternatives?
Mr. BERNANKE. Well, again, I think that competition is the best
solution, and I give particular credit to credit unions. They have
done some especially good work in terms of providing remittance
services to allow people to get money back to their families without
exorbitant cost. But I think we should continue to urge banks and
other financial institutions to reach out into underserved neighborhoods. That is, in fact, part of the Community Reinvestment Act
to try to do that to give people the alternative rather than the
storefront in their neighborhood.
So I think that is a desirable goal, and through financial literacy
education and working with banks and community development experts, I think we can make progress in that direction, and I would
very much like to support that.
Senator AKAKA. Thank you very much for your responses.
Thank you, Mr. Chairman.
Chairman DODD. Thank you very much.
Senator Crapo, you are next, then Senator Bayh, and then I believe we are prepared to move to the additional panel members
here. So Senator Crapo.
Senator CRAPO. Thank you very much, Mr. Chairman.
I want to return for just a moment—I know you have gone over
this a lot already—to the question of speculation and the issue of
prohibiting or aggressively regulating the over-the-counter derivatives. And, you know, I understand that measures to enhance the
transparency in our energy markets are a very appropriate response to today's global markets. I am concerned, however, that
33
overly restrictive limitations on the number of speculative positions
that can be held by individuals or other entities could have significant impacts on liquidity in those markets and naturally have the
opposite impact that we would intend by those actions, namely, to
reduce liquidity and actually drive the price of fuel up or petroleum
up.
Could you comment on that?
Mr. BERNANKE. Certainly. First of all, OTC derivatives are not
really unregulated in that the dealers and the banks who make
these transactions are, of course, regulated in one way or another,
and one of the things that the oversight regulators do is make sure
that they are taking adequate precautions of a counterparty risk,
that they are managing their positions in a safe way.
In general, I think there is some reason to look for more standardization where possible so that we could begin to use particular
exchanges as ways of improving liquidity and management of
counterparty risk. But I think there is always going to be some
scope for over-the-counter products because they are the ones that
customize to the particular needs of the other party.
So I think it is important for us to maintain our oversight of the
dealers and the banks. We need to continue to work to make sure
that the clearing and settlement process works efficiently so there
is no confusion or delay. There is some scope for working toward
standardization in order to move toward essential counterparties or
exchanges. But I think we are always going to have over-thecounter derivatives. They serve a useful function. They help with
risk sharing. They provide liquidity to hedgers. And so, I am not
advocating any major change in the way we look at those particular instruments other than making sure we clear them and settle them properly.
Senator CRAPO. If you take, say, futures trading in petroleum as
an example, isn't it correct that for every transaction, there is a
counterparty? In other words, every time there is a buyer, there is
also a seller.
Mr. BERNANKE. Yes, of course. With almost no exceptions, speculators in commodities never take delivery. They have to sell their
position when it comes due, and so they are not in any way using
up the physical resource that underlies the contract. So there has
always to be two sides to every transaction.
Senator CRAPO. And the liquidity that we are talking about, am
I correct, is primarily being provided for those who are not actual
users of petroleum. This liquidity is primarily coming from pension
funds. Is that not correct?
Mr. BERNANKE. Well, it depends which side of the transaction
you are on. You have people on both sides who are trying to make
a bet essentially on whether oil prices will go up or down. But,
clearly, one of the major economic functions of futures markets is
to allow those who want to lay off their risk, like an airline, the
opportunity to sell or to buy forward the fuel so that they will not
be subject to the risk of price fluctuations. And it is the activities
of speculators in those markets that provides the other side of that
transaction and makes those markets liquid and allows them to
serve that function.
34
Senator CRAPO. The airlines are a good example. As you know,
a number of the CEOs of a number of airlines have maintained
that the price of their jet fuel is being forced unnaturally high because of market speculation in the futures market. Do you believe
that they are correct in that?
Mr. BERNANKE. Well, as I have indicated, I think that it is
worthwhile making sure that, there is some transparency, that we
are doing all we can to make sure these markets are as liquid and
as efficient as possible. CFTC has the primary responsibility for
that. We are happy to work with them and try to support that.
So I am not saying there cannot be improvements made in these
markets, but my best guess, as I have indicated a few times now,
is that I do not think that speculative activity per se, or particularly manipulation, is the principal cause of the increases in energy
and other commodity prices that we have been seeing.
Senator CRAPO. Thank you.
Chairman DODD. Thank you, Senator, very much.
Senator Bayh.
Senator BAYH. Thank you, Mr. Chairman, and given the nature
of our having to leave to vote and then come back, I hope that my
questions are not redundant. It is an occupational hazard.
You mentioned that the housing turmoil is sort of the crux of
many of the challenges that we are currently facing. Have there
been any analogous episodes in other countries previously or in our
own that might give some guidance as to—or further guidance as
to when this might bottom out?
Mr. BERNANKE. There have been similar episodes in the U.K. and
Australia, for example. But it is hard to draw strict analogies. One
reason is that the financing systems are different in the different
countries. Clearly, in this case, the high loan-to-value subprime adjustable rate mortgages, those sorts of instruments were particularly sensitive to the decline in house prices that we saw, and the
effects, therefore, on credit quality and on bank balance sheets
were stronger. So there are other examples, and we have looked at
those. Most of them suggest, which is something which I am sure
we are all happy to hear, that eventually the new equilibriums is
established, the housing market comes back into balance, and the
negative effects of that are ended, and you begin to see more stable
growth again. I am sure that will happen here, but there is not an
exact analogy.
Senator BAYH. Well, along those lines—and I know you are reluctant to offer advice to the legislative branch of Government, but I
am sure you have followed the bill that passed out of the Senate
last week. Going over to the House, there may be some marginal
adjustments, but probably not more than that. Is there anything
else we should be looking at doing here in a timely fashion to address the housing challenge that has not been included in this legislation?
Mr. BERNANKE. NO, I do not think so. Not that I can think of.
Again, as this next hearing will reveal, of course, you now have a
set of issues and questions to answer relating to the GSEs, and, of
course, that fits directly with the elements of the bill that already
include a stronger regulator. So I think that is going to be a very,
very important issue in the next weeks and months for the
35
Senator BAYH. And that is going to raise the topic of borrowing
from the discount window, which I would like to ask you about.
What currently is the amount that has been let from the window
as we gather here today?
Mr. BERNANKE. Well, the loans are short-term loans, and they
are rolled over. So I could not give you
Senator BAYH. We do not know the
Mr. BERNANKE. Several hundred billion dollars outstanding at
any given time. But I
Senator BAYH. Several hundred billion at a time?
Mr. BERNANKE. At a given time, yes.
Senator BAYH. IS there any limit to the amount that can be utilized through that mechanism, any practical limit? We have the investment banks partaking. If we get the GSEs partaking, I am just
wondering how much more there is to be had from that mechanism.
Mr. BERNANKE. I think the Federal Reserve's balance sheet is
about $900 billion, and even if we reached that level, which I have
no expectation we would, there are other things we could do to address that.
Senator BAYH. I read here recently—I think it was the Economist. I cannot recall the source of the data, but it caught my eye,
and I would like your reaction to it. The assertion was by some analysts that of the stimulus checks that had been sent, 90 percent
of the amount had been saved. Do you have a reaction to that?
Mr. BERNANKE. I do not know how they would know that. The
historical experience, based, for example, on the checks that were
sent in 2001, suggests that people spent something on the order of
40 to 50 percent of their check within a few quarters. The relatively strong consumer spending number, as we saw recently,
could be due to even a higher propensity to spend out of those
checks. So to my way of thinking, so far it seems that they are having an effect, but we will not really know for sure until we see how
things play out over the next two quarters.
Senator BAYH. Just two final questions, Mr. Chairman. Chairman Dodd asked you about the prospects of a second stimulus
package moving through. My question is: If we are really looking
at trying to buttress the consumer at this fragile time, doesn't income and wealth level, don't those affect the marginal propensity
to consume? Is that an accurate statement?
Mr. BERNANKE. That is generally thought to be the case.
Senator BAYH. And should that not lead us to focus on those who
are more likely to consumer, you know, the more middle-class,
lower-middle-class level, if propping up the consumer is our aim?
Mr. BERNANKE. AS I said when we were discussing the first stimulus package, one of the criteria was to be targeted, which means
to go to people who would be more likely to spend in the short
term, and, generally speaking though it is not uniform, there tends
to be a higher spending propensity from people of lower income and
lower wealth
Senator BAYH. My final question here as my time expires: There
has been a recent increase in the price of credit default swaps on
U.S. Treasurys. What do you think accounts for that? And should
36
that be a matter of some concern in the message the market seems
to be sending about their confidence?
Mr. BERNANKE. There has been a lot of movement in a variety
of spreads, for example, the spreads between newly issued and previously issued bonds and so on. I would not read too much into
that. It is a very small change. I think it has more to do with liquidity in markets and other risk aversion—other types of behavior
rather than any sense that there is a default risk. That would be
my guess.
Senator BAYH. Thank you, Mr. Chairman.
Chairman DODD. Thank you very much, Senator.
We have one additional question from Senator Schumer.
Senator SCHUMER. Thank you, Mr. Chairman, and thank you for
being here. I had two.
One is not about the Fannie and Freddie rescue per se, but just
about the criteria. There is tremendous focus on the stock price,
which we all know has sunk a great deal. But it seems to me that
of much greater importance to the economy and to the markets and
even to the stability of Fannie and Freddie is the differential that
Fannie and Freddie have to pay for their bonds and, say, the U.S.
Government has to pay for Treasury's. Do you agree with that, and
could you give us some indication of how the bond spread is going?
And how does it measures in terms of Fannie and Freddie's stability?
Mr. BERNANKE. Well, that bond spread opened up last week. It
has generally come in since Paulson announced these actions. I
think that is very important, both because Fannie and Freddie obligations, both MBS and corporate debt, are held all over the world,
including large amounts by banks, so that is very important. And,
second, that determines their marginal cost of finance for mortgages, which ultimately we want to make sure that mortgages are
available at a reasonable price.
So the announcements have been generally good for the debt because of the sense that the Government is going to become involved
in these agencies. The stock prices are also important because they
affect the ability of Fannie and Freddie to raise capital. And I
think at this point, there is probably a lot of uncertainty for shareholders as to exactly what is going to happen and to what extent
that will affect the value of their shares.
Senator SCHUMER. One final question. There has been a lot of
talk now about somehow limiting short selling, particularly in financial companies, because of all the problems. Now, a while ago
we had something called the uptick rule, which provided some
measure of restraint on short sellers. When we changed from selling stocks from eighths to hundredths, an uptick of one one-hundredth does not mean much. But I have heard some ideas recently—I have been toying with it—of recommending that we go
back to the uptick rule and say you don't need a one one-hundredth
uptick, but you need 12 upticks, and you get back to the oneeighth.
Do you have any thoughts, preliminary thoughts, on whether
that would be a good idea and, in general, your view on short selling as it affects the markets here?
37
Mr. BERNANKE. Well, I think you do not want to rule out short
selling as a general matter. That is a way for markets to be efficient and for people to take a view on where a stock price ought
to be. There are already limits on so-called naked shorts without
owning the stock, and certainly we want to be very careful about
situations in which a potential short seller spreads unverified rumors and so on.
I think I am in an excellent position here to answer your question because Chairman Cox is going to be sitting next to me in a
few minutes, and I think he could give you a much better sense of
where they are at the SEC on this issue. But my short answer is
that some limits on short selling are probably appropriate, but we
want to make sure that legitimate short selling remains part of the
market.
Senator SCHUMER. I agree with both.
Thank you, Mr. Chairman.
Chairman DODD. Thank you very much, Senator, and with that,
we are going to take a couple minutes' break, give the Chairman
an opportunity to take a few minutes, and we will invite Secretary
Paulson and Chairman Cox to come into the room, and we will
begin the second phase of this hearing. So we will take about 5
minutes here.
[Whereupon, at 12:09 p.m., the hearing was adjourned.]
[Prepared statements, response to written questions, and additional material supplied for the record follow:]
38
PREPARED STATEMENT OF BEN S. BERNANKE
CHAIRMAN,
BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
JULY 15, 2008
Chairman Dodd, Senator Shelby, and Members of the Committee, I am pleased
to present the Federal Reserve's Monetary Policy Report to the Congress.
The U.S. economy and financial system have confronted some significant challenges thus far in 2008. The contraction in housing activity that began in 2006 and
the associated deterioration in mortgage markets that became evident last year
have led to sizable losses at financial institutions and a sharp tightening in overall
credit conditions. The effects of the housing contraction and of the financial
headwinds on spending and economic activity have been compounded by rapid increases in the prices of energy and other commodities, which have sapped household
purchasing power even as they have boosted inflation. Against this backdrop, economic activity has advanced at a sluggish pace during the first half of this year,
while inflation has remained elevated.
Following a significant reduction in its policy rate over the second half of 2007,
the Federal Open Market Committee (FOMC) eased policy considerably further
through the spring to counter actual and expected weakness in economic growth and
to mitigate downside risks to economic activity. In addition, the Federal Reserve expanded some of the special liquidity programs that were established last year and
implemented additional facilities to support the functioning of financial markets and
foster financial stability. Although these policy actions have had positive effects, the
economy continues to face numerous difficulties, including ongoing strains in financial markets, declining house prices, a softening labor market, and rising prices of
oil, food, and some other commodities. Let me now turn to a more detailed discussion of some of these key issues.
Developments in financial markets and their implications for the macroeconomic
outlook have been a focus of monetary policymakers over the past year. In the second half of 2007, the deteriorating performance of subprime mortgages in the
United States triggered turbulence in domestic and international financial markets
as investors became markedly less willing to bear credit risks of any type. In the
first quarter of 2008, reports of further losses and write-downs at financial institutions intensified investor concerns and resulted in further sharp reductions in market liquidity. By March, many dealers and other institutions, even those that had
relied heavily on short-term secured financing, were facing much more stringent
borrowing conditions.
In mid-March, a major investment bank, The Bear Stearns Companies, Inc., was
pushed to the brink of failure after suddenly losing access to short-term financing
markets. The Federal Reserve judged that a disorderly failure of Bear Stearns
would pose a serious threat to overall financial stability and would most likely have
significant adverse implications for the U.S. economy. After discussions with the Securities and Exchange Commission and in consultation with the Treasury, we invoked emergency authorities to provide special financing to facilitate the acquisition
of Bear Stearns by JPMorgan Chase & Co. In addition, the Federal Reserve used
emergency authorities to establish two new facilities to provide backstop liquidity
to primary dealers, with the goals of stabilizing financial
conditions and increasing
the availability of credit to the broader economy.1 We have also taken additional
steps to address liquidity pressures in the banking system, including a further easing of the terms for bank borrowing at the discount window and increases in the
amount of credit made available to banks through the Term Auction Facility. The
FOMC also authorized expansions of its currency swap arrangements with the European Central Bank and the Swiss National Bank to facilitate increased dollar
lending by those institutions to banks in their jurisdictions.
These steps to address liquidity pressures coupled with monetary easing seem to
have been helpful in mitigating some market strains. During the second quarter,
credit spreads generally narrowed, liquidity pressures ebbed, and a number of financial institutions raised new capital. However, as events in recent weeks have demonstrated, many financial markets and institutions remain under considerable
stress, in part because the outlook for the economy, and thus for credit quality, remains uncertain. In recent days, investors became particularly concerned about the
financial condition of the government-sponsored enterprises (GSEs), Fannie Mae
1
Primary dealers are financial institutions that trade in U.S. government securities with the
Federal Reserve Bank of New York. On behalf of the Federal Reserve System, the New York
Fed's Open Market Desk engages in the trades to implement monetary policy.
39
and Freddie Mac. In view of this development, and given the importance of these
firms to the mortgage market, the Treasury announced a legislative proposal to bolster their capital, access to liquidity, and regulatory oversight. As a supplement to
the Treasury's existing authority to lend to the GSEs and as a bridge to the time
when the Congress decides how to proceed on these matters, the Board of Governors
authorized the Federal Reserve Bank of New York to lend to Fannie Mae and
Freddie Mac, should that become necessary. Any lending would be collateralized by
U.S. government and Federal agency securities. In general, healthy economic
growth depends on well-functioning financial markets. Consequently, helping the financial markets to return to more normal functioning will continue to be a top priority of the Federal Reserve.
I turn now to current economic developments and prospects. The economy has
continued to expand, but at a subdued pace. In the labor market, private payroll
employment has declined this year, falling at an average pace of 94,000 jobs per
month through June. Employment in the construction and manufacturing sectors
has been particularly hard hit, although employment declines in a number of other
sectors are evident as well. The unemployment rate has risen and now stands at
5V2 percent.
In the housing sector, activity continues to weaken. Although sales of existing
homes have been about unchanged this year, sales of new homes have continued
to fall, and inventories of unsold new homes remain high. In response, homebuilders
continue to scale back the pace of housing starts. Home prices are falling, particularly in regions that experienced the largest price increases earlier this decade. The
declines in home prices have contributed to the rising tide of foreclosures; by adding
to the stock of vacant homes for sale, these foreclosures have, in turn, intensified
the downward pressure on home prices in some areas.
Personal consumption expenditures have advanced at a modest pace so far this
year, generally holding up somewhat better than might have been expected given
the array of forces weighing on household finances and attitudes. In particular, with
the labor market softening and consumer price inflation elevated, real earnings have
been stagnant so far this year; declining values of equities and houses have taken
their toll on household balance sheets; credit conditions have tightened; and indicators of consumer sentiment have fallen sharply. More positively, the fiscal stimulus
package is providing some timely support to household incomes. Overall, consumption spending seems likely to be restrained over coming quarters.
In the business sector, real outlays for equipment and software were about flat
in the first quarter of the year, and construction of nonresidential structures slowed
appreciably. In the second quarter, the available data suggest that business fixed
investment appears to have expanded moderately. Nevertheless, surveys of capital
spending plans indicate that firms remain concerned about the economic and financial environment, including sharply rising costs of inputs and indications of tightening credit, and they are likely to be cautious with spending in the second half of
the year. However, strong export growth continues to be a significant boon to many
U.S. companies.
In conjunction with the June FOMC meeting, Board members and Reserve Bank
presidents prepared economic projections covering the years 2008 through 2010. On
balance, most FOMC participants expected that, over the remainder of this year,
output would expand at a pace appreciably below its trend rate, primarily because
of continued weakness in housing markets, elevated energy prices, and tight credit
conditions. Growth is projected to pick up gradually over the next 2 years as residential construction bottoms out and begins a slow recovery and as credit conditions
gradually improve. However, FOMC participants indicated that considerable uncertainty surrounded their outlook for economic growth and viewed the risks to their
forecasts as skewed to the downside.
Inflation has remained high, running at nearly a 3V2 percent annual rate over the
first 5 months of this year as measured by the price index for personal consumption
expenditures. And, with gasoline and other consumer energy prices rising in recent
weeks, inflation seems likely to move temporarily higher in the near term.
The elevated level of overall consumer inflation largely reflects a continued sharp
run-up in the prices of many commodities, especially oil but also certain crops and
metals. 2 The spot price of West Texas intermediate crude oil soared about 60 percent in 2007 and, thus far this year, has climbed an additional 50 percent or so.
The price of oil currently stands at about five times its level toward the beginning
2
The dominant role of commodity prices in driving the recent increase in inflation can be seen
by contrasting the overall inflation rate with the so-called core measure of inflation, which excludes food and energy prices. Core inflation has been fairly steady this year at an annual rate
of about 2 percent.
40
of this decade. Our best judgment is that this surge in prices has been driven predominantly by strong growth in underlying demand and tight supply conditions in
global oil markets. Over the past several years, the world economy has expanded
at its fastest pace in decades, leading to substantial increases in the demand for oil.
Moreover, growth has been concentrated in developing and emerging market economies, where energy consumption has been further stimulated by rapid industrialization and by government subsidies that hold down the price of energy faced by ultimate users.
On the supply side, despite sharp increases in prices, the production of oil has
risen only slightly in the past few years. Much of the subdued supply response reflects inadequate investment and production shortfalls in politically volatile regions
where large portions of the world's oil reserves are located. Additionally, many governments have been tightening their control over oil resources, impeding foreign investment and hindering efforts to boost capacity and production. Finally, sustainable rates of production in some of the more secure and accessible oil fields, such
as those in the North Sea, have been declining. In view of these factors, estimates
of long-term oil supplies have been marked down in recent months. Longdated oil
futures prices have risen along with spot prices, suggesting that market participants
also see oil supply conditions remaining tight for years to come.
The decline in the foreign exchange value of the dollar has also contributed somewhat to the increase in oil prices. The precise size of this effect is difficult to ascertain, as the causal relationships between oil prices and the dollar are complex and
run in both directions. However, the price of oil has risen significantly in terms of
all major currencies, suggesting that factors other than the dollar, notably shifts in
the underlying global demand for and supply of oil, have been the principal drivers
of the increase in prices.
Another concern that has been raised is that financial speculation has added
markedly to upward pressures on oil prices. Certainly, investor interest in oil and
other commodities has increased substantially of late. However, if financial speculation were pushing oil prices above the levels consistent with the fundamentals of
supply and demand, we would expect inventories of crude oil and petroleum products to increase as supply rose and demand fell. But in fact, available data on oil
inventories show notable declines over the past year. This is not to say that useful
steps could not be taken to improve the transparency and functioning of futures
markets, only that such steps are unlikely to substantially affect the prices of oil
or other commodities in the longer term.
Although the inflationary effect of rising oil and agricultural commodity prices is
evident in the retail prices of energy and food, the extent to which the high prices
of oil and other raw materials have been passed through to the prices of non-energy,
non-food finished goods and services seems thus far to have been limited. But with
businesses facing persistently higher input prices, they may attempt to pass through
such costs into prices of final goods and services more aggressively than they have
so far. Moreover, as the foreign exchange value of the dollar has declined, rises in
import prices have put greater upward pressure on business costs and consumer
prices. In their economic projections for the June FOMC meeting, monetary policymakers marked up their forecasts for inflation during 2008 as a whole. FOMC participants continue to expect inflation to moderate in 2009 and 2010, as slower global
growth leads to a cooling of commodity markets, as pressures on resource utilization
decline, and as longer-term inflation expectations remain reasonably well anchored.
However, in light of the persistent escalation of commodity prices in recent quarters,
FOMC participants viewed the inflation outlook as unusually uncertain and cited
the possibility that commodity prices will continue to rise as an important risk to
the inflation forecast. Moreover, the currently high level of inflation, if sustained,
might lead the public to revise up its expectations for longer-term inflation. If that
were to occur, and those revised expectations were to become embedded in the domestic wage- and price-setting process, we could see an unwelcome rise in actual
inflation over the longer term. A critical responsibility of monetary policymakers is
to prevent that process from taking hold.
At present, accurately assessing and appropriately balancing the risks to the outlook for growth and inflation is a significant challenge for monetary policymakers.
The possibility of higher energy prices, tighter credit conditions, and a still-deeper
contraction in housing markets all represent significant downside risks to the outlook for growth. At the same time, upside risks to the inflation outlook have intensified lately, as the rising prices of energy and some other commodities have led to
a sharp pickup in inflation and some measures of inflation expectations have moved
higher. Given the high degree of uncertainty, monetary policymakers will need to
carefully assess incoming information bearing on the outlook for both inflation and
growth. In light of the increase in upside inflation risk, we must be particularly
41
alert to any indications, such as an erosion of longer-term inflation expectations,
that the inflationary impulses from commodity prices are becoming embedded in the
domestic wage- and price-setting process.
I would like to conclude my remarks by providing a brief update on some of the
Federal Reserve's actions in the area of consumer protection. At the time of our report last February, I described the Board's proposal to adopt comprehensive new
regulations to prohibit unfair or deceptive practices in the mortgage market, using
our authority under the Home Ownership and Equity Protection Act of 1994. After
reviewing the more than 4,500 comment letters we received on the proposed rules,
the Board approved the final rules yesterday.
The new rules apply to all types of mortgage lenders and will establish lending
standards aimed at curbing abuses while preserving responsible subprime lending
and sustainable homeownership. The final rules prohibit lenders from making higher-priced loans without due regard for consumers' ability to make the scheduled
payments and require lenders to verify the income and assets on which they rely
when making the credit decision. Also, for higher-priced loans, lenders now will be
required to establish escrow accounts so that property taxes and insurance costs will
be included in consumers' regular monthly payments. The final rules also prohibit
prepayment penalties for higher-priced loans in cases in which the consumer's payment can increase during the first few years and restrict prepayment penalties on
other higher-priced loans Other measures address the coercion of appraisers,
servicer practices, and other issues. We believe the new rules will help to restore
confidence in the mortgage market.
In May, working jointly with the Office of Thrift Supervision and the National
Credit Union Administration, the Board issued proposed rules under the Federal
Trade Commission Act to address unfair or deceptive practices for credit card accounts and overdraft protection plans. Credit cards provide a convenient source of
credit for many consumers, but the terms of credit card loans have become more
complex, which has reduced transparency. Our consumer testing has persuaded us
that disclosures alone cannot solve this problem. Thus, the Board's proposed rules
would require card issuers to alter their practices in ways that will allow consumers
to better understand how their own decisions and actions will affect their costs.
Card issuers would be prohibited from increasing interest rates retroactively to
cover prior purchases except under very limited circumstances. For accounts having
multiple interest rates, when consumers seek to pay down their balance by paying
more than the minimum, card issuers would be prohibited from maximizing interest
charges by applying excess payments to the lowest rate balance first. The proposed
rules dealing with bank overdraft services seek to give consumers greater control
by ensuring that they have ample opportunity to opt out of automatic payments of
overdrafts. The Board has already received more than 20,000 comment letters in response to the proposed rules.
Thank you. I would be pleased to take your questions.
42
RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY
FROM BEN S. BERNANKE
Q.I. Inflation: Mr. Chairman, I have great concerns about inflation.
Inflation degrades consumer's purchasing power and reduces the
value of many investments, including people's homes. Additionally,
continued food and energy price increases can have negative effects
on consumer confidence and potentially unhinge inflation expectations.
How large of a shift in expectations would the FOMC have to see
before it began to tighten the target for the Federal Funds rate?
Please comment on whether you have observed a pass-through of
higher input prices for commodities and energy in the form of higher prices for finished goods?
A.1. The inflationary effects of the sharp increases in oil and agricultural commodity prices earlier this year are clearly evident in
the retail prices of energy and food. In particular, the PCE price
index for food and beverages increased almost 6 percent over the
12 months ending in August 2008, while the PCE price index for
energy moved up 28 percent over that same period. The acceleration in the price indexes for these two components of spending accounted for much of the pickup in the 12-month change in the overall PCE price index to 4.5 percent in August 2008 from 2 percent
over the 12 months ending in August 2007.
It appears that, to some extent, the earlier increases in the prices
of oil and other raw materials have been passed through to the
prices of non-energy, non-food finished goods and services. Prices
for consumer items that have a high energy content—such as airfares and other transportation services, housekeeping supplies, and
household operations—have moved up noticeably this year; moreover, energy and other basic input costs could well have pushed up
prices for a range of other items for which the direct effect of commodity prices is more difficult to identify. In the aggregate, the
PCE price index excluding food and energy rose at an annual rate
of 2.6 percent over the 12 months ending in August 2008, about
one-half percentage point faster than over the 12 months ending in
August 2007.
Thus far, however, we have not seen the sort of run up in labor
compensation and inflation expectations that could lead to a deterioration in the longer term outlook for inflation. In particular, although some indicators of inflation expectations have increased,
long-term inflation expectations still appear to be reasonably well
anchored. Indeed, given the recent sharp declines in the prices for
crude oil and other commodities and the weakening in economic
conditions, the FOMC believes that inflation is likely to moderate
later this year and in 2009. Of course, the Committee will continue
to monitor the incoming information on inflation and inflation expectations carefully.
Q.2. Update on Bear Stearns: Chairman Bernanke, the Federal Reserve created a limited liability corporation (Maiden Lane LLC) to
acquire and manage certain assets from Bear Stearns, with the
goal of maximizing repayment of the original loan back to the Federal Reserve Bank of New York. We all hope that this loan will be
repaid in its entirety through the sale of these assets over time.
43
How has the value of the Bear Stearns portfolio changed over
time?
In the few months since this transaction occurred, has anything
changed that would lead to a reassessment of potential losses?
A.2. As indicated in the Federal Reserve's weekly H.4.1 statistical
releases, the fair value of the net portfolio holdings of Maiden Lane
LLC was $29,816 billion as of March 14, 2008, $28,893 billion as
of June 26, 2008, and $29,018 billion as of June 30, 2008. The Federal Reserve will publish in the H.4.1 statistical release an updated
fair value of the net portfolio holdings of Maiden Lane LLC as of
the end of each calendar quarter. The fair value of the net portfolio
holdings of Maiden Lane LLC was $26,979 billion as of November
26, 2008, which reflects valuations as of September 30, 2008.
As more fully explained in my testimony before the Committee
on April 3, 2008, the Federal Reserve decided to finance a portion
of Bear Stearns' assets to facilitate the acquisition of the firm by
JPMorgan Chase to address the severe consequences that likely
would have resulted from a disorderly liquidation of the firm in the
unusually fragile circumstances that then prevailed. In taking this
action, the Federal Reserve consulted closely with the Treasury Department.
In order to maximize the returns to the Federal Reserve and the
taxpayer, the Federal Reserve has engaged an independent portfolio management firm to professionally manage the assets held by
Maiden Lane LLC. The assets will be managed with a long-term
time horizon of at least 10 years. Although the value of the portfolio declined between March 14, 2008, and June 30, 2008, given
the long-term time horizon for the portfolio it is too early to estimate what, if any, net losses might result from the eventual liquidation of the portfolio. Importantly, as previously announced,
JPMorgan Chase will bear the first $1 billion of any losses on the
collateral pool.
Q.3. Negative Real Interest Rates: Chairman Bernanke, real interest rates appear to be negative at present, since the nominal shortterm rate is lower than inflation.
Does having a negative real rate of interest during a period of
increased inflation harm the Fed's ability to work towards maintaining price stability?
For how long can the Fed run a negative real interest rate before
inflation pressures grow to dangerous levels?
A.3. The FOMC has judged the current level of short-term interest
rates as appropriate in light of its statutory objectives of maximum
employment and price stability. Relatively low real short-term interest rates are currently necessary to counter the adverse effects
of the broad range of factors restraining aggregate spending and
output. Such factors include severe strains on financial markets
and institutions, tight credit conditions, the ongoing housing correction, and elevated energy prices, which reduce households' discretionary income. As such, we do not believe that the current low
level of real short-term interest rates is likely to have an adverse
effect on the economy. Clearly, the highly accommodative stance of
monetary policy cannot be maintained indefinitely. But, in view of
the expectation for inflation to decline, such a stance is appropriate
44
for a time to help foster moderate economic growth in the face of
the range of factors that is restraining growth. The Committee believes that inflation is likely to moderate later this year and during
2009 as the effect of recent sharp drops in the prices of energy and
other commodity prices shows through to broad price indexes and
as slack in the economy resulting from slower economic growth reduces pressure on resources.
Q.4. FOMC Statement Bias: Mr. Chairman, in the FOMC's most
recent statement, the Committee seemed to shift its bias away
from concerns over slower growth, towards concern about inflation
and inflation expectations.
Would you elaborate on what this shift means for future policy
decisions?
Additionally, how long would inflation rates have to stay elevated
for the Committee to display unambiguous bias towards alleviating
inflation concerns?
A.4. In conducting monetary policy, the Committee carefully monitors ongoing developments in the economy and financial markets
that influence the outlook for the economy and inflation. From time
to time, the Federal Reserve adjusts its policy stance in view of the
evolving economic outlook and risks to the outlook. After each
meeting, the Committee issues a statement that explains any adjustment to its policy stance and characterizes the outlook for economic growth and inflation. In the period before the June meeting,
incoming economic data had indicated that economic growth in the
second quarter was stronger than had been expected. Also, financial market conditions appeared to have improved somewhat, although markets clearly remained under stress. Meanwhile, oil
prices had increased further. In these circumstances, the Committee judged at its June meeting that the downside risks to
growth diminished and the upside risks to inflation had increased.
An important uncertainty in the outlook for inflation is whether
the current elevated level of total inflation may lead to upward
pressure on longer-term inflation expectations. At present, although some indicators of inflation expectations have increased,
long-term inflation expectations still appear to be reasonably well
anchored. However, the Committee is monitoring inflation and inflation expectations very carefully.
RESPONSE TO WRITTEN QUESTIONS OF SENATOR BUNNING
FROM BEN S. BERNANKE
Q.I. The number and severity of credit rating downgrades from
credit rating agencies in the last year casts doubt on the reliability
of such ratings. What is the Fed doing to verify the credit rating
of the collateral you are accepting at the various Fed facilities?
A.1. The Federal Reserve regularly updates the credit ratings of assets pledged as collateral and uses multiple ratings rather than
just one. Assets are regularly marked to market and haircuts are
applied to provide adequate protection against market, liquidity,
and credit risks. In cases where ratings are less reliable, we require a higher rating than we would otherwise. It should be noted
that the entire pool of collateral pledged by a depository institution
45
secures any loans to that institution; moreover, the Federal Reserve has recourse to the borrower under all of its lending facilities
beyond the specific collateral pledged.
Although credit ratings are one determinant of the eligibility of
collateral pledged to Federal Reserve liquidity facilities, Reserve
Banks also perform independent credit analysis when receiving collateral and especially when extending a loan to a depository institution. That analysis is based on publicly available information as
well as on supervisory information on both the quality of the collateral and on the financial condition of the pledging institution.
Q.2. In 2006, Congress passed the Credit Rating Agency Reform
Act, which created a formal process for recognizing and examining
credit rating agencies with a goal of increasing competition and
rating quality. Under that law, the SEC has now recognized 10 National Recognized Statistical Rating Organizations. However, the
Fed only accepts credit ratings from the three largest rating agencies for collateral taken at the various Fed facilities. Why does the
Fed not accept ratings from the other approved agencies? Are there
any plans to revisit that prohibition?
A.2. The Federal Reserve accepts a very large volume of collateral,
and it is critically important to be able to access credit ratings and
other information on a timely basis in a fully automated fashion.
The Federal Reserve is open to utilizing credit ratings of all
NRSROs consistent with this basic requirement.
Q.3. Given the concerns about the government-sponsored entities
that led the Fed to grant them access to a lending facility and the
Treasury Department to ask for rescue legislation, has the Fed
changed its practices on accepting GSE-backed securities as collateral at the Fed facilities? Have you increased the collateral required when GSE-backed collateral is posted?
A.3. Securities issued or guaranteed by the GSEs remain eligible
collateral at the Federal Reserve's various liquidity support facilities. The market prices of GSE securities pledged as collateral are
regularly updated and the haircuts are determined to provide the
Federal Reserve with adequate protection against market, liquidity, and credit risk. The haircuts applied to collateral pledged by
depository institutions to the discount window are regularly recalibrated by the Federal Reserve, and it has not been necessary to
change those applied to GSE-related securities. Haircuts applied to
securities pledged by primary dealers for repurchase agreements,
the primary dealer credit facility, and the term securities lending
facility are chosen to be consistent with, but slightly more conservative than, market practice.
46
For list ;i 10:00 a.m., EDT
Monetary Policy Report
to the Congress
July 15, 2008
Board of Governors of the Federal Reserve System
47
Monetary Policy Report
to the Congress
Submitted pursuant to section 2B
of the Federal Reserve Act
July 15,2008
Board of Governors of the Federal Reserve System
48
Letter of Transmittal
BOARD OF GOVERNORS OF nn
FEDERAL RESERVE SvstBM
Washington. D.C.July 15. 2008
THI PRESIDENT of Tilt SENATE
THE SPEAKER OH THE HOUSE OH REPRESENTATIVES
The Board of Governors is pleased to submit its Monetary' Policy Report to the Congress
pursuant to section 2B of the Federal Reserve Act.
Sincerely,
en Bernanke, Chairman
49
Contents
Part 1
I Overview: Monetary Policy and the Economic Outlook
Part 2
3 Recent Economic and Financial Developments
"\ The Household Sector
3
7
Residential Investment and Finance
GRBSUMF Sjjending and Household Finance
10 The Business Sector
JO
Fixed Investment
10
hi ventory In vestmen t
I1
Corporate Profits ami Business Finance
13 The Government Sector
13
Federal Government
14
Federal Bom>iring
15
State and Local Government
15
State and Local Government Borrowing
16 National Saving
\h The External Sector
16
International Trade
17
The Financial Account
19 The Labor Market
19
Employment and Unemployment
20
Productivity and Labor Compensation
21 Prices
23 Financial Markets
23
Market Functioning and Financial Stability
25
Debt mid Financial Intermediation
28
Eqttitv Markets
29
Policv Expectations and Interest Rales
30
Monies and RtMt'lW
3 0 International Developments
30
International Financial Markets
32
Advanced Foreign Economies
33
Emerging Market Economies
Part 3
35 Monetary Policy over the First Half of 20(18
Part 4
39 Summary of Economic Projections
ii
T i e Out look
41 Risks to the Outlook
42 DiversIly of Parllclpanls' Views
Boxes
ft Kccent Federal Reserve Initiatives to Address Problems in the Mortgage Market
IK Commodity Prices
2(> The Federal Reserve's Liquidity Operations
45 Forecast Uncertainty
51
P&rtl
Overview:
Monetary Policy and the Economic Outlook
The U.S. economy remained sluggish in the first half of
pated to remain reasonably well anchored, with futures
200H. and strep increases in ((HMIIUHILIV prices fmxr.lt'ri
markets iiiclicaliu^ thai CHIUCIHHILIV pikts
L iHI-.iLiin-t pin i- Jntl.iti-iji
to flatten ciul. and with pressures on resources l i k e l y
I he riiiH\iii_i3 iiuirkfC L Niiiin
art- rxpcuHtl
ued (o contract, weighing on overall economic activity.
toease, inflation is projected to moderate appreciably
Against a backdrop of mourning losses incurred by
in 2009. FOMC participants indicate that consider-
major financial institutions, financial market conditions
able uncertainty surrounds Ihe outlook for economic
deteriorated sharply furlher toward the end of the first
^ m n i t i ,<nd thai ihey see ilu- risks arciuud Midi Quilaok
IJIL.LIIIT
b
.! LJr\rlif[jnu"iit llul Lliffiilcju'd lc> y\E rrt\
a% skewed en 131L- liiiwTisiitr. ~YUv\ <ilsci W T prcispc^ris fur
impair the funitinning n f (he overall financial system
inflation as unusually uncertain, and they view the risks
and lo hinder economic growth. In response, (he Federal
surrounding, their forecasts Tor inflation as skewed to
Reserve undertook a number o f significant actions lo
I he upside.
address liquidity pressures faced by banks and other
financial institutions, thereby aii^ineiiEiu^ ilu- lnjiin.kr.
e
fiiliiirnLiifj measures implemented in the s cond half
In the second half of 2007 , ihe deteriorating perfor
mance o f subpritne mortgages in the United Stales triggered a reassessment o f credit and liquidity risks across
of 2flO7r Taken together. these measures fostered some
a broad range o f assets, leading to widespread strains
improvement in the functioning o f financial markets,
and turbulence in domestic and international financial
but considerable strains persist. In view o f ihe implica-
markets. During the first quarter o f 2008. reports o f
tions o f thesubstantial reduction in credit availability
further losses and wrlle-downs at major linancial insti-
and Ihe continuing decline in housing act ivity for the
mricms incrnsttHtl concerns .LJUMLI cretlit JJUI lic|LIiili[^
eronmhir oulitmk. The KEilerd lOpen Market Committee
risks and resulted in a further sharp reduction o f market
( F O M C } further eased the stance o f monetary policy.
liquidity. Risk spreads—particularly for structured cred-
After cutting the target federal funds rate 100 basis
it products—widened dramatical l y, and securilization
points in the second half of 2007, the F O M C reduced
activity ail but shut down in a number o f markets. By
rates another 225 basis points ov ER the first four months
March, many securities dealers and other institutions
of 2008. Tiie further easing o f policy was seen ascon-
itiiil had rrlii^d !iejivilN' {in shcirMemi tinancing in mar
sistent with fostering price stability over time, given the
kets for repurchase agreements were facing much more
Committee's expectation that aflatten!ng-out of energy
stringent borrowing conditions.
prices and increasing economic slack would damp inflationary pressures.
I Jn- iiuAt PM9BM etmioEhif projeciioi^ H_• I jh.ir i i•_ J
In mid-March, a major investment bank. The Bear
Steams Companies, Inc.. was pushed TO the brink
i.hi faiE URE after suddenly losing access to short-term
p;iii|% in l-£)Mt meetings (l^Uniui IIH-IJIIHT^ and Rrservr
financing markets, "file Federal Reserve judged Ihat a
Bank president) are presented in p;ir[ A of Ihis repurt.
LIIVIIILIITK Liihirr MF \U\t\ S[pjims wntiU\ 11.1-4.L- threat
According to these projections* the economy is expected
cued overall financial stability and would most likely
to expand slowly over the rest of t his yea R. FOMC par-
have had significant adverse implications for the U.S.
ticipants anticipate a gradual strengthening of economic
economy. After discussions with the Securities and
growth over co mi ng quarters as the lagged effects of
ii.ifliiiuge (]cinuThssiun and in Hinsullalicm willi l)ie
|his| mnneijry p»liry acijonv umicl gr<tcltiHiUv jmprtiv-
Treasury, the Federal Reservedetermined THAT it should
ing financial market conditions, begin to provide addi-
invoke emergency authorities to provide special financ-
tional lift to spending and as housing activity begins to
ing lo facilitate the acquisition of Bear Steams by
stabilize. FOMC participants marked up their forecasts
JPMorgan Chase & Co. The Federal Reserve also used
of inflation for 2008 as a whole, reflecting the upward
emergency authorities lo establish the Term Securities
pri'ssurp mi in Hill inn fruni rising c oiuiiiiMliiv pritW,
Lending Fac i lity and the Primary Dealer Credit Fatality
However, willi louderrun inJlaiiori expectations anliri-
lo support Ihe liimidily nt |»riiii.i[\ dealers and financial
I
2
Monetary Policy Report LO ihe Congress
July 2008
markets more generally, which would bolster the availability ofcredit lo the overall economy.1 (See the box
cmIIled "The Federal Reserve's Liquidity Operations"
in pad 2. page 26.) Other sleps taken by the Federal
Reserve in recent months lo address strains In financial
markels Include a furt her easing in t he terms for bank
borrowing at the discount window and an increase In
the amount of credit made available to banks through
the Term Auction Facility. The FOMC also authorized
increases in its currency swap arrange ments with ihc
European Central Bank and the Swiss National Bank to
Facilitate an expansion of dollar lending operations lo
banks in (heir jurisdictions.
Over the second quarter financial market conditions improved somewhat—credit spreads generally
narrowed, liquidity pressures ebbed, and financial
institutions made progress in raising new capital. St ill,
asset prices continue to be volatile, and many financial
markels and institutions remain under considerable
stress. Very recentl y, the share prices of Fannie Mae
and Freddie Mac dropped sharply on investor concerns
about their financial condition and capllal position. The
Treasury announced a legislative Initiative lo bolster the
capita], access lo liquidity, and regulatory oversight of
the government-sponsored enterprises (GSEs). As
a supplement to the Treasury's existing authority lo
lend lo the CSEs, ihe Board of Governors eslablishcd
a temporary arrangemenl that allows the Federal
Reserve lo extend credit to Fannie Mae and Freddie
Mac, if necessary.
The sluggish pace of economic activity in the first
half oF 2008 was accompanied by a further deterioration
in the labor market. Private-sector payroll employment
declined al an average monthly pace of 94.000, and the
unemployment rale rose to 5'6 percent. Moreover, real
labor income appears lo have been flat in the first hall
of Ihe year. Although wages rose in nominal terms, the
I. Pftnury Uc-jtm U P fuim lhal Iradr- in (J.S. pm rrnutriri wnirilin H ilh Ihr Fcdml Jtntnr fiirik at N™ Vnri. On brfu I f of lltr
Fnlml k n m r S>Urrn. I be N M YDT L M O Opm Mvkci Dt>4
uch Iradra ID imptnnml ntunrlarv pclkry.
purchasing power of those nominal gains was eroded
by ihe rapid increases in CONSUMER prices. Declining
employment, stagnant real wages, and lower eqully
and home values weighed on consumer sentiment and
spending. In addition, amid falling house prices and
rising foreclosures, activity in ihe housing sector continued lo decrease. The resulting softness in business
sales and profits also made the environment for capital spending less hospitable. The weakness in overall
domestic demand was partly offset bv strong growth of
export which were supported by a sustained expansion
of foreign activity and a lower dollar.
The substantial further rise this year in the prices of
many commodities, especially oil and agricultural products, largely reflected strong growth of physical demand
that outstripped supply in these markets, Although
weakening economic activity and rising prices have
tempered demand lor com modi ties in many industrialized nations, demand has continued to grow in booming emerging market economies However, supplies of
commodities have generally nol kept pace for a variety
of reasons, including political tensions In some oilproducing nations, higher input ants, lags In ihe development of new capacity, and more recently, Hoods in
tin- Miihu"i( I" '..imii.1-1, fli-Linw I In.- iru.jhin.L1. iiu rt^i s
in materials prices have passed through into retail prices
of energy, food, and some other items.
Overall consumer price inflation, as measured by
the price index for personal consumption expenditures,
remained elevated in the first half of 2008, largely
because of the sharp increases in the prices of many
commodities. The decline in the foreign exchange value
of the dollar has boosted import prices more generally and thus has also put upward pressure on inflation.
Nonetheless, increases In labor costs and core consumer
prices (which exclude the direct •effects of movements
in energy and food prices) have remained moderate.
The rapid advance in nverall prices has bomled some
measures nf inflation expectations: Near-lean inflation
expectations have risen considerably in recenl months,
am] some indicators of longer-term inflaiiun expectations have also moved up—a development that will
require close monitoring in The period ahead
53
Part2
Recent Economic and Financial Developments
The growth of economic activity, which slowed sharply
in Ilu1 fourth (|Uiiiitrr ul 2007, u'liiainrd sijbji.ir in ilu1
lirst half of 2008. Although ihc reslraim on activity
late in 2007 was concentrated in thr housing sector,
spillovers to other areas of the economy began to show
through more clearly in the lirst haiF of ZOm Meanwhil e , consumer price inflation has remained elevated
Ihis year primarily because of steep increases In the
prices ofmany commodities Probably in response to
ilu1 \iAiMi- rise in headline price indexes, sonic i tut it .L
tors of longer-term inflation expectations have risen in
recent months. However, increases in labor costs and
core prices have own fairly stable* reflecting in pan ihe
softening In aggregate activity.
I iiLiiK i;il markei stirs* \\MH \Y,H\ i\vxv]ti\wi\ OVIT MICJ
second half of last year intensified in the first quarter
of this year. Increased concerns about the possibility of
a global economic slowdown and a generalized flight
from riskier asset s cont ributed to sharply wider risk
spreads heightened volatility, and impaired liquidity across a range of markets The Federal Reserve
responded 10 (hesrdevelopments and their jHiientLiI
adverse implications for the economy by aggressively
easing the stance of monetary policy and by taking a
number of steps TO BOLSTER liquidity and enhance market
functioning. Conditions in Financ ial markets Improved
Change In real o j o u domestic product, 2002-0
an the chiiin-type price
D Tc*
Mill
Sulk, rhruujjh SJO?, kludge
tKmgt a tram Ikormht M MJJ
I Lktcfrtn cu Unmrdvi. f
somewhat In the wake of these actions, but significant
Mraius remain Wtlh (rcclil rnnclilicms li^lil. «tuit\ JIIH!
n a t e valuta falling, and rafiidly rising comnnHlily
prices boosting costs and ronsunier prices, growth of
household and business spending appears to have been
sluggish over ihe lirst half of the year.
The 1loLischttld Sector
Residential Investment and Finance
2HQ
2DM
MOS
J006
TOOT
2D0H
d h m n m d to ib Oral (furtrr from hr flail qwrirr cf I
p
Stmci. DepMiii • <rf Ca«iiwcf. Btwu of
Housing demand, residential construction, and home
prices have all continued to Fall so far this year. Following a decline at an annual rale of 43 percem In (be
M=I. n d half of 2007. sales of new ho tint's dec reasEKl at
HEI annual rait' of 32 permit in the first five months of
2008, However, sales of single-family existing homes,
which dropped at an annual rale of 26 percent in the
second half of last year have been about unchanged
this year. Moreover, pending home sales, which provirie it glimpse til llie |KK f nf exisEin^ humr ulcs in ilu1
uioncbs ahead, mi ne[ k v r k t ] nut in the spring, hinting
al some stabilization in transactions in ihc resale market. Siill. for [he overall housing sector, the challenging
mortgage lending environment and the concerns of
54
4
Monetary Policy Report lo ihc Congress
July 2008
prospective humehuver* about further dedinev in hoiis**
prires arc likely runiinuing [o depress tinusing lEeitLincI.
As new home sales have continued to Aw lim-.
hamenuildcrs have siniggled lo work down iheir substantial ov erhang of unsaid houses. As a consequence,
residential construction activity has been pared further
this year, [n the single-Tamilv housing sector, new units
were started at an annual rale of 674.000 in May—
dow n more than 13 percenl this year and roughly
60 percent sin ilit' pOdk reached in the first quarter
*>\ ^UOti. Despite [hcM- tin-ft pindui litm CUTS, ilu 1 slink
of UNSOLD homes has moved down only 20 percent from
its n. i ini.l 111:-.11 in i..!: I1. XiIIil> \\ 11• -• • i \ .iln.ui"! M I.Hr. r
tol i t e three- month average pare of sales, the months'
supply 4it uiiSHilcl IIL'U IIDIIILA ILLS (cuiliniifd [o rise .unj
sloodal 1(H* mmiriis in May. I" the milIlitarnilv seciox.
starts averaged an annual rate of about 320,000 units
during the first five months of 2008. a level of atlivity
al Ihe lower end of its range in me past several years.
AIL told, ihe decline in residential investment (rimmed
the growth rate of real gross domestic product (GDP)
about I percenlage point in (he first quarter of 2008 and
appears to have held down the second-quarter growth
rate by about the same amount.
Mouse prices also have continued lo fall. The monthly price imlex pulilisheil liv ihe tJflicf ol h'ditnil Kunming Enterprise Oversight dropped at a 6 percent annual
rate in the first four months of 2008 (the latest available
data), a slightly faster rale of decline than in the second
half of 2007 / In Mayh the average price of existing
2.. thK JIWVJ, KtW1 pmtw^Hil> ^mkmof tkrirprat\ion\ prtrr indn for raining \\ng\t-family hoiqn puhliihnl hy
Private housing surts. |
l k i K i q n tor Apnl wd MJ>.
(/hongc in prices or'c.tistm^ singlc-fimiiv IHHISCS,
19K8-2OOS
V
— IJ
I
I L I L J I J I L i
L J I
I
I I I i I L I I
HII:
J0Q8 p i : tk^gn MK
Ijvm one
wily. TheS*
Hin^lrltiitrt in 11k."
. F M I t p m U-jrt\*.-TM>fiv -tHIkt uf hnklal llnuutig
t; b f SAP t"ue-ShilbT.C1iKJ«9Mcrh.-JKhk l A d u n p :
single-family homes sold—which does not control for
changes in the mix of houses sold but is available on a
mint' murk h,\\i\ ULI\ JIIKUII 71: |nn iiii IM-1IIH MI,I[
[jf a year earlier. Although lower prices should eventually hrlp holster housing demand, survey and anecduia!
reports syggesl lhat ex pect at ions of further house price
declines are quite prevalent, a consideration t hat may
make potential buyers reluctant la purchase homes until
prices show signs of slabili/ing.
The rising volume of foreclosures likely has contributed lo falling house prices. Continuing the upward
b-end that began in late 2006. about 550,000 loans
began the foreclosure process In the first quarter of
2008-m o r e lhan double the average quarterly rate
fmni 200:1 u> 2005. Ihis rise in furecltKiiire iians v.ill
iucriMM1 ihe sunph1 cif IHHIWS for \ale iiiilevs lnjirti\',ri v
i JIII [nuke ii[i [he Jiiissit! |uiyjneut% «r arrange wilh |he
lender* or rnrcrlgagt* servkers to have their loan^ modi
fied-J Lenders and mongnge vrf\rirenp have inrreasingly been working with borrowers io modify loans lo
allow borrowers lo remain in iheir homes. However,
some borrowers may not be able lo afford even reduced
month]}r payments, and other borrowers may nol wish
lo keep their properties in an environmenl of falling
house prices. Thus, the share of foreclosure starts that
. A loan nun ' ^ modiltrd h\ irdurinf; ihr principil tulanrr,
ihe imnnX rale, or rxlcnlir^ ihp Inm w a\ lo nuVr munlh -
h juyn
Tdhk
BoardofGovernors
ultimately result in t he loss of a home serins Hkety to be
higher in [he rurrent episode than customarily has been
lie case. {See the \MX emitted "Recent Federal Reserve
Jniiiaiivps lu Address PmiiLeins in tin- Montage Mar
ket" on page 6.)
The rales of delinquency continued to rise in the
\\\\{
of the Federal Reserve System
ivc dcJaults on subprimc2/2Sloans.2S
of originalion, 2001 07
— s
(M
gage loans. Problems remained espetially severe for
sub prime loans. However, the growih rate of iubpriinr
delinquencies has, slowed this year while that of prime
and near-prime delinquencies—part icularly on
adjustable-rate loans—has picked up. Credit quality
is sir ongly related to the originalinn date of mnrlgage
bans, with ILMTIS originated in 20Uti a mi 2007 much
more likely to experience delinquency and default than
loans originated in previous years. The poorer performance oT the more recent loan vintages reflects 3 generaldeterioraltnu in uud^nuJmigsEniiHLird*, chrou^li tinr]y
2007 and I l irdec l i n e i n house prices since 2007, which
ii.i-. increased Ihe occurrence of negative homeowner
cy ntn. 2001 OK
-
M07
/
—
6
—
A
—
3
— 20
/
/
IMIJ ' ! j —
l>
—
10
/
-
—
i
i
q
J
|
J
a
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>)
l..»o l i e Imon*
) d»(3 IIIFOUVII « w k t m I JKII < m t
! of tiuth HKI^MUIAI 1*1 lhc IhdKilnl >Vai Liu) lutl
J hi Hie ii iUfJ Inm W. r~ cumple. n^sbty S PCTT<OI nf ?ll
^
inn: in Lht yms Mrt] |p ZdtH hod tkbulicd by tin
Ibirw 1lw> MR M mnnlhi LIILL TV LiJ V prniili u[ tbo BROI J« -""^
h q h :INIT DK tuMAJ (Mi irwwiipHc Jiu. A 2 JR hun i* i KKyMr Ion
J flint role InMhc ftrJ J ycaft irtd LHI mlju^Uhk-TJIL lur II>L' rLnLJIIIinu-
ttyy
ID
X
/
-
5auwx
- All-A pools
loans.
mm
\\-\\ 1\H>I\\]\\ Lh| i'llUH .IL l ( t \ \ , t | | I .Ik^UILCS 1)1 JIL.lK
—
5
Fir
e[|ulEy for houses purc hased near the peak of the real
BBHl market.
New subprime mortgage loans remained largely
unavailable in thefirst half of 2008. and borrowers with
higher rrerlil ri^k lt;ni m mm ui governmenl ^usr^iiirp
pragranu. such as Ihat u( \W Federal Housing Admin]slraeEon, to obtain mortgage loans. The availability of
prime mortgage credit has been held down by a further
lightening of lending standards at many commercial
hanks, according tn ihc Senior Loan Officer Opinion
Survey on [Junk Lending Prac tices conducted in jinmi
aryand April. Securllizalion of mortgages by the government sponsored enterprises {CSEs)h Fannie Mae and
Fr«lriie Mae, was robust through April, although the
CkSEs lighlcne<| siand'irtK and Increased ^iLinnlee fee^.
for prime loans, iutereM rjtes on < uniontiLii;.^ h vi iL rale
mortgages were up slightly, on NET, over the tirslhalfof
2008 after declining ntoderalely late East year.1 Rales on
conforming adjustable rale mortgages dropped inJanu
ary but have since reversed a ptirtinn of that decline.
Offered vain on JUMBOFI xed-rale loans—which ran
up in the second halfoflast year as the sec urilizallon
4. Lonfnnnlni; iibortpaflp* afr ihow rli^lbir tot purchjM1 \n l-an
• in- M.:i ..i . I : n-iI-11-- Mar; chry nnhl brNt^lvalrni in li^k lo.i |<iiiM,
inwtRjRr nidi aiSD prfa-nt Itun-ED-vuEur riHlo, .imi Ibrv f Jniwl
f xfore! chf caiiftrfm1ii£ lain IhiiJi.
6
Monetary Policy Report to the Congress
July 2008
Rvamt federal Reserve Initiatives to Address Problems in the Mortgage Market
The hifih rate of mortgageforeclosuresis Creating
personal, economic, and social distress for many
homeowner* and communities. The Federal
Reserve is collaborating with olher re.R,uf.ilors,
community Brou05., |H>[icy organiza tions, financial institutions, and public officials to identify
solutions to prevent unnecessary foreclosures
and Their negative effects. The Federal Reserve
also has taken a number of regulatory and supervisory actions to reduce ihe likelihood of such
problems in (he future.
tn 2007, the Federal Reserve and olher banking agencies called on mortgage lenders and
morlRG,Re servicers Eo work closely with borrowers who flfr having difficulty meeting Their mortgage payment obligations. Foreclosure cannot
always be avoided, hut pnjdent loan workouts
and olher fosvm it Ration techniques that help
troubled borrowers can te less cosily lo lenders
than foreclosure.
The FiiJvr.il KI-M'FW'K HttniftUVrtiiship ,mr|
Mortgage Initiatives reflec ta comprehensive
strategy across rhe Federal Reserve System to
provide information and outreach to prevent
unnecessary foreclosures and to stabilize communiliev Under thi'sij i nil Olives, the Federal
Reserve has been providing community coaltlions, counseling agenc ies, and others with
detailed analyses identifying nei
market tor such loans dried up— remained elevated in
the fiRt half of 200£> and spreads between rales offered
on these loans and oit conforming loans stayed unusually wide / To support the market for larger loans, the
Congress raised the conforming hmi limit temporarily
fur Z(IOHr which allnvv^l lUv t,Si\ m lack Ihi-sc mori
gages. HoweviT. bflOBSt the |n"i'piiyn^'nt i hararleristics of jumbo mortgage borrowers are different from
those of other borrowers, the GSEs and other market
p.si ri< ijmtiK 111 -1 i(kd in tr \u fmol \\\vw "jmiilr" i [niftuni
inj;" murlgd^es with olhrr mortgages \\\w\i tTfitlin^
riii i-r t; •_• i:";i• IMU ki-il \efurities (MBS}. As n result, tin1
secondary market Tor such mortgages has thus far failed
to thrive. Concerns expressed by public policymakers
piTMiatk'd Fannie Mae and Freddie Mac lo make greal-
at high risk of foreclosures. With this information, community leaders can target their scarce
resources to borrowers in need of counseling
and other interventions that may help prevent
unnecessary foreclosures. One example of this
effort is the online dynamic maps and data that
illustrate nonprime loan conditions across the
United Stales (available aE www,newyorkfeci.org/
mortgagemaps). In addition, community affairs
n.llii :•- ,i, r,,sv lh, fcdt7.il R r v r v r Sy^tE/ni li.ivi'
sponsored or cosponsored more than 75 events
Maletl to foreclosures since January 2007,
reaching more than 5r800 attendees including
k-ndrrh. r cmnylnrv r rfIiiniuriitv drvrktpmi'nl
specialist and policymakers.
The Federal Reserve alsois helping to address
the challenges Chat foreclosed homes present,
such as decreased home values and vacant
properties that can cEetefiorjte from neglect.
Toward thi& t*tv}r the Federal Reserve entered into
a partners hip this spring with MeighborWorks
America, a national nonprofit organisation, to
work together in identifying strategies to mitigate
the effect of foreclosures and vacant homes on
communities. In June 2OO7P the Federal Reserve
began hosting a series of forums in several cities acrnss the coon Cry to examine the effects
that tbreclosures have on neighborhoods in
]xjlh strong and weak housing markets aitd lo
!^pt\:
.
-
•
—
l«p.
I«J1
*
2000
The JiU. ^hurli wv MtUy ind tUnid Itirmigh July •, ZOW. uv
I . . . ^.'
5. Juitvbu inongagn arc ihtwibai txend ihr inaxiiinjin size of J
HmrofttiIflfi loan; ilK-y it? UpJiJlK rxirikkil ro burroivtrs\Yiihrfl£<
EtVrly MrmlR rmtll htiLDfin.
i •' <
l l . "
• '^' I • •
Baani of Governors of the Federal Reserve System
assess the t[Mili. niVdiiliilik' ED local f.oniniunilie*; to
address the consequences of foreclosures.
The Federal Reserve is committed m fostering
an environment that supports he homeownership goals of creditworthy borrowers with
appropriate consumer protection and respon'
sible lending practices. El is usingit s regulatory
and supervisory au T horit ies to help avoid future
f?rol)tpm& in montage* markets. In coordination
with other federal supervisory agencies n d the
Conference of Stole Bank Supervisors, the Federal
Reserve issued principles-based guidance on specific typesof adjustable-rate subprime mortflafles
in June 2007. The guidance b designed to help
ensure llvt borrowers who choose an adjustafoler.ite ninnrr^,b|jit» w\ s loLm ihjl lht»y can afford to
repay and can refinance wilhoul prepayment
i I O I K i i 11-:^iUti\ li• i11U-1v \>. i M -ni-i 111 N ,i11r M ii ifrrir111n l n r l K - i K C opHT.11
•-
In E>etember 20O7, ( he Board proposed new
rules under the Home Ownership and Equity
Proteclion Actt o ban unfair and deceptive mortgage tending practices. The Board received about
4,500 1 r./iirn.-iil-, i.<ii ll«- Fmij-u'-.Ll .intl l.ikint; inlti
comjderdiion ihes# commentsr issued new r u f
rn |uEy. For con^umere ^eceivinK higher-priced
mortj"agesr the final rules prohibit lenders from
extending credit withoul regard to a borrower's
ability to repay, require lenders to verify income
. IIT I .I-^H;V ihr-v rrk
LJJMHI in IMAIIIL: II ..HI-.
interest rale reset. The Federal Reserve issued
nequire lenders lo eslablish escrow accounis iw
taxes and insurance, and prohibit prepaymenl
penalties unkss certain conditions are mel. In
addition, the rules also are designed to curtail
deceptive mortgage advertising and to ensure
thiH t [nisunscr^ FLJ[ i-ivr nVMt^j^i- [Jim krturt^ .il
.1 [inir w\wn I hi' inlnrnT,itinn is likely I" IK1 mini
uwful lo them.
Finally, Ihe Board also is undertaking a broad
and rigorous review of the Truth in Lending Act,
which involves extensive consumer testing of
1,111 nthed hi \it\tH j>n^Mni |tj rt^vit'w mmumi'i
iMSM'r-io-understand tli«.l»iurE.i!» hiicmJrl help consumers beller eva l uate Ibe loans that are offered
to them and thus make more-appropriale choices
when financing their homes.
f H ' n - U K rrn .! I I M - - I I I I , I | I I I
11.nih| Ni-iim
t ' i . - rn ,-
sirtliLif jiLiitLbfict1 tjri rUjillr.idtlif]i>j\ nictrtHAftrt in
200b.
Strong uniform enforcement of Ihe consumer
prolectton regulations that govern mortgage lenders is critical TO avoid future problems in mortg^ffi markets. Together with other federal and
stale supervisory agencies, the Federal Reserve
proletiion compliance jnd impost.1 corrective or
enforcement actions, as warranted, at selecled
CTffToru iujump-Kt<irt trading in the market for jumlxi
cnnRirming kuin^i. and the CiSE-.s \I~A\C rrct'cilly laken •:•
variety of act ions lo encourage THE development ofthat
market.
The weakness in the housing market was associated with a sharp slowing in ihe growth a( hnuscholtl
riHirt^a^e ittLhi 10 an annual r4iir of !i pcrcnir in the hrsi
quarter nf .-iIHJH. dtiuu from l>' i percent in ^007 Jnd
11 '/i percent In 2006, The available indicators suggest
(hat mortgage debt likely slowed further in Ihe second
quarter.
Consumer Spending and Household Finance
The growth rate of consumer spending slowed some
in ihe tirsl half of 2(308 from its solid part1 in the second half of 2IHI7 The slmvinj; reflected a number of
restraining infl uences. The growth rate of real labur
income has stepped down subsEanliaily since last sum-
riUirl^'iK'' (li^'tctMJfL' (JocuriUMlK. CIr;trt-r .ind
i bsngf to r
pennut HKSW
'urn ctpcnliliim
I
urras labor market conditions have weakened and
as rislii" prices for food and energy have pui a sizable
7
8
Monetary Policy Reporl to Ihe Congress
July ZOOS
Consumer unlimcnt. I
real terms. In the past couple of months, par tof the
u r i i j i i on liiniM'lntli] im nines t jiusni \n i3n- ^i.i^:i.niuii
V n - : The {'iififcmiKC [kuni J J I J afr tlWMftlt JinJ C"itt1kl [hfruyft JiAc
J W K . The Ktufrr> L mi crHi> of MKhipJn 111* we n»n(hl> MMJ « m d
thrush J i»f11 mi iur> o l i n u l f 1i* Jul> ^OCnt
S O U m r*c C'ufifctrtMs Buald *>d Rfi*ct\ I nn rt\rtV flT Micfaifllt S i * .
rey* ofCo
denl In consume rs' purchasing power. Al (he same time,
household wealth has been reduced by declining values
uf Ikjlli if]uitii>% and h u u w In addition, twrriiwing
al kinks iLJ liiMim- oullays liiis ln'c LIMLC Tmm1 diflicull
asterms and standards on consumer credit have been
li^liiL'iu'il. Alihuugh [In- tax relates lhat liciu%eholds
began receiving in ihc spring an? MkrU cu%hi{>ning
these effects lo some extent ,consumers appear lo be
quite downbeat. Measures of consumer confidence,
which had dropped sharply in the second hall of Jim? ,
plungrtl fuhhi-r in Ilk1 rirsl hslfoTikis y ^ r ^ n d novv
MHIHI 3.1 cir EM'IOU" liir Itiw Irveh rcat ln"i] in tlir t h jrl\
1990s.
Real personal consumption expenditures (PCE) rose
at a modest annual rate of 1 percent In the first quarter.
The available data suggest that spending picked up in
llu1 srrcHitl f|iurlri r , ri'|M)Hi'ill\ iHrnslnl h\ ui\ nhb;]li's.
Spending on light motor vehicles was lackluster in the
lirsl half of the year, as high gasoline prices curbed
demand for sport utility vehicles and pickup trucks.
Outlays for other types of goods fell slightly in the hist
ijudrl^r IHJI appear lu liavr tunk-d bark up lit recent
months Spending on service h j \ held up well in recent
quarters.
Following a sharp deceleration in the second half
of last year, real labor income has been flat so far this
year, as numinnl wage gains have IHTH emded by rising
muMiEitrr |]rice\. .V LT..IJ^L l«mrl\ t'Lirniiif's. A mvasinv
of wages for production or nonsupervisory workers,
roseat the same rale as the PCE price index in the live
months through May: thus, wages were unchanged in
In real wages was likely alleviated temporarily by the
tax rebates tha t were paid out In May and June. As a
result of theserelates,gmwih in real disposable personal income (DPI)—that is. afirr ia\ income adjusted
for in Hal ion—which was subpar in Ihc fourth quarter of
2007 and ihe firsl quarter of 2008. likely jumped in ihe
second quarter. Despite an increase in transfers reflecting [tie recently passed extension o f unemployment
iiiMii.irn i- liTTii-liis. real DPI is liki'ly lei fall 1ML k in ihf
third quarter asthe disbursement ofrebates slows con
siderably.
After several years of providing an impetus lo spend
ing. household wealth has been a negative Influence
thi% year. Cluiigrs in ImuM-liold nd \untU ii'iiil lo inrln
ITH v i nriMirin'c v|>i• n-iti• i• ^ innM Eicas i h u\n
,i [HTIIK]
of a year or two. Accordingl y, the drop last year in the
ratio of household net worth relative to income probably weighed on consumption outlays in the tirst half
ot2008. Moreover. Ihis year's din lines in residential
real estate values and in equity prires have exacerbated
the situation. Flagging wealth has likely left households less inclined to raise their spending at a rate t hat
exceeds Income growth, and the personal saving rate
has flatteited otit over the past few quarters. In May, the
saving rale jumped to 5 percent, as the immediate effect
of tax rebates in many households was lo boost savings.
Overall household debt increased al an annual rale of
HIFHHII '.\ui JHT-C i-Fil in l l w tirM quarter (tf 'HHVA. a iHiL,iL!r
cle< eli'Mttmi Ironi the U' i \H-U t-nt .id\,ii« *• m 2007
Household debt appears to have slowed further in the
TV i l i U n qiurteily utd nlcnJ Itwnifh 2W»OI The
nr rj(x> n the tMm nf bm«facild nd vntlk •»
i
^
Rcxr* Dcwd. fim of Funtk
59
Board of Governors of the Federal Reserve System
9
first halt of this year but by less Ihim short-term markei
interest rales.
t)viTjll rreilit {jitnlily DF ronsnnirr ]UAT\S WAS ilflcrkirated soiiie^'luii in rcctnt ciuiriilis. D{LlLiH|UEbni:y rates {in
O0QBIBW hiaiix at roiiuiienial banks ami cu\ii\ ve Juki
finance companies rose in ihe lirst quarter but stayed
within the range experienced over ihe past I D years.
Although household bankruptcy tilings remained
low relative to (he levels seen before the changes in
bankruptcy law implemented in late 2005. the bankruplty rate rose modestly in the tirsl few munltis of
20O8.
Srcoiuhirv 1 [iiark[ L t i\Ma Mif^esi ilun Funding for
r n ' i l i t ["arc! LIIIIE iiuici Etians l u s tici'ii -A i-l I Mi.iiiii.iiiiii:
in recent MONTHS. Notably, issuance of asset -backed
securities (ABS) tied LO credit card loans and auto loans
has remained robust despite spreads of yields on these
securllies over comparable-malurity swap rales Ihat
continue to be near historically high levels. In contrast,
pressures in secondary markets for sludent loan ABS
second i|n,]il«i. ]ic(.LUM' ihcgmwlhol I M-hciliIdetM
have reportedly afreeted I heavaiIdhiIiiy «fsuth credit
was slightly less than thegrowth in nominal DPI in the
The rcuuhnrsenient funuuEa For government-guarantffld
rirsl quarter and Interest rales on mortgage and consumMudei^E Iciaiu did not adequately compensate lenders
erdehl ili'cliiifi.i ;i bit, rln- ratio nt financial • ^l • I i•;. • i i• • • • -^ Ffir liie higtiiT luiidiu^ ecjsi in wKLiriii/jniiiu nurki'Ls,
and issuance of guaranteed sludent loan ABS dropped
lo DPI us k. d town.
sharply early En 2G0&. Legislation enacted in May gave
Consumer (nonmorlgagc) dcbl expanded al an annudie Department of FduraMon ;md the Treasury (he
al ralu ol S-^ percent in the first quarter, aboul the same
pace as in 2007. Lurtsumrr drlit ^niwili tn-ld up ilt^piU'
• : i l l . i : i M1-. i i ; provide \ ! m : l •: -1 -1. 11 • 11! i • 11:'-. Hi i;r I: '< ;| n n •.
j
a n f)t>f(wl [[^lUiiilngof lending terms and standards at
l l u t leiul to MutlfiLls. ;IJL[! L iv;iiljl)iLlv t i l slndent loans
banks. In pan, this pattern may reflect some subslituappears lo have improved. However, concerns persist
Mon away from mortgage credit. Also, interest rales on
.: bo ut access to loans by students at community and
aulo loans and! on crcdil cards generally declined in the
career colleges, as these loans tend to be less pro.1liable
Nan:
TTK dau arc qujrwtly and tuieiid lh
:tKJS:(j; »the avenyc Tor ^jwil KHJ MH)
SoUKK tltiunnwriL nf L'tMnmtftt. UtiFL'j
h 20O8:Q2; Hie reading for
for lenders.
Household financial obJigaiions rjiio, 1
NOT
IlitihU art LJILJFKTIJ Jisrf*\lflkl ihronjiJi ~<MK:OI. Th
• >hli;._i• • •_• i-- i.ili>• »'i|i .1!
1
:iHM
111. --.1:1- • • I [L~L|LJhrcL] p j \ i r k : n l i • > 1 • 1.1<>iI-.•.:^>
Lmnci'-. iniiirjrt. *, and (Kiificfly Lu^i, jll nEiiulod by dufuiubli
income.
SiHUi. J«L-rjl JlfwM ttuufJ.
• 11
Mi." 11.iv.1 ;ITL-
L|Li.irlLT;V j n d
L'^k"iiJ LJIILHJ|
h • IK*- rvriAii! ii1'kun> 50 dj>-> ornwre pani di>
200b
L0
Monetary Fottcy Report us the Congress
July 2DOH
rale tjF J 1 * percent in the firs tquarter after a smaller
The Business Sector
c11"c 3iin.• i n I]11' previ^TLis i | U i i r d T . I h r ^i•--_i11 • 1111•= - :i:>.I:• .11-.•: .
Fixed Investment
Mij^:;i^t (finii 1-4ipit.1I s|K-iiL]iiij; nn rtjuiipmr-ii A\H\ \uh
After having posted rubust gains in the niulili*' oftasi
year, real business fixed investment lost some steam in
the fourth quarter and eked out only a small advance in
the first quarter of 2008. Economic and financial conditions Ihat influence capital spending deteriorated appreciably late last year and early this year: Business sales
<iiuwed, E'mpmalr pmlils fell, ami cnnlil roiuliliuTis Fur
\-mn- Ij-cinowers lighiened. Jn jddiiinn. Ihp brightened
concern about the- economic outlook may have caused
some firms to postpone or abandon plans for capital
expansion thisyear.
Real business outlays for equipment and software
iverr ll :LI in I In1 lirM quarter {*rm\lh in rrjil ^|Hhiuliii^ on
highlech equipment and software slowed to an annual
rale of about 10 percent, down from the 13 percent pace
recorded in 2007. in addition, business spending on
motor vehicles tumbled. Inv estment in Equipment other
than high tec h and transportation dropped at an annual
ware felt In the second quarter: Business purchases of
new motor vehicles reportedly slipped again; shipments
of nondefense capital goods (adjusted to exclude both
iraTisjKjrlaliuTi lirnis nm\ gtmds thai wrre M-III abroad)
were IciviiT. cin J V I T I ^ I 1 , iit April .ITHJ Mnv ih^n in [fir
first quaner; and the lone of recent surveys of business
conditions remained downbeat.
Nanresidenllal construction activity, which exhibited
considerable vigor in ZOOtiand 2007. slowed appreciably in the lira quarter of 2008. Real oullays Tor
111 • •.-. i • • r i: 111 • • i •= i. 11 l:iiiMni!'N i l i i Inn il -11.11 |iK in ihe ". i -'
quarter, and increases in oullays for most other types of
Lwildirit* MC|)]N-(| dnw n Morr-recenl <lala on construction Expenditures suggest that spending on nonrestdential struct ures may have bounced back in Ilie second
L|LJiiriLT Hciive'irr, di'tiTinrtKiti!1 ecom>mir anil tlnanrial
conditions indicate t hat this rebound may be shortlived. In addition to the weakening of business sales
and proIlls, vacancy rales turned up in the lirsl quarter
(the latest available data). Moreover, the financing
i-iw iTnriiiu"ii[ lias r p i n a i n e d c l i f t i r u l i : l i a n k l r m l i n g t*i\\
in real business fixed UWMtuawa, 2002-0
cers have reported a significant lightening of terms and
standards for commercial real estate- loans, and funding
llirnugh (hi* commercial cnuriL^jge lurked M-^U lilies
(CMBS) market has continued t OBE extremely limited.
Despite sluggish rural sales. Inventories declined again
in the first quarter of 2008 as firms acted promptly to
Change in real business inventories, 2002-0
._. I lifh.iM-hft|mpmrn(1tad M^UT,
JUJI
I_J
I
I
I
I
I
I
I_J
~upcr Hish-Cfch cV"TimCTd ffMrv^ 1
S m i H i . Drpor&ncnl of-t'cfnmnvr. Ehire-Mi-or
DcpMtmrni of t'oflweferr Buna -rf ho
61
Bikini of (JmvrnuFi of flit' Fttffnil Rt'.vm- System 11
prevent invE'iniiry inihuLinn^ from arising, Antnmakery which ti-id worked to bring days' supply down (o a
sustainable level lasl year, have moved aggressively to
keep product ion aligned with demand in recent quarters. Excluding motor vehicles, real inventory Irtveslmenl fell in dtp fourth quarter of 2007 to iis hmesi
Ivvel in KVCnl years and then InmEii negative in ihc
first quarter of this year. According lo the limited available, data, nonaulo businesses continued lo liquidate
real inventories early in the second quarter. Business
surveys suggest thai companies are generally comfortable wilb llieir (lirircil Mm k levels. Xuriellu'less. .i few
industries, most notably those pirnlm in^ 1 UIKIMK InIM
supplies, are showing some tVfthttOt of inventory
overhangs.
S a pcrccnl af scclur gross domestic prwlutt, I
i
f h 2DW:QI. CnHlc*
U M * l | ' i *)| ^ M v
Corporate Profits and Business Finance
[7iu iM' Economic Aiuryti*.
The sluggish pace of business inveslmenl in recent
months is (IIJL1 In part to ilu* ^^ E-Lik-L-EiLn^ of domestic
protitnhilllv mid the l i j j n n crnJLi conditions I ••• i-ii
In ^iiNLe Inisinrssc, tn t\v lijsi CJLJ:JI-|L^E M( MttK. im.il
economic prortls Tor all U,S, corporations were down
slighlly from their level four quarters earlier; a nearly
20 percent rise in receipts from foreign subsidiaries was
nci| Miliificni in ullu't A Vh. percent fall in dcirnesiic:jlly
generated profits. Although profits as a share of output
in the nonlinanrial corporate sector have declined in
recent quarters, they remain well above previous cyclical lows. For companies in the S&P 500, operating
earnings per share fell 17 percent over the year ending
ici the : i i -. i I|IL-.HUI. This dibtnline was i : ilun dfTOLini •
ed for by plummeting earnings M financial linns, whirh
reported large wrile-downs on leveraged loans and
mortgage-related assels.n For nonttnancial firms in the
S&P 500, earnings rose nearly IL percent over the four
quarters ending in the first quarter of 2008; energySBCtOf lim;s \\w\\ J Mmng 31 prrri'iu increase in eaming, whereas earnings at nther ncritinanrial firnjs rest1
Alh percenh
Although credit has remained available to the business sector, yields on corporate bonds Increased significantly over the h'rst half of ihe year, and banks reported
11;•,!• ii-i terms .iml sunidcircK on rommerrlal and iuduv
trial loan^ and cm commercial real estate loans. All ut!d.
[he growth rate of the debt of nonlinanrial businesses
fell from \\V\ percent in 2007 to 914 percent In me firsl
quarter of 2008: the available data point lo a further
deceleration in the second quarter of this year
On balance, the composition of borrowing by nonfinancial businesses has shifted this year toward longerniiUmiK debt. Net bond issuance by iitinfniaitcial firms
has been strong. Speculative-grade issuance, which
droppetl sharply lale last year and was practically nil
in ihe first quarter, rebounded markedly in the second
quarter while investment-grade issuance has continued
to be robust. Spreads between yields on investment:iiii speculative ^j.nir fminK iind diose on I'oiurjarjhle
maturity Treasury securitJE's c:limbed in January and
then surged in March, After narrowing in April and
i:\.\iti LLHUfWDcnls i>f rwi liii:Ltti:in^ (or rnji)t1njn*.Li
orate businesses, 2O03-Q&
an]
6. A u i i UTilF-tluwm anJ capital lossri arr ^rmnil ly vtcv I Jtlttt
fmni ihrcjiculallon nf «-£HiLHiik |»r»MMju1 arr me luclril ;LS JII
rxppfiv In Ibr op*TiilInppanilng\ jxv sturruflnuitrl.il lirnm
ion
Si HI The ilatD i i f I
The dH* fPF 2(KH Q 3 o
nmp^ncnb t\<cnpt bond* m
f Ikidftl, rlirtujf fundi lina
\'l
Monetary Polity Report lo the Congress
July 2008
May. band spreads jumped again In la te June. Ou island
III '. i iMinin M i,U |)Li]Hhr (I'H fur ucuitithinujl firms hus
bwn Illllr rliHiigpri, on nrl. this year. YiMck mi n-cinh
nancial CP have moved down si nce Ihr ginning of
the year, roughly In line with other short-term interest
rales, although spreads between yields an lower-rated
nirid lii^fn'r inwt\ rnuiiiihnir i;d CP remain \w\\ ,ilimi- IIM1
leveh fnrrv.i ii i ii L; fie En re thi" imsel of I lit1 liiiiuirijl cljfficulties last summer.
Commercial and industrial (C&l) loans at banks
expanded briskly in the lirst quarter and then slowed
markedly In Ihe second quarter. In the Senior l oan OffiC B O p i n i u i i S u r v e y i.ik'-n i n I n.ii.: r i . m l A p r i l , • •:•!
Components o f net equity IssoaftCt, 2<nu 08
•
•
I
PuHi
Private- iiauante
KrputvhiLiC*
— Trtal
s k l e n i h L V lie I h ; H l i ( n i ^ <tf I w r i k s r e p o r t e d iluic i h e y h a i J
tightened credit standards and boosted spreads on C&l
loans. According to the respondent banks, the move
to a more stringent lending posture mainly reflected a
iwe
less favorable i n n m r r u i u I.-EKtin rt ruininii iI-LIIUKIK H.-.I
EICTII hiiVuuK were v h l . .•Ifuii at a distouTil.
i,T»\\ {fjitily isMjaiHT hy iitintin,inrial firms [tippi-rE
in I
lirsf (|Liiirter and rehounded in the second quarter.
A '. i i : r 11 i "-.-•: I i r 11 - in * -11. i r * • repurth^si^ LI I I-LI rash nuTfji 1 ^
Nel percentage ofdomestic batiks lightening
ami intr^jsing jiprva^Js t>n t^rrtrncrvinl nrrd iTuInMri
k w u U) Urge and iiU'tiium-jii/t'J bOBKHWl. 1992
y relired through
f'jikh imeMnl by prwiit equity
Ki proceeds.
i: Etianl. |lnw i»r lumJ* Jad
• i nx!in i l l (nlciiirn i- Utr risk; J *-. i • M i j j • • .ml tr.n l i m i , i k i i
noled concerns about Ihe capital position of their own
bank as a reason for lightening standards. The secondary market for syndicated leveraged loans remained
relatively weak, but loans associated with some promi-
C- h i u
urkein and e
led to a notable reduction of net equity retirement in the
lirsl I|I ..iii-i
Jin 1 rrrclil (|Uii!iu cif rnjiiliiLiiLL iiil uirjKirtilifJiiN f;en
cr.illv h*\s ri• 111.i irii--iI M'llid I he M \ iLimtlii ir;ii]ing \xnw\
default rate was very low despite a small lick up in
June. Thr [JHmqiu'iuy rale mi (.!JtI \n$n\ .H criniiTien M I
banks continued Ihe mild increase that began last year.
but it remained subdued by historical standards. RatIngs downgrades in the iirsl five months of this year
were niodral. only sliglitly exceeding upgrades. Balance
slice! ItijuidJiy ai i m n f i i u T i r i a l f u r p i i r d t i o i i s remained
IK-Nuill rUDOa nulMamtinjj t'nrptfralt- boiul^, 1992-2008
I - M -
!••:••
Null I he d j l j JJT iliswn Tnjvti J MJhi^v lifrwr.illv LmidLiLEcd II"HLI Ermcr
per yoa-r (he last obHnotion n froni IIILL Apnl 3O0R B H Q . mliiLli ( o w n
24MIK (Jl. \ r t pfrvenlJ|K i*tfwiw-tmlnpc ufhaiih^ TVf*.irtiJij 3 h^litcriinji. (i(
ilambnli at V taOBH In v f « j J \ I fin Ihr pcatnUfT nrfunint Jn cnMf. nt
1 d t f r t w . SpmdA j r t i m u i n h l 1* the hun raw l t u ihe haul t L « I ul
Tunih. The JcfiniUnn Tor firm FVC wfigeslcd For. l t d ijOKnlL> used hy,
limey nry^iiHkiili 11 [haE Ltffr ami n^iliuni-ii^fd llnrs hj1. c jnimj.1 u k i nl
SS mlti
lt
i DosnlL Scnkv Ixun (Mikfr
Sun'ey c
S" 'ii lbc dnEn arc
Itufli nuiih if ihe f
of farads true de-fjullAl in Ihr ftb imHiltn
..:iiln ,: MI inn I-IN••-•• I-.
-j by 2 lo
-1.1I --.- Ihe ik-i •••!:. and 1hcn
dniii,:Ll by Uw [We VJ
bnoj\ HHUIMJUJIIT^ al I ho *m] oM Ik: vak-ndji
ijiiirm MtiriwdiJieK pr^tili n u lhf -^
Snoa Mhvdy'h ln\ o l n n Serv
63
Bonn! of Governors of (he Federal Reserve System
uency rales on eommureia] real
of 10-year irt^ L^lftUill-^
i; -Kn;t in! s w u n i i o « n ; r
by securiiics rating, I947-2UO3
— ID
J ~ \
— 1.400
—
SO
—
«0
— -BO
—
job
I I
2000
I99J I W i IWfc
2000 ZM »0* 300* 30*
c an*forn w m m i l b o t i m l hfc •
HI nlcul iWwqk J^tKH.^I. Ik JJLI Fat
Klcd ^uvunUn KAJHSt we mmnMj wd ctmd ibiniffc f
fa
I I J A J ntl< ' M IIS arr ibr pfii
2Q0&. The d
V PQl
i 34 0
Th
f
p
K ibe- pawn aT koiu W y
in;ranot mftpig MfRil
S O I M I : For H H I I M L I I I bootiv Faknl KIUIKUI
t.uoviAn <IHEK'II, T rntrlhianl Rcfufli ul I'tifelrUafi dUI I
V fdf llfc
2003
widening of spreads reported! v TPtloclo
concerns regarding standards ftir
nrKifruTitingcommer-
^Lil ninrt^i^r% ov(T llir pasi Fi^i' vf-irs and likely a\vt
III\L-stms' M j r i n f U o f MnicCun^l liiurni' PFUKILULES murr
generally. After hitting a record level in early 2007.
Issuance o f C M B S dropped sharply late lasl year and
slowed id a trickle so far t his year
The Government Sector
Federal Government
1
Jii^h ihrciujih Uit> lirst t|ujrlt'r uf2U(IS r .mil li-\i riifif
The deficit in ihe federal unified budget has widened
slaved very low.
during Ihe current fiscal year after having narrowed in
In the April 2008 Senior Loan Officer Opinion
Survey, a large frarlion of hanks reported having iighli-jinl crc-flJl s-EiiiLd.iiL!> U I I A iiiiinien i.il rral rcMlr ln.ins
1
ihe preceding few years. A substantial p o r i i o U ofihe
rebates authorized by the Economic Stimulus Act o f
2008 was distributed in M a y and June, which caused
Drliru|uency rales cin cummcTtia! rral I'MJCI luan\ tur
a significant widening o f the deficil. In addition, the
construction and land dewlopnienl projects extended
growth o f receipts has slowed in response l a the weaker
by commercial banks moved sharply higher in the first
pace o f Economic activity, anil ihegrowth of ouihv s
quarter o f 2008 aflef rising noliceably lasl year. In
has stepped up. Over the first nine months o f fiscal year
ronlravt. clrlin[|urnr>' rates cm lumk loans llial finance
20O8—from October through June—(he unified budget
gcon
recorded a deficil lhal was S M S billion grealer lhan dur-
m i e r c iaE properties moved up only slightly.
Delinquency rates on commercial niorlgages held by
ing the comparable period ending in June 2007 - When
life insurance companies and t hose in C M B S pools,
measured relative lo nominal CJDF. the deficit mo v ed up
which mcislly linamc enisling tonnnrrcLil properties,
from I'/i percent in liscal 2007 to 2l k percent during
ri-mained low.
Despite the generally solid performance of com-
the 12 months ending in June 2008: a continued slow
pace of economic activity and additional revenue losses
mercial mortgages in socurlESzed pools, spreads o f
associated wilh the Stimulus Act are expected |o widen
yields on C M B S over comparable-maturily swap rales
ihe detitil further in the final three months of Jiscal
soared to unprecedented levels early in 200R. In retenl
2008.
T E i l l i s . these spreads haw narrowed somewhat, hut
ihey remain well above levels seen before this year. The
The Economic Stimulus Act is estimated to result in
about $1 15 billion o f rebates being seni lo households
64
14
Monetary Policy Report to the Congress
July ZOOS
C'hangc in real pjvemmcnl expenditures
on consum^lton amd inveslmeBtt 2OW -O8
Federal receipts and tttpendilfflM,
• fafcnl
• Sukud
KM
Noit
f
_1
J
|
L_
fod-tadlprt
, I f d r J U vt \ ir<*iintitf •\hjJ>'-iv
proAtci {HDP} ki fH Ibe fvtii ipurtrr> tfklmtf m V* I nf ;rjm. rcrapt
nprnklim-vr kxihc I ' nxoih^ ndmp m Anc i-~l (JDPntfu wc
1007:01 * * l * m . Q l
S U L U I : Office of
in 2003 and 2009. The rebates began lo bo distributed
In t he last Tew days of April, and by the end or June,
approximately 580 billion worth of rebates had been
disbursed, accounting for more lhan half of [ he widening of Ihe budge! d e f t * In the lirsl nine monlhs of fiscal
2008 rdattve lo die same period in fiscal 2007.
Ilii- slower ( H H ' uf {^oiiumic diliviiy IMS nil intu
receipts. Excluding the budgetary effects ofstimulus
rebates, federal revenues in the first nine months
of fiscal 2008 were only 2 percent higher lhan in the
same period in fiscal 20(17. down from a riseof
6^i percent in lineal 2(XJ7 and cansldtrablv smaller
UIHIEI [lir clnublc fli^il ji^itis n-ccirdnl in lisral Z005 and
fiscal ZOOS. The slowdown in federal revenues has been
most pronounced for corporate receipts, reflecting the
decline in corporate profits since Ihe middle or 2007.
Individual Income and payroll lax receipls—excluding
the stimulus rehale.salso haw slowed, likel; lii'iwse
»f [In1 MiMlhbr guin% in fwrMjujI inrnnic1 during thr rurren! fiscal year.
Nominal federal outlays in the first nine months
of fiscal 2008 were 6tt percent above their level in
the comparable period in fiscal 20D7. a faster pace of
increase than was recunJiii in ti«al 'HK17 bul geiwtally
Ik'hm Die rapid increases seen in fiscal 2002 through
2006. So far this fiscal year, thegrowth of outlays for
defense has stepped up ?elalive to llscal 2006 and 2007.
and spending has continued to rise apace In mosl major
iKHidcfi'iisf tLai^ories. Inllienmnllisahfad r oullass
will In1 tiunijH'd up furtlitT by the i viiiismn cif i-ligihil
in hu iMiiLni|)lr^ nii.-iii iij-Miiiiurr iH'iii'tiis Lti indn idiuK
who have exhauslei! their benefits.
As measured in Ihc national income and product
accounts (NIPA), real federal expenditures on consumplion and gross Investment— the pan of federal spending
lhat is a direct componenl of GDP—increased at an
annual rale ofi% percent In Ihe first quarter, a contribution of 0.3 percentage point to real GDP growth. Real
i l c l V n w v|K-ii(1iiii; ,14 r n i n i L r d Un ahiuiM I ho m i n i 1 r i s r .
.r. !•• • 111 r^ -11 - r i •-. i - null.i 1 . ^ MIII', i -11 - -J -= i uy. t n iin- M ' • • i • • I
4) 11 LLI NT. (li-irllNI 1 ^iHTlilllI 1 ! .l[i|n\;r - Til ill 1 -1 |;: I-'-.I ii
another sizable increase, and given currently enacted
appropriations, it is likely to rise further In coming
quarters.
al Borrowing
Federal debt rose at an annual rate of 714 percent in the
first two quarters of fiscal year 2008—from October
llmiugh Marc h—a notable step-up from the Wt pcrcenl
pace in fiscal 2007. As of Ihe end of March, the ralio
of federal debt held by Ihc public lo nominal GDP
was about 37 ptrcenl, slightly higher lhan in recent
years.
The deterioration in Ihe budget position of the federal guvcnimeiit k-d thr Treasury lo rrinirwiutr ihr oneyear Treasury bill, which was last issued in 2001, I The
initial auction on June 3 was very well received, wilh a
bid-locover ratio above 3. Issuance also increased for
both shorter- and longer-maturity Treasury securities.
I he proportion of nominal coupon securities purchased
at Treasury aurlions by foreign investors changed l i t t
Board of Governors of(tic Fntentt Reserve System
15
SEatt and li>ca! iio^-inmcni net savin];. I*JHN ^HhN
rvi, :
_
-
J.
imp
—
Ki
r
H.II:
»
I
\
-
/
\
/
r
v—- •
— 50
— 23
M
—
I
l
l
i
i
1
i
ion
14U
1
I4H
1
1 1
300S
I •"••HI
• • : • •
:
-
.
i
:
l
I
.•
.
1
1'rt.i
l-^i.
l'^w
3H2
?IN-5
JI/I.N
K<PII: T V i l l , khit'-il j f r Hfu^UiHy. n(r Lift • rulmtul iiKiinkf arid |Krak>.1
Horn: TIK tlita c^ntd Umnifh 30OK:QI. TtacdiU fm A N Ihrmiffa HW7
.•-• 1f • H 1
f 111
l foEn
l h
l
A
l
I K M\ [l|
H.I«'|Jri= h i i.n .n Jii .nil ,ILII r.r.1 ihi- 11 ,i 11 nl• . T . . . , I I -.I I . I L I . • ,-*.t
,•1 i , | p ? i i r..r
:\*n\f
i-rti > >r : m
fcQl»«Kl iK- ..
jhcdu ill" E^OfluttlH: AlUJyui
.
jnrmj.1 n k I\LIUJOI M M nLiir* Iwld J\ iniL-^l MK. :II-- ,.: k-.tr.il | m
h\|lUP|t
s. ,• .-. , 1 LJcrul fa• ' - . • i • , . : BuoftL Ikiw ul" fm*!-• I'JI.L
t ) n ihe uniEays sitle o f i he aecouuEv.
nominal spend-
j n ^ hd1! l o n l i n i j e t l tit rL%f. pnriiruiarlv for t"X|M• II• II:•:I:—
on health care and energy items. In real terms, expenditures on consumption and grass investment by slate and
local gavenimE'nls (as measures] in the NIPA) rose only
.L II-JI in llir MM quarter, JS ini"reu%fs in ibx[Mbi]dlEunis {in
years. However, holdings o f Treasury securities by
h
iiinr L-iu;ii nplVi.il iiisiiinri[iris nil i31 •• I - E -• I • • i. • L l < r v n \ r I L.tnk tuin-ni {ip^fiiliuiis werr largely «fFv [ [jy A tin line in
outlays on structures. However construcMon expendiof New York increased! more rapidly in the first half of
ltures fire voEniite from quarter |o fuiarUT, and ihe dai<i
2008 than over any nf ibr previous three1 ypafs.
over the first half of 2008 ami remains in the rang? of
10 perreiH lc> ^ 5 pprrcnl cp|}\ervpd itvpr l l i r pasl %rvrral
if
i;'l: M.LV ••ni;".rs[ EIL.IE rt\L] ^.e.iiL- .iiu! UH .it
\-\\M-\I
d i l u t e s f u r Mrut tur e s picked up in Ihe second quarter.
State and Local Government
Mi.-.invJiili-. state j n d lu< ,il MiiiiiL- remained elevated
through June.
The fiscal positions of slate and local government
began to weaken lns( year and have <qn[inned io drieritiran1 in 200R. Afitir having Improved si(iiiLji('anLlv
from Z0U3 to 2006. net saving by tlie sector—which is
broadly similar to the surplus in an operating budget—
turned slightly negative in 2007. and this measure
moved further inio negative territory in ihe firsl quarter
tif200S. Tlic clek'rinrjuifiii in hucl^el r^uiclilidiis \*a\
(HirujTfd its iiHTi'Jirf's in ri'Vfnufs Unw s\u\vn\ while
nominal expenditures have risen 31 a brisk pace. The
slnudfpu II in slate tnoBBt En m i n i m i b n Kdknnd i
pallem similar to ihe one lhal hasenitTged al Ihe federal
If.vel. Cnrpnralereceip|%have rli-c linrcl. .mil iln- rise in
individual income taxes hiis lHjt(niic niun- SLIIHIUIKI. A I
ihe same time, state receipts from sales taxes haw softened markedEyr At the local level, the decline in house
prices has nut yel liegun 10 rtirh local properly tax revi-mn-s..11• |ici--: i;ilih.
ln.il im iLL;IM-S in Leu .il iL-Li-ijn^ IHJIH
ihis s(hLirc:p u>fhii^ liki-lv t u slow more Eioiirrahiy in the
nexi few years.
State and Local Government Borrowing
Bond I ^siu ntru by stale and local governments slow ed
moderately in the first quanor of 2008 as the cost of
borrowing rose. Investors demanded higher returns, in
pan Ixrause of concerns ahoyI the strength of linancial
gliiiranlors iluii Insure many ]iiniiiri|uil Ivinds iuid in
pjn IM^-HJSI.1 [if tuncems aboul ihe effect ufd poienlial
economic slowdown on state and EocaE government revenues/ Beginning in February, these investor appreheu-
7. Cnm-rrih jtwul lltr (iniucijl^ujMiNurhiuuM- in £007, but
t^Piiinunl tU/v,HflratPCN did nun utrur uitlll roth ibii-yriu. In Juor.
Moody ' i iihJ Si Jlhldl d A P « f 's JewTiftfakil M HI A and Arlilmc. IWJ
oTihr- \vf?"4 fjfavM\ii.H\ frwn AAA lo AA <* lowtr. Ni-*i- IXMHI lutur
:• ik< c- liuiiih'\i Iu'. ish:inil en HM.1
mii etui .ift' t | r w « t « rljLiih-Jally
• M t f K , Jnd U N niunlcJpialirin luvi' staU>d ttirkr inlrnlicMi lc» dJ%p H H V t t f p W H I D a a d k n t l l l lhL'Mn.'nj^Lh nl'Ihciruwn ralirRS.
66
Monetary Policy Report lo I lie Congress
July 2008
sionsalso led lo widespread failures of rate-resetting
auctions for andion rale securities (ARS) issued by
stale and local governments.* Pressures In the- municipal securities market eased somewhat In the second
ijii-Hin. ciIci-rI,L» with the broader relaxation ul linaiii i.t!
market slrains. [n addition, ratings upgrades ofmunicipalilies greatly exceeded downgrades in the second
quarter. Since March, municipal bond Issuance has
rebounded, and a significant Traction uf Tailing ARS
issues have IJHMI paid down with the proceeds of stani hi 11 ITOEUI I-AIH-1.
widened, the fiscal positions of slale and local government deleriorated. and business saving decreased.
Accordingly, lotal national saving as a share of nominal
GDP. which has been declining, on balance, since the
Luc 11IEHK. \KKI l,ilkn HI LI hi slum Imv NIELLI L Iruni iluh
third quarter of2005. whic h was marked by sizable
hurricane-re lated property losses). Ifnol reversed over
the longer run, persistent low levels of saving will be
associated wllli either slower capilal formation or i t m
liiim'd heavy borrowing from abroad, either of n h i i l i
would n-IunI [hi1 rise in (luh Miiinl^rtl of livini* ri( U.S.
residents over ijiTie and |urn|H'r the iibilify of llir IUUEIII
to m e e l t Ihe retirement needs of its aging population.
National Saving
Total nel national saving—lhat is, the saving of households, businesses, and governineitls excluding depreciation charges—dipped below zero in the tireI quarter of
2008. After having stood al an already low rate (if I S
The External Sector
IIL-ii • -111 cif nominal ( i D P in lite si"f mid quarter of 2007 r
Foreign demand has continued lo BE an important
source of strength for the U.S. economy. Net exports
contributed % percentage point lo Ihe growth of real
GDP in the first quarter of 2008 after adding a similar
amount to grmvlh in 2007- H ie growth of real exports
cif ^EHHIM and services I'KpanEk^l at a. 5'.^ [irnnit fjace in
the lirsi quarter, mmleraling from the Wh percent surge
\n rudc-d in ilit1 second linill oi 2M>t \L\port growth
in the lir\t {jiiartiT was su|][iorlrd li> higher r^jKirls ol
agricultural products, consumer goods, industrial sup
plies, and services. In contrast, exports of both aircraft
and automobiles moved down after rising rapidly In
the second half oF £007, Exports to Europe and Latin
America rose robustly (in current dollars), whik
the national saving rale declined steadily over the
subsequent three quarters, as the federal budget deficit
K ARS i i c Sodg-lrnn sccurii I t * whu^c i m i t r M Mir^dn- cni'i
11
.1 • i- _• • I. •• I -. •! 11: al-ili --• .i M i MU i-.. tvpiral ly t v r t y 7, 28, Err
3S davs. Asuriht'fndof 2W7. ihosi/t uClhe ARSinsTkri In tin1
Liiltrtl Suli's was about 1330 bJllluii. iboul half orwltldi was
afiTHinMtl furtiy muniiipd] rtTWttW AnHJ^HTItfWI hiK wtlrrt
i in rMnri (h i nol tiiii fnrlltr rnlin- iBWM an iirirmC nEE-Irtiiw 1 hicnnlriH'4 imxLnmni. t IH^EI durlirxi rjitLirr. lhci3%Mil h(Mnrr\ircni
brf«rc llx1 aurLinn rMa I n nwwrcHiKif ihe Mfurlrt^^nd rerrlvr ji
lii^ hnirmi rai*1-. whJrh K usually, lnn JMH net f^.trik.
l Lu the maximum hW nlr.
Net anna,
I,H M|. f^^ ^•'.Ili-
— t
r.
— J
i
..I
•
/
\
— i
h
1 1 1 1 1 1 1 1 i i I i i i i i 1 1 1 1 1 4I
\t**
|W2
I1N6
2000
'
iiv 4m) f^trnj Ihn Hjfh 2D0H;Ol Nc
Miliri|f i l lht MilTI i\ (VfuMUl dlhl ftt[ hrHftft* >J vm^t n ..i i ii - i : . : jvtmt of
stibe ind hx-il gDvcmirKfiCv
S"r F. i |lfI»r1irwiilLi1-[[H
International Trade
(."haniio in ri]al imports and*]X|wrts ofuoods arnl MC
2(KI0 -0S
• Import*
• ' •i- i
V LfliJJj
— 1
III
67
Board ofGovernor* ofthe Perietal Reserve System 17
U.S. trade and cuirvni j
balances. 2000 08
exports lo Canada and to OPEC countries fell back.
Data KM April and May suggest thai Exports continued
(u expand in thf srtomi ijudrtrr. wilhexpuris uf indus
trial supplies showing particular STRENGT
The positive cortlribution of ncl exports in thr first
quarter reflected. in part, a ¥i percent decline in real
Imports of goods and services. Imports of automotive
products and consumer goods fell in line with slowing
U.S. domestic demand, more than offsetting higher real
imparts of ail and a slight Increase in imports of capital
goods. Imports from China ami Modes declined (in
< 11r i • m i|n!|.![M ivInTt'as iinjHirls from { JIIHKI.I, |,i|) HI
.•ml OPI-T rciururies r\|i.iTidEiiJ. After t.ilim^ ^fLbr[]^
Prices of oil and nuntuc! commmitlics, 2
in Man:h, imports relHiiintliil. on avsragK, in April and
\hi\, A\ i[]t|Hirls n\ ( a|nLil ritnifirnrnt iirnl I'DIIMI itn-r
goods increased strongly.
In the first quarter of 2008, the U.S. current account
deficit was S706 billion at an annual rate, or 5 percent
or GDP, $25 billion narrower titan its level in 2iW\
the narrowing largely reflects higher net investment
tin fHiic. A targe iniprn^Tinriii in ilie IHJIMHI iMcle clelicit
wasoffset by a sharp increase in the bill for imported
oil, which resulted from Ihe jump in oil prices.
Compared with 2007, prices for imports of both
m.iti'ii.il inti'rm^E' ,ind iini^lx d IMMH^ .IrH• \m rfM\in» nr
nun ii foster I,IN-S sti t,\t Ilii% ycjr. Alltiougii impcin priri 1
increases also reflect the depreciation of the dollar, rising commodity prices (discussed in more detail in Ihe
box entitled "Comnuxlilv Prices' mi p i " r IB] have sij>
nilirantly Ixiostetf the- rale of inipiirl pric e inllation. In
the NtNL IJIMTIIT. prices of ini|Hirtecl guods r.\( lmlin» nil
a nd natural gas r u v at an annual tale of about Ti percent, a pace more than twice that of the previous year.
Available data suggest that Import price inflation was
sharply higher in Ihe second quarter.
The Financial Account
In late 2007 and the first quarter of 2008, Ihe U.S. current account deficit was financed primarily by foreign
purchases of U.S. securities, as has BEEN the norm in
rcc thn[ \CAT\. NIP glrfial liujnc fril luniHiil \YA\ {uniiimed
lo leave an imprint on both Ihe sources and composition
of cross-border financial flows, including a net private
outflow in the first quarter. Meanwhile, foreign official
inflows provided all of the financing Emm alirodd during iln= IMM i^iiiir ICI. driven lt\ rwi [Jiinthisrs til LJ.S.
a s u r y and agency securities by Asian institutions.
U.S. ncl financial inflows. 2003-08
JOO7
JOOB
llW iliLi jrc iminllil> Thic tnl JTKC is Ihc ifHri priic of Wpl Tf M I
naic ixl. JF*J ihc Lbi ohcrhHnm t% tht d^engf TH1 Jdly I -4,
The [*KC yf mFurl twnmndrtws n m indn nf 45
.^munnJUi fmccv and?*lci«ti Itawifh May 20OL
x VM L-ITI. LJW CHwiudMy KAevefa Bureau; fof nHtfud
i u t i n u l Mondanr Fund.
68
IS
Monetary Policy Report lo fiu Congress
July 2008
Commodity Prices
Prices lor crude oif and many other com modi ties
cuiiijruin lto soar through the ;\t^ half OF 2006.
After shooting up about bU percent lost year,
thespot price of West Texas intermediate i rude
oil -has increased an additional 50 percent ihus
far in 2008, climbing from S92 per barrel in
December 2007 lo about ( 140 recently. While
weaker economic growth and the high level
of prices appear tobedamping oil demand in
irnliMii.iim-d R&ionSj dr-uund from emerging
market countries remains robust. The continued
strength in emerging market demand reflects, in
piM, [iijifrnmynl Sulfetdies thdt limit I he pvsv
through of higher crude prices to retail products
a nd thus mu le ( he response to higher prices..
Furthermore, on the supply side, incoming
information since (he beginning ot the « M r has
been decidedly downbeat, with non-OPEC production continuing to fall short oi expectations.
Despite addilionjl investment, oil production
capacity has not risen at a pact' commensurate
with the growth of global demand. The lack of
ifMff capacity has led, in turn, to heightened
sensitivity o l oil prices lo political developments.
Unusually large nel purchases of corporate securities also contributed to foreign official Inflows, likely
reflecting sovereign utdkh fund activity,
such as ongoing tensions i-i the Middle East and
ir|,1,|li|:i|\
i n Si^i-r:,].
£ h \ - f>r;, r i H H u M i
•• \ , \ t < <. i
NYME X oil futures contract (currently for delivery in 2016] has also risen to about S140 per
barrel and suggests that the balance of supply
and demand is.expected to remain tight for some
time to come.
Nearer-term market pressures have been
retleeled in domestic inventories of both
crude oil and rMined oil products,, which have
dec lined notably in recent mo n thsand stand
well BELOW year-eariter levels. Inventories also
appear lo be tight in other countries (although
d a ta are less complete for eme r ging market
couninesk ledn inventories increase the vulnerability of petroleum markets to any disruptions in
pruduttiun. (rjnspuUdtinn, ,^rt<l rtTinini;. \v\i\i fi
is o l particular concern during hurricane season.
The tightness of inventories suggests that the
recent increases in oil prices reflect near-term
demand and supply pressures, rather than speculative hoarding.
Prices of nonfuel commodities were quite
volatile in the first half of 2008. Through early
Foreign private demand appeared lo remain robusl
for the safest U.S. investments—net private purchases
of U.S. Treasury stvuriliey wliirfi surged hi the third
[jiiiiTdT of 2Of)7 whrn llir tLinruill I H ^ J E I , rrmiiiued j [
N t l private f
purchases of U.S.
near-record levels through April 2008. In contrast, corporate bond purchases by Foreign private investors have
been weaker in each quarter of ihe turmoil than in any
previous quarter since 2002. Corparale equity purchases
liave i\m
MIMTI \VT\ wt-ak in 2(H1H lliruiij;h April aflrr i
Mronji rebound in thr Runili t|ii;irErr nf 2007. O^crjll.
total inflows from foreign private acquisitions of U.S.
securities were well below average in the first quarter
of 2008 but slightly above
the nine-year low set in the
third quarter uf 2007 as ilk1 lurmuH IK'^JTI.
Inflows Imrii pm,Hi- pim IJ.ISHX tjf L..S. sriurilit h s in
the first quarter of 2008 were offset by strong outflows
associated with U.S. direct investment abroad and
by Interbank Hows. Somewhal surprisingly given the
global financial turmoil the strength seen In U.S. direct
NOB' Ottm U S wembn totludt nvp«mc cqwDn wd bcnK i
t S ^
investment abroad En Z007 penisted Ihruugii the fourth
[jiiartrr and into [he llrsl quiirH'r nf i?(W)ft. In additim;.
nel lending abroad by U.S.-residpnt banks, which
69
Boaid of Governors of {tie Federal Reserve System
March, prices of many commodities rose sharp ly, including (hose for &on*e foods (such as corn and wheat) a net
melata 4in [MrtiiuLir, copper and ,1 In minimi. This broadbawcl price increase appears to have been driven mainly
by growth in GLOBAL demand. More recenlly, however
price movements have been less uniform, and commodities such as wheat and nickel have seen sharp price
fll-t I M i l l . S - ' V i T t l l H i ^
-
• , M . | | [ h r t i - l i .HMIIHj.hr'.
;.;•.•
es hdYe continued lo sojr, particularly tht* price of corn,
which hai been directed by weather-related concerns,
including the recenl Floods in ( he Midwest. The price of
rice has also increased sharply (his year, which has led a
number of rice *producinR cou ntries to enact export ban?,
-•• I d i n ^ I n i i | i w . i f [ J p r r ^ h i i f t - o n K I O I I . I I | i r i i n ^ . N i n n i L - . h L <-i\
cos)*., increased grain price aJ*D have been reflected in
higher prices for meal and dairy products
The supply response of farm crops lo price increase*
typically has had a relatively short time LAG, usually
through increasing land under cultivation. Although
increases in acreage devaiod to one crop Ktvv mctntrv
< tirni' .it ihc fwptnw t*i mhur trops, yields have risen and
should conlinue lo do so fts more-advanted seed varieties
and cuJtivalion techniques Are employed.
In addition to supply and demand conditions in the
physit.iJ niH^rkrih, irthrt i.u tors have boon cited s^can-
tributing to the rise in commodily prices in recent years,
in-, h.ii: IL: ili:>rL£ i.iiiort of ihf (hjll.ir Aw,i lower interest
rales. All els ebeing equal, # lower value of thedollar
Emplfes A higher dollar price «i conirnodiUesr but (he
causal relationships between the exchange value of (he
dollar and commodity prices are complex and run in
both directions. The fad that commodity prices have
risen significantly in termsof all n>aj[>r<ufrt?nci^ WBgBb
1h,n iaclurs other ih,m ihe depreciation ui thedolbr have
Iseen jmpoMan tcause? of the rise in prices. SimilirK i i i
relationship between interest rates and commodily prices
may depend on what is driving changes in interest rales.
For example, to theextent that lower Interest rates reflect
.1 rrl.itivrk v,<-.\k i t thnomy .intl IhuSSAfl^f demand foi
- u nimod I I I E S inEereft rales and commodity prites may
tend to move in the same direction. And irrespective
of their cause, lower interest rales might also lead lo a
buildup in commodily inventories—AS a result of reduced
n INANC in g costs oi holding inventories—potentially putting upward pressure on prices. However, inventory levels
of key commodities have not risen Ihis year, a foei that
is at odds with such explanations of price increases that
emphasize the role of interest rates.
lends in Ix- (JLILU1 volatik1. lus increased with LIIILIMLL]
consisEency since the turmoil began; ihesc outflows,
primarily front foreign-owned hanks lo their European
Hl'liliiiLrs. wen1 [JJII1 ic'LikirlV lar^Eb in Marcfi as
in U.S. and European Interbank Funding markets
ro-iiitonsMied.
N d change in private payroll employment. 2002-08
The Labor Market
Employment and Unemployment
III
ll
II
rji y ;
iota
ion
2«H
HOT) S-.inr.inii huun^u *
STH-PH: IVparttiKin.if I j
<
f
— 1M
I I
The demand for fo\nn has hern {cintrartlnR this yesr.
After having increased 5 ! .000 per month, an average,
in the second half of 21)07. p r • i va t e1 - - payroll employment
declined at an average tnonlhly pace of 94.000 in the
first halfof2008. Over the samp period, (he civilian
nLjitnvm.rni rate mnverl up more than ^ prrcrnfage
potnt. to SW percenl.
Job losses in the first half of 2008 were concentrated
in I lie const ruction and manilfarHiring sectors. Although
businesses in ihese induslrirs have bprn trimnting
payrnlts lor moir than i^n yrarv, the downwing II.L\
i;Hf[iii]ii'd during the past several immths. In addition,
job losses have begun to mount ihls year In the whole-
70
2U
Monetary Policy Reporl lo Ihe Congress
July 2008
Civilian unemployment rait. I
jtj[>s (JS op|Ki\rtl CM those w l m YoluuMrilv \vU ilirir jcilis
or were new entrants lo Ihc labor force) rose, on net,
this spring. In addition, the percentage of persons who
reported that they were working par tlime for economic
reasons Increased sharply. Thus Tar. the labur forte par
licipaiian rate, which typically falls during pe riods of
taljor riKirkei weaknesv ha\ rrmaiiufl %lea<ly and Mcim}
at 66.1 percent in June, near the middle of the range
that has prevailed since early 2007.
Oilier indicators also point lo further deterioration
in I.ihnnr n i i i t k r l i ( H u l i l i m l s rliis u\ir.
\'\\\,\\f
\n\\i\\
(ii ImsiTicsses Mij!^n,i">i iluic ItriTis p l j n m c c i n i i n u i 1 r u i
u r n ; hiH k D M h i r i n g in I In 1 ncjir i t J t n
Ndfl
\ | ihr wnw1 lime,
according to surveys of consumers, assessments of
labor market prospects in the year ahead, which had
worsened late last year, slipped furt her in the rlrsi half
The Jail Jrf mucilhlj ind
Snaoc Dqummw of Lahut.
sale and relail trade sectors and in the professional and
business services category. Even among the many sec
Lnis in uliirh [),i\ml]^ \IA\P lonliniitfl I-CJ fx^iiiicl. MIC:II
as lerhnical ^r^'ices providm ami rjitLn^ <nul i\\ inkin«
establishments,job gains have been less robust so far
this year than In 2007. A notable exception has been
hiring by providers of health and education services,
which has remained strong.
The unemployment rate, which rose Vi percentage
poinl in 2007. increased another Vi percentage point in
1
[hi lirsi h-jlf oT i l i ^ year. 1 nil id I f l.imi\ IOT unnii^iloyineni insurance am! ihr iiLiriilx^r o! inclivifluii!% receiving
unemployment insurance benefits moved up considerably over Ihe six months ending in June; accordingly.
Ihe share of uneitiployed workers who lost their last
Productivity and Labor Compensation
Gains in labor productivity \u\\v muved up significantly
of late. According to Ihe latest available published data,
output per hour in the nonfami business sector rase
,'il-i percent during Ihe year ending in Ihe first quarter
of 2008, up from the ft percent increase recorded over
the preceding four quarters. On average. Ihe rise in productivity over the past twoyears, although less than the
ouEsi/ifl nu ww\ |K)MI(I earlier in ihr [Irtdcle, suggesl
lhal the fundamental forces that in recent years have
supported a solid uptrend in underlying productivity
remain in place. Those forces Include the rapid pace of
technological change and the ongoing efforts by firms
Change tn outpul pw hour. IWK itiW.
Labor force participation rate, I975-2OOB
It J I I I 1 I I I 1 I M J 1 1 L I I J I I I J L I M 1 L M 1 L I M I
t*>7$
tttt
I'm
S « P « I : DefkHinml of I jhw. Uurmi rf Litar
200*
<i] i Kurtbdirt hiuim^ H I M . The dill Mr ifuMUrK jnd cilcnl
L^I Chuge-iimtr Towtfiunen.
71
Bonn} ofCovfmon afllir
al Reserve System 21
en* of providing henprtts, rose 3]^ prrcfnl in nominal
[crms bclwccn March 20fl7 and March ZOOS ((hp Litest
available data), [he same gain as was recorded over the
preceding 12 months. Although the increase in the wage
and salary irjmpunriit uf ihe HCI vtigctl duwn. thr riit'
Measures of change in hourly compensation, 1998-2008
in iM'in'tils t'ir\l\ [lukrcl 1 • | :• ni.iikcdlN. H I T I H I [ \ msl.s
wen1 pushed up by a shisrp ris<= in emplnyET comrihu[ions to reciremenl plans, which likely rrHetEed. In par),
the weak perfoimance of the slock market and an atypically small increase in employer contributions in the
None Tlw tkria i
T. The (KwCanii fruiiiY*.t »«i
iihiii> .mil t
x.h.M. r i^ .
Hha L-ndm^ in iht UiC ntmith nl <.'*.• h
u i i K t a farim. £i-ivcmn«[»l. ronproril
LLi-bLTOI! b ; lb? 1 ( 1 U--LII h-LiL i i [he
S*K IUI: Ikpjrliiviil of] J K H , Hiixciui at IJIRH SLUUKH.
to use information technology lo Improve the efficiency
of (heir operations. Increases in Ehe amount of capital,
Prices
produclivily giowih.
Broad measures of hourly labor compensntion have
no) kept pace with the rapEd increases in bath overall
4 MIIMIIIHT pi ill's IIIILI IHMOI pmilui ii1, itv, [lespile A I. I I •: :• i
uiarkrl lli;it, until rrcrnlly, IIIHI IHHMI generally ligtil- The
riii]f)ij'sjin'nl m \ l i m l r \
According in prrLjniinary rhu^, rficnpriis^iiun prr
hour in the rmn|.irm EHisinpss {IVFB) settnr—an aliema[ive measure of hourly compensalion derived from ihe
data in the NIPA—rose 4 percent over the year ending
in the lirsl quarler of 2008, down from a 5 percent gain
in 1 In- previous year. t£et'ju\e ni i11 • - slnwET^rcjwth in
NFB hourly ["mnpiiiisaM«n iinrt I lie f^sirr grcjwili in pro
duclivily over the period, unil labor cosls rose just
Vi percenl over the year ending in Ihe first quarter of
ZOOS after having increased 414 perccnl over the preceding year. On average, Ihe rise in unil labor costs over
the past two years is about on PAR with the increas
rrrcmlrci in llu1 prccitliii^ iwtt yearv
lit
I! 1111 | t t i \ . i [ i - i [ n l i i \ l i \
work
en, which rnrasuriFS both wages and the cost to employ-
c in urtii litKirCLiMx L'WM 2
Headline inflation remained elevated in ihe llrst half
of 2008. as price** Tor hciiti FIICHI SIHI energy uinlimu'd
to surge. The chaiii-lvpr prkv index for personal ronsumption expenditures increased at an annual rale of
3 4 perccnl between December 2007 and May ZOOS,
about ihe same as the brisk pace registered over the
12 months nf 20D7. Exti tiding food and energy
ilenis. the l J (!i" prite index raw M AW -SFIIIUMI rjiicnf
19 pertrnt over ihe first S months of the year, down
front the 2.2 percent increase over the 12 months of
2007.
Energy prices, which jumped 20 percent over 2007r
1.11 iL 11111 LL-i.I lei M>iir in the lirsl (ive nioiiEhs (it this vear.
Spurred by risingcrude nil costs, motor fuel prices(mi
tinned to move up through May, and increases in prices
of healing fuel and natural gas also jumped appreciably.
1-iiMlimiiiiie. [fn1 [wvi llitMii^h n( MIL- in- Mid fiigh le^eK
2
I
1
1
14 -;<
NtMifii
|
1
THHI
|
|
1
i
i
|
. Nbrfij^nik tiutinc-Y^ \&skM. Ilk.' L1J!.I Arc qLuflcrlj
Sum F
1 Wrori nu.Mn o f Labor. Runnv o f 1. nhor Slotnl
1
:IHI»
I 1
of crude oil prices into retail gasoline prices was only
pariiai, and wholesale and retail margins were unusua lly compressed in May. As these margins reiurn m
more typical levels, retail prices are likely to rise further. Indeed, survey evidence suggests that prices at the
pump jumped again in June and early July, The recent
pickup in natural gas prices apparently rejected substitution by utilities and other users away from relatively
72
TL
Monetary Polity Report 10 ilit Congress
July ZMJ8
AElemalive
Change in core consumer prices, 2002
u s of price change, 2Q07-D&
PJkf m
I
r
Z0Q7
Chain type lt,>l iff •
t"hair-l>7>e pnrciMJcT for
Ul COHHMFiptlOfltflpc
?-9
1 >i IIKIIII^ I'KHI .
IAi linllll•f(HU i IhlnHTRV
'."..'.
M.11 k.-i rusi-il V. 1 •JLI hMiing IHKHI mil rangy
idJ
U
?.s
Z.3
M
U
zon
u
u
:<:•
:5^
2.D
in
f-.iu (udiitiJ. fiitid tttd rnrtRt
N['n
f kinnrv flpr Iwwd m qurtcrly ^ T T i p ^ oT w w i u l l v Mljn4rd diti
AJHIIMHI U y f B ^ ( J » t t f a w f h Ir w i m d ^ i i l n uF 2DH7 jml h
SOLKE: For chain-r>pc m m u m . FJepar
bconom^r A m l ^ k Fw ii icrd-u CJKN iiii'.tturr v nrHrmrnr oT t JIKT. Bumti
is fnwn [Jwcmfrrr lo M
, (or «.-luin-[>|K pnH ifltijx. Uepanintni
Hk- Analysis.
expensive crude oil as well AS I he unexpec ted shutdown
of soma produclion in the Gulfor Mexico during Ihc
spring.
Food prices have also picked up fur tier 11)is year.
Afler climbing 4 * percent in 2007, the PCE price index
Tor Tood and beverages increased at an annual rale of
more Inan 6 percent between December 2007 and May
2008. High grain prices and sirong export demand have
In-iii |n i r i i i i i\\ liAjniNNiljIi 1 Im sizable increases in die
retail prices of poultry, tish. eggs, cereal and bakery
items. Tats and oils, and a variety orother prepared
Toads. In addition, the index Tor fruits and vegetables
i f e at an annual rale of T Vt percent over the FIRST five
nioiirfis [>F flic yi-ar, likt-ly rifli-rlin^, in [.mil. (tiffin
input Costs. Aliliuii^li wcirld y,t;i\\\ |)iml»n I ton improved
•his spring, excessively wet weather and Hooding In the
Midwest boosted spot prices for corn and soybeans in
June.
ISe small decline in core PCE price Inflation ihts
year m.i^i'i] yum1 MjIftUcriiLiI bn[ Lir^elv urFsellin^
crosscurrents. Shelter costs have continued to decelerate
as housing markets have softened further. In addition, a
moderation in the pace of medical care price Increases
ti-is .i KLU In-IM i In'.-, n <fii<
|• i in i- i n 1 t , i 1 i i i n tliis V c n
Im.-mi
[rii^t, |iritrs uf run1 wrvitE's besides mrcLk JI ;ind shrlter
i ns[s !mv{' iutri'ased mori1 ntpidly. Sii^iiliirEy. prices of
core goods, which declined some in 2007, were about
Itrii. on rn'i. Qyer (lie i i N ( i \ i i ninntlis of this year.
More frindamentally, increased slack In labor and
product markets is likely damping price increases Mils
year. Unwrver, ii inintlHT {iF oilier lUcitirs are pulling
upward pressure on core inflation. Higher prices for
energy and other Industrial commodities continue to
add lo [he cost of producing a wide variety of goads,
and increases in the prices of non -oil i mpn rts have
picked up appreciably. McireoviT. iiiiliiiii.ni i\\[in uinui-especially for the near term, have moved up since the
mm ofthe year. Probably reflecting the elevated level
of actual headline inflation, the median expectation
for year-ahead inflation n
i the Reuters/University OF
Michigan Surveys of Consumers moved up lo about
"<',- percent at the end of 2007 and Ilien continued to rise
in 200R; it reached 5.,'t percent in the preliminary July
ibslinialEb- 1 l<mn I-I. ilu- upward infivrinunl in Longer run
inII31ion expectations has been much less pronounced.
According to the preliminary July result in the Reuters/
University of Michigan survey, median 5- lo 10-year
inilaiinn expectations were 2A percent for a third
ruusftutivc- iiicjTilli, cuniuared with the- n^ulin^s in the
range of 3 percent lo 3H percent thai had prevaiNl For
the preceding few years. Similarly, estimates of 10-year
inflation compensation, as measured by the spreads of
yields on nominal Treasury securities over those on
Iheir i ilfialion protected cniinterpans. have moved up
.;ni UT 2 0 i basis points, on balance, since t he turn of the
year. However, most ofthat increase reflected higher
inflation compensation over the next 5 years; estimates
of inflation compensation 5 to 10 years ahead were up
only 10 hasis [Joints by early July. According to Hie
Survey of Professional l-'orecaslers conducted by 'he
Federal Reserve Bank of Philadelphia, expectations of
infl a tion over the next 10 years licked up in the first
halfof 2008. though they remain essentially unchanged
since 1998.
Broader .NIPA -hascd measures of inflation, which
an1 avjilable only through the llrst qLiiiriLT tiFthis \ih;it.
slowed relalive to the pace of the past couple of years.
73
Bonn] of Gnwmtir* erf the Federal RPSPJIV Syitrm
The latest dala show a rise in Iho price index for CDP
less Food and energy of about 2 percent over Ihe year
culling in the liiM quarter, down JIIHUJI 1 percentage
pcjinl from t he figure for ihf year ending in ihe firsl
quarter o f 2007, In addition lo a lower reading forcor e
PCE inflation over the past lour quarters, prices for
some other components of fin a l demand4 especially
rural rui liun. deceleniicd.
Financial Markets
The rlrt.Urd risk spreads, liijjh Yoljtilitv, ami ini|uiirfk<]<
functioning lhat characteriird donteslk and internaMortal financial markets in ihc second half of 2007 conlinued through the first half of 2008. Spillovers from ihe
slumping U.S. bousing market were die largest direct i
V J I I : U - nj iln.-vi- |jii. - M i n ^ l i u i a •-^•iiij.iliyi.tl i l n j u f r o m
riskier ayseis p;iriit ul.srh siruclureU credit |mxlm h
and worries about a global economic slowdown also
contributed to financial strains.1' The Federal Reserve
lowered the target federal funds rate an additional
225 b asis points over the first four months of 2008 in
rt'spotiv loa lirirriuniLiiigciuilcKik feir economic
activity.
Financial strains increased significantly during the
first quarter, leading to a liquidity crisis in March at The
Bear Stearns Companies, Inc.. a major investment bank,
and to its subsequent acquisition by JPMorgan Chase
A Co. AiMiiioiia] ariicms Lnikcji by ihr E-4HII-J.II l^.-st-j\c
[n improve markel functioning and liquidity, including ihe introduceinn of liquidiiy fariliiies for primary
dealers, appeared lo have an ameliorative effect, and
tensions eased somewhat in the second quarter. (See the
box entitled The Federal Reserves Liquidity Operations'' on pjgr 26J Ni'if'rtlu'k 1 ^. tuudiiion!* in a brtwil
range o l domestic and mlE'rciational nnaEidal markeis
remained strained relative to previous years,. This
week, ihe BoaFd of Governors announced a temporary
arrangement that allows the Federal Reserve to extend
credit lo Fannie Mae and Freddie Mac, if necessary.
kels in the second half of 2007, Substantial losses on
even the highesl -raled structured products based on
subprlme mortgages caused market participants to reas\r\\ r I -ir • risks JiwHLiCed wilh uthcr slRJilumi tiiMTirial
iriMniiiifiiis LLIKI raised ccinremsahout Ihe exposures of
major financial institutions lo these asseis. As liquidity
in markels for structured products evaporated, banks
V.MI
L
h u t i.-i.l. n i l ! I - , I M r n - n i ] n i i . i [ i K
[ n\at]\] i \ u m
.ISM-IS
on their balance sheets than they anticipated. In addili»n. banks' Iciws nn nUirlgjge rt-l.m-i] sriurtlies JIH.I
other aueis prompted oedil concerns anion^ cnunterparlies. Both nE these ferinrs ronirihuli'd lo sirains in
bank funding markels. The rcsulling deleveraging in
the financial sector reduced the availability of credit to
the overall economy. By late 2007, U.S. house prices
had tieguu lei tail, rcsLiJrulkil imeMiiM'iit WAS ctMiCrarl
ing sharply, ami indicators of nverail economic activity
had softened noticeably. These developments induced
investors lo pull back from a broader range of financial
assets, leading to impaired liquidity conditions In
many markets, with widened risk spreads and elevated
vol ati lities.
This market turbulence Cm)tinned inlo early ZOOS.
as liquidity in many financial markets continued to be
impaired and risk spreads remained wide. After declining sharply late lasl yearh Issuance of non-agencyspurisort>il inorl^L^r b;n. kttl sei 11 c i 1 I-I • v ?SM-iili.Lll\
UJIIIC to a halt by the iH^mniiigcif 2008. and w lYinhn,
markei Irades of these assets were rare. Price indexes
of non- agency -sponsored subprime MBS basetl on
derivatives markets decIined furlher. However, the
unusuai pressures that had bren apparent in short-term
Gross i nuance of security's hacked by JII-A and
« nf i t i l m Mi^tf] nfc
Market Functioning and Financial Stability
The deteriorating per form ance ofsubprime mortgages
in ihe Unilei) Slates prompted widespread Mriiins and
turbulence in domestic and international financial marV.i i
9. In a
unrtwl v n
and rhV f
l cmtit produd. Ihf nrdU rKi of
rv iv wftmcntfll Imoiriix hf\ of ta
\l,*tgif<n. t
J I I . A fm.4% 3iif a mix of prink.', i^jkr-ptt™. jnd
•utih koAi itt lyptnlly m i l e M hi^Jkrr-L|Lu.]iiH
nofrimfeEHful jm.irti/jtHHi rinKTum or ether
23
74
24
Monetary Policy Report to the Congress
July 2008
Price iriikxtf of subprirtte rt^wiBa
mi credit default maps, 2WJ UK
Spreads of corporate bond yields over comparable
oiT-!liL--niii Treasury yields, by securiitcs raiinj;. t99S-2(10S
I
.
1
J
2002
n
TIK dm a
n tcTrt lu pairiii
inveslmem grade funding markets in December eased
considerably in January, diving to a t omhlnation » l
ihe passing of ycdr nid luljucr slut't rtumrns ,ntrl Mn'
provision ol additional liquidity by Ihe Federal Reserve
and foreign central banks.
In February and March, short- and long-term funding markets came under renewed ptrssurc after reports
of further losses and wile -downs at major banks,
broker-dealers, and the government-sponsored enter
prises. Fears of a weakening economy exacerbated a
.".i-iiiT.ili/ni fli^lu Ironi JII liul \\iv safesl assets. Repurchase agreement (repo) market mvp
LCDX indexes. 2007-OB
Sim. Tltt Jali OK ibily JHMJ CM em I tlw^vh July 9, JOOfl. E K I I LCDX
indH cmsiib uf 100 singl^Hnw cmht Arfiull N»BJW refrreiKing cnli(K»
uilh 1in,[.lK-ri \vndhralcd Uapn. chiL Iralf in I bo ic^Htdirir uurLcl Imr
k v c n p d louu. StLrk> N K^twi [raJimt an May 22,2007, s « i e 4 «(k-mh-T
i . IWT. mi wFKS Hum A [xil U. :00S.
L
J
L
2006
IW5
ITw diLi irr oki.il> jrtJ H t f « j [hmu|fH Julj M. ^IHI^ | h f vprf
rf ilu.L viol *W nil IO->i:if biwklMiidH H)-«« Tnfj*ur> ywU
IKruol fmr\ un«4h«l ti-irpi^.iti1 yield BHWI u^k1^g Ma
ata
rnarkiti preFrrerici- Ftir Treasury i <ill. mi.il ,nnl pushed
i,iLi• \ L)31 I [L , j M i j i, ; : r n i • i,i] 1.11EI,Mi-r<iI ri •]n iv 111 ]ir^N 11 I i <iI
lows thai were well below the target federal funds rale.
As liquidity for MBS not sponsored by the GSEs and
for other private-label asset-backed securities dried up.
the heightened uncertainly re-ganling values or these
Instruments led to an unprecedented increase In the
ni.ir^jn. it\
Ei.iii• i l l .
t r ^ n i r c d (in T\-\\f,\ bi.is.i-i| i»\ sue li
r n l l i i r i ' i i i l : IIJC i i i i i ' t r s i r.»ir sfm'iid >m F|H-M- [TJUJS ;I£MI
T[}\C. S j i i r . n h {]|'inr[M)ri![e iirnl tJSK htJiitl yieEd% civrr
yields on comparable-maturity Treasury securities
Jumped lo mulliyear highs. Ratios of yields on municipal bonds la yields on Treasury securities spiked, and
failures were widespread in the auction rale securities
markets for munic ipal securities, sludenl loans, ami nib
er a>wC> Prices f ell in the secondary niarkel f o r lever
aged loans, and implied spreads on indexes of loan-only
credit default swaps, or LCDX, reached record levels
In February. Liquidity was strained In many markets:
for example, in Ihe market fttr Treasury fuupun seriiri
tii'%, l}iil-jskecl spreaiK JIIII S.|JICLLCK bt'lwrni yields im
off-the-nin and on-thc-run securities reached mulliyear
highs. Bid-asked spreads In the leveraged loan market
also widened noticeably. The orderly resolution ofthe
Bear Slearus situation along with the implementation uf
the Primary Dealer Credit Facility and Ihe Term Securities Lending Faciiily in March appeared to reduce
strains in short-term funding markets and to relieve
liquidity pressures more broadly across fixed-Income
markets (see the box entitled "The Federal Reserve's
Liquidity Operations" on page 26).
liven [ficuigli {urnliLLtMi'v in MACMI markets iinprnvEsI
somewhat afler mid-March, pressures in some shorl-
75
Brtiinf af Govfrnors ufilir i-'t'dt'nit Krsrrvr System
lower. a[ least for lerrns of Ihree nionlhs and less. The
expansion in May of the Federal Reserve's Term Auction Facilily and of (lie associated swap lines widt llie
European Central Bank and the Swiss National Bank
appears to have tnnirihulrd tn tiis easing of pressures.
Himi'icr,
— 1.000
— Tog
— 600
jTi: Tht liaiiirt wftrLk iiid «inuJ Lhfiiigli Juk *. 500S.
r )'KU rpivida art hx • IW-Jiy malunly u d I R cupKHcd i
y Tiuu md Clnr MID
linHJ m^rkE-is ccmiinupd m itn• -ww'.; inici April.
Vi^Lii spreads rtisr in April on unMr;ir«l i.i .-in M
assel-harked, anri lower-rated nnnrinannal commercial paper Interbank term funding pressures, as measured by spreads of term London interba nk offered
rdlfi aver LoiiiparjJilE' jiiiiinrity iivrrni^lit \ud(-\ swap
jfc|«. peaitH in April I mi have sino' mcivcti ^rl^Hkwh^l
h i r i n c i - i b . i t i k i n i n J i i h ! . .L1 I I r I IL^ J^I I-.IEHT I I I . M I
three mnnllis. transaction volumes are reportedly low,
and spreads remain high.
In Eonger-terni financial markels. pressures generally eased in April and May. Spreads of conforming
ninrt^agr Mirs ,IINI {orjMiraK1 Iniiiit yields uver yields
on enm pa rablr-niaturily Treasury1 seen r I Mrs nanrowrd.
and prices and liquidity in Ihe secondary market for
leveraged loans increased. However, yield spreads for
corporale bonds and mortgages moved higher in June.
KtjLitlv piitrvs nt tiujniicil iiiLrnihuliarii'N, an-c lutiiny ththousing-rftstl^l tiSEs. Fannie Mac ami Fr«klii i Mar.
dropped sharply in June and early July as concerns
mounted both aboul ihcir losses and longer-term proiilability and about the prospects For earnings dilution
given the considerable new capital that may need to be
raised. OVITJII, im Inn Mrs of lirujic diil nurktt slt.iiiis
remain rlevhlnl romp^red wilh llieir Wvrls in prcvirius
years.
Bpbt and Financial Intcnnediation
The total dcbl of the domestic nonrinancial sector
expanded at an annual rale t i f f i n percent in ihe first
c|u;irtiT uf^UUK. a UJIIU'WIILLI sluwer p j i r i l i - i in 2007.
One-month Libor minus overnight irukw swap rain, 2O07-O8
EDKNildomesticronfinjnuLiL Jebt. ihJ;M-20OK
\J
1 1
1. ...
.. In
.
Apr
JuLh
I
Ihf i1;Hu j n ; duty arid
vuap (OlSh u ut i n K i ^ i "
I IK- Jiiri.Tcm.c tvi-rt Lsrlh i n K I H I
h>' jH.«ng.in|jt 11K lloolinjr. ot
B
t i l l I >I_L ll J
"
'
1
1 .
Inn
I HI
vm
-••
-i ii
Aff.
ll',
JlLlj
III J'HI>
11 h I
..J
ch; (ta-us. nt Ihe J|{rcnE r
JI (Ik- fixtd Me Jlhl inurrd jt
ratf I ihir \* the t.tHhiofl irl
II'IL-ILLI IIIL-
Si* KL y
fur LiKif. bruitli l
A^MWiiiiun; li 1 * ibe 1 t\S me, l
c MMBoard. How of funds J
76
26
Monetary Poli
t t i the Congress
July ZWJ8
The Federal Reserve's Liquidity Operations
In response TO serious financial strains, the Federal Reserve has laken a number of steps since
August 2007 to enhance liquidity and losier ihe
Improved FUN c tioning of financial markets and
thereby promote its dual objectives of maximum
employment and pru r ".Libuitv.
The Federal Reserve eased the terms of access
Inr borrowing by depository institutions UNDER
the regular primary credit program, or discourn
window. The spread of (he primary credit rale
over the target federal funds rate was narrowed
from 1 00 tasit points lo 50 \IAM points in
August 2007 and lo 35 basis points in March.
The maximum loan lenm was extended lo 10
days in August 2007 and to 90 days in March;
institutions have ihe option lo renew lerm loons
so Ions as Ihey remain in sound financial condition. Over time, more institutions have used the
discount window, and Ihe more accommodative
lemrs for borrowing al the window have reportedly improved confidence by assuring deposit
lory instilutinns that backstop lEquidily will be
available should t hey need it.
in December 2007. the* Federal Reserve
introduced the Term Auction Facility (TAFhF
through whic h predetermined amounts of" discount window crediI- are auctioned every two
n t t ' k h r o H•!L— iinI.- M^rr.^^^.•lv <ni ( u r m > HJI .IS>IHII
one month. In effect, TAF auctions arc similar
lu open market, operationsbut are conducted
with depository institutions rather than primary
derilro and .i^.m^r a much hruauVf r.i?ii:i- of colbterftl than is accepted in stand ard open market
operations. The TAF appears to have overcome
the reluctance lo borrow associated with standafd discount window lending because of its
competitive auction format, the certainly thai
a large amount of'credit would be matte available, and the fact that it is not designed to meet
uigeni funding needs. Indeed; a large number
The moderation in borrowing was mainly accounted
for by a slowdown in the growth of hou sell old 'EiL,
partic ularly mortgage debt. Bcirrciwing by nnnlinanri al
]JIIMMI-^I-S alsodcccleralifl. but J[ a 9'i ptTtrnt pace, ji
was still high by historical standards. Preliminary data
suggest that overall debt growth slowed further in the
second quarter
Commercial bank credit increased al an annual
rate of JJ± (XTCI'III in the l"tr\t half of 2008. dciwn si^IIiMeant!y from ihe 10W percent expansion registered
of banks—ranging at various poinls in lime from
around 50 lo more lhan 90—have participated
in each of the Ib auctions held thus far. The size
of individual TAF auctions was raised in several
steps from an initial level of $20 trillion ai Emeption last December to S75 billion mwl recently;
the amount of TAF credil currently ouisMnding is
S1 50 bill km.
In conjunction with ihe introduction of the
TAF, Ih e Federal Reserve atso established swap
lines wjlh the European Central H.mk and the
Swiss National Bank to provide dollar iwnh to
facilitate dollar lending by ihose central hanks
IO banks in their jurisdictions. These swap lines
have been enlarged over lime and currently
stand at 550 billion with the European Central
Bank and $1 2 billion wilh theSwiss National
[(.ink.
In response to the unprecedented pressures in
short-term repurchase agreement (repo) markets
earlier this year, Ihe Federal Reserve initiated
a special program of 28-day term repurchase
agreements; $B0 biilion of such agreements are
currently outstanding. These agreements were
designed to enhance the ability of primary dealers lo obtain term funding for any assets that
sre eligible as collateral in conventional open
market opera tions. Also, on March 11, ihe Federal Reserve announced plans to create the Term
Securities Lending Facility (TSLF), in which the
Federal Reserve tends Treasurysecurities held in
its portfolio at auction against Ihe colfalerai of
high-grade securities held by dealers. In addition to conventional open market operation
collateral—Treasury securities, agency securities,
and agency-sponsored mortgage- backed securities [MBS*—the Federat Reserve now accepts
AAA-raled residential MBS, commercial MBS,
and other asset-backed securities as collateral at
the TSLF. The Federal Reserve sets a minimum
hi i!007.|Cl Conunercial and industrial loans, deceleraled
sharply aftergrowingat AN annual rale of more lhan
25 percent in the fourth quarter of 2007, The surge in
C&I loans late last year reportedly reflected, in part, the
difficulties thai banks faced in selling syndicated loans
la ronbank investors: as a result, banks had lo Fund a
HI n*-j{r< ih n l r of lunh tTrdil in 2007 h»s turn ad;mini Iu
irmcnr ihc flT ls nf ihr f o m m i a n of a Lu^e rDnimcnru] Lunk ro a
tlifitI imliltilia
77
fkwnf ufGtivrntttrs
ufilir
ii Reserve System 27
ItuMirturd lU
bid rate for each TSLF AUC tion. Bids submitted
at most TSLF auctions have fallen short of the
announced auction quantities. Nevertheless
market participants have indicated tha( Ihe TSLF
has conlribuled to improved functioning in repo
Treasury, agreed to supply term funding, secured
by $30 hilfioit in Bear Stijnirn> ,mvi\ to f.icilttnite
the purchase, IPMorgan Chase completed the
acquisition of Pear Stearns on lune 26, and the
I '•<}•• 1,11 Kr^eiM-1••>i-i=iKir".i -11JJ>rr>•. m a t c h
hl
- ' 1 -11'
in.itki-r-x
11LNn .hi l u n d i i i H i m lii.ir H . i l r
Pressures in short-term funding markets
worsened sharply in mid-March, On March 13,
The Bear Stearns Companies, Inc., 3 prominent
investment h j n t and primly dealer, advised
the Federal Reserve and other government agen'
In a further effort to prevent A possible down'
u.inl ^|]irhil n\ financial markets, the* Federal
Reserve also used its emergency authorities \o
create the Primary Dea l er C REDiit F ac i lit y [PDCFj
in mid-March. The POCF allows primary dealers
i ii->. [ i u l n-, i ii 11 • •>• J i I -H |io^i;iim li.id IJI-IITKU^II-II
hi 11
sifinificantfy and that it would be forced to file
for bankruptcy the next day unles ahenutfw
sources of funds became available. A bankruptcy fifing would have forced the secured
creditors and counterparties of Bear Steams to
liquidate the underlying, collateral, and given
the illiquidity of markets, ihose creditors and
counterparties might well have sustained substantial loses. If they had responded to losses or
the unexpected illiquidity oi their holdings by
pulling hack front providing secured financing
toother firms and by dumping large volumes of
lateral that includes a broad rangeof investmentgrade securities. In effect, the PDCF provides primary dealers with A liquidity backstop similar To
the discount window that is available to deposiini1. institutions.
These liquidity measures appear to have contributed lo Some improvement in financial markets sinc E late March,
Over recent days, the share prices of Fannie
Mae and Freddie Mac dropped sharply on investor concerns about their financial condition and
capital position. The Treasury announced a legislative initiative to Iwlste* the capital, access io
liquidity, and regulatory oversight of the governmenl-sponsored enterprises [CSEsk As A supplement to the Treasury's existing authority to lend
to the CSEs, the Hoard of Governors established
a temporary arrangement that allows the Fedn,il ki-MTLi' in intend . rrclil Hi F .iriini- \\.»- .incj
Freddie Mac, if necessary. In establishing this
iliii|iinl j ^ i - h i NII r I: i - m.irkit. .L IIIIJJ I I liic-J.-r
financial crisis likely would have ensued with
consequent harm to the overall economy. In
such circumslanceSj the Federjl Reserve Board
judged rh,it i| was appropriate to use its emergency lending aulhorities under the Federal
k i M - u . - Af 1 t n . i ' . 11111
.i . i i v . j f l i r V i l o s u r r >i-l ESi-.ir
Stearns. Accordingly 1 , the Federal Reservej after
«iii< u^himi*, ^^ i1h r11• - 'n-i uritirn .irnJ i M E•.• r• I_LICommission and in close consultation w i t h (he
In-.iMir.. .)L:ri'i-iJ [o pun idr- ,|.ort-li-nn lun.riii;.:
to Bear Stearns through JPMorpan Chase & Co.
< JI.H-1 :1 ;i • 11 :•! 11 iV, i • I;.'. -\\ i i k i • • 111
\t'W<
;.•..Ml (. h.L-1-
v, .it riu' d i l f o t i r l l wirtfJmi .lu.nriM Ci>l-
^ii.in^r'iih'iil. iFn- Kuilrfl rfci'M IM il I K .LuTiUhnlv
under section 13(1 33 of Ihe Federal Reserve Act.
Credit under this arrangement will be extended
at (he primary credit rate and secured by governme nt and federal agency securities.
agreed to purchase Bear Stearns and assume (he
company's financial obligations. The Federal
Reserve, again in close consultation with (he
IHIIII1JH-I t.A [ireviouslv tcjinmitliii larjjE1 syncJicatrd drals
on their balance shells. |n the [Irst quarter uf200H.
C&I loans grew at A lower but still qu i t e fast rate of
lfi l /i percent, with part of the strength reportedly due Eo
Increased utilization of existing credit lines, the pricing
of which reflected previous Lending practices. En the
sri'tiiitj ijiianiT. t ' f t l lending itindiTJti-ii ^i^nillc anlly
furtlnT. a fiiiiit'cii ctjoststrnl with regxirls fmni Ihc April
Senior Loan Officer O pin ion Survey, which indicated
a Further lightening DF credit standards and terms and
weakening of demand for C&[ loans. Commercial real
estate loans grew at an annual rait? of about SH* percent
in the first half of £U0£. only slightly slower than their
pace in 2007.
After contracting sharply in thp final quartet of
2007. the outstanding stock of residential mortgages at
commercial banks rinse Vk percent in the first quarter,
En part because of a sluggish pace of securitizatton. In
the SECOND quarter, however* banks' hol dings of residrniial mortgage loans foil again, a pattern consistent
28
Monetary Poltcy Repon (o the Congress
July 2MB
Commercial bank probability, 1
Ktfitfnu) l * L l « C l
A
1^
—
If.
M
i on rquiiV
\
~
i;
in
Ql —
t
IWJ
iwi
l«t
MM
;m;
The overall delinquency rate on loans held by commercial banks rose in die first quarter lo Its highest level
since the early 1990s, and the chargeoff rate Increased
lo ihr upper eiKl of its range siim* 2000. The deleriora
tion in rredil quality was accounted for primarily by
continued erosion in Ihe performance of residential
mortgages and a considerable worsening in construction
and land development loans, but performance of most
oilier types of loans also weakened. To bolster equity
positions diminislk^l hy asM-l virilfduwiis .unl loair
loss provisions, commercial b anks raised a substantial
volume of capital in the first half of ZOOS: some banks
reduced dividends to further shore up their capital.
am;
The Ala fMcnd through :W*(J[ T h c d r i i w «nud trough
V f
i^fcn hi JOOK V ' 1 « Jnmijf ml*.
Equity Markets
Overall, share prices have dropped about IS percent
from the end of 2007. The declines were led by the
financial sector, especially depository institutions and
broker-dealers, which fell 37 percent and 41 percent, on
\-, irti rhr nii^uin^ v,i.Mkni'ss in iln.! housing iimrVri .mil
111 • - niliK i d i\ .I i 3 ,i 111131 v, (i| nmrlgagr H I • • I u I IPHIU [h ; il average, respectively. The energy and basic materials
sectors avoided the downtrend and have changed little
hiiiitc i i j i i i i \ l i n n nt (ri'iln pit ki-d up significant I v in
on HIT
the lirsl half of 2008. likely because of the decline in
ALIII.II JIKI implied volatilities cif hniad ec^uitv prite
shorl-temi market rales to which such loans are generindexes shot up last year with Ihe onset of financial
ally (led. However, commercial banks have taken sleps
strains. The partial easing of financ ial strains in the
to limit their exposure lo Ihese loans; according to Ihe
second quarter was associated wilh modesl declines
April Senior Loan Officer Opinion Survey, a significant
in the actual and implied volatilities of cquily prices
portion of respondents initiated thai they had tightened
to levels still above those of the past few years. The
their credit standards fbr approving new applications
12-inonthforward expected earnings-price ratio for
far h<mic {Kjiiily linrs nl rrttiil. and a imNsble |>n)|)(tr
SAP 500 firms jumped in the first half of 200S. while
tion reported that they had also timicd tending TERMS
llu1 long- lerm real Treasury yield rose only slightly. I!«•
on existing lines, mainly in response to declines in
difference between Ihese Iwo values—a rough measure
properly values. Despite the reported lightening of
of Ihe premium that investors require for holding equity
crrdit conditions in Ilk1 huuu-hnld switw. runsuini-r
leu us yjvw iiL J IIICHIITJTI1 |i<iri' in [lie llr\E l u l f o f
ZOOS.
Siock pTKP imlcxfr. \99$-2OQX
Profitability of the commercial banking sector
improved somewhat in the first quarter of 2008 but
remaii^ed well bchm- llir leveh seen l>eforr ilic Mimnwr
uf 2007. MJIIV liirj;*.1 biiiilfi m r i v r d J si^nihijut IHXJM
ID I heir 1ip>t-(|U3rier jinci(ils a&a result uf their Makes in
Visa—(he initial public offering of which occurred in
March. However, continued writedowns of mortgagerelaled assets and leveraged loans, along with increasing lt>an Iciss prDVisicim, hrld proliK duwn in ilk- fiftl
qn^ner. C'nnrpms ^Ijcigl recent and potential lOBBBI ll^l^^'
weighed heavily on bank slock prices this year. The
median spread on credit default swaps on the senior
debt of major banks climbed from 50 basis points al
ihe end of ZM7 to more than 100 basis poinls in midMtfTfli. After dri'lining noticeably in April duel \\a\, il
relumed close to the March peak in late June.
Reports of CwrfHwn mi In
JA
—
79
BoanfofGoirmons of the Frdeml ( h n r System 29
Imptied SAP $00 VDlaiility, 1995 2
»ym
-Sh
I
I
I
I
I
I
I
I
I
I
I
I
I
ton
iwn
MM
M»
:aa*
:UOT
•A4 oknil Ibtnu^i lutyflL20HI
2tfM. T k Tntt otn*f% j j k * 11 H I m t n u l f h i w d M I d u Jvough July 4, i t t
ibvL poet Lr^Vv fa k j k u b k i ! inwti j w inj;bkJ a*.vfij[T of ofHMH (*JV*Y.
SCH.IH.-I: Chicago BoardO
ptmaEx
shares— has r EA c he d i he high end of its range over the
p.lM 2 0 UMis
Policy Expectations and Interest Rates
The current targcl for the federal Funds rales at 2 prrcent, is substantially below THY level that investors
expected as of late December 2007, According to
futures quotes at that lime, market participants expected
iiiLii Mil1 fiuliTJil IUIHK rjiLc wnuld IH1 around 'A'-; [KTM-JH
hy July- LrtHiking tnrwanl. howner. insrMuri now
expect thai Ihe next policy move will be up. and a small
degree of Eighlcntng has been priced in by Ihe end of
2008. Measures of uncertainty abou tme path of policy
iovh viii)i the Diksci of tinimt IJI lurbuli'iic r ],\\i year LIIUI
AT? ujiTPniJy near Mir high rml tt( ihi-ir rrt]i«Ei nver thp
pasi 10 years.
Treasury yields fell sharpK1 from ihernd of 2007
ihrongh March amid concerns about the health of financial firms, severe strains in financial markets, a weakening economic oullook, and lower expectations for future
[Kjlicy rales. Siine laic Miiuli, ^ t< • Lc 1^ \IA\V risen 'At ross
(he curve as fearsof a deep economic contraction have
receded and concerns about me inflation outlook have
increased. On net, 2-year yields are down 65 basis
poinls, and 10-year yields are down 20 basis points
since me start of the year,
Yields nn TreHMiry iiMldiimu pi i iit-< i• -•.I serurilie^
largely moved in line with nominal yields—that tef they
fell illrough mid-March and then rose—but ihc rise
since March has been somewhal less than (hat of nominal yields. En addition, shifting liquidity conditions in
die markpEs |nr nominal and indexed Treasury securities at times affected the spreads between nominal and
indexed yields, also known as inHalion compensation.
On net, 10-year inflation compensation has ri s en aboul
20 basis points since the end of 2007. suggesting som e
inrreasf* in invesinrs' {twrmis aboui thp inHntjon out
look. Inflation compensation rose o^er both (he near
lerrn and Ihe longer lermh hut the increase was larger
over t he near term, as compensation over the next
5 yean Jose about 30 basis points whereas compensation over ihe period from 5 years ahead to 10 years
ahead rose only 10 iwsis points. In pan because of a tag
in ihe iudi'xaimn of inflalion -prolected securities, near
term inflation compensation can bestrongly affected by
TIPS-ha*L-d inIIJlMil ciiii
'•I
-
•
I
I
[
,i»i
I
unt
I
xn$
I
2004
i
xxn
|_J
mm
Vii.
[he liHd J/L- •iiiS jnd n\*&i OAHth IJK 4. 3«1« H I K J .HI A
^HUfmihM of .ht jttld itmt hM TKUIM) .ifliiHwv-pro4KtAl mumm
111 PSj w tih ih: rhxiHHl oTT-tlv-fuii Ttrawy jnU nn*c
STB RL I I c»tTiJ Kfsc^c IturJ ^iL-ut^HMh hmJ no ilil* fiun >fcd tn Ih:
hnknt I M U UmL ,.f s™ Vort. nt Harbyv
80
30
Monetary Policy Report to the Congress
July 200E
regarding ihe appropriate quantity of reserves to be supplied each day through open market operations have
been i nni|ilic.ili!il. iirnl Mihcilicy in Uie fedrnil fmlds
rate has been elevated. The authority to pay interest «n
reserves could be helpful to the Federal Reserve in limiling Ihe volatility in the federal funds rale. The ability
to pay interest on reserves would also allow (he Federal
Reserve to manage its balance sheet more efficiently
in circumstances in which promoting linancial stability required the provision of substantial amounts of
III\HJIMI[ windem rrctlil to llu1 ILJI.UIL ial \ecdir. In light
of these considerations, the Federal Reserve has asked
Ihe Congress lo accelerate Ihe effect ive date of statutory
authority to pay interest on reserve balances, which is
currently October 2011.
HOIK T t v t b a f n d P m # ZUWQI v d n cMinuicd Tor ^MKS.Cj:
ThfA^h 2007, ifat diu ft* W u l <M a limit h. qua Her M
Lmrt Ih.*|ujr1tr
IMSH. Ac fiul ahen j i n n refers to J0W.<J? K I H I I C 1k> ~UU7:(>J jf in J rwnu.il
rtc M2 COHHU of cwKitcy. aavricr'* check*, dnnwd dqmil^ nthcr
d b W
dtpUuli, UHHIp JcpOuli Kfeluditig nto*C} nuikrl Lkpn\H
JIdeiHininjiiHi Imw drpoubv md bal-inoe^ MI Jdiil nhimiy
. JrtVrtal
I n h t n . i l i m i . i l Ui'vi'luji
International Financial Markets
I I k w l , SmjMK.il RLJCJM: lib, 'MDBCV Slml
the latest movements in energy and Food prices: Ehcse
prices have risen sharply in recenl monlhs.
Money and Reserves
MZ is estimated to have expanded al an annual race of
7^i pfn enl over ihc hrM halfofi!008. notably faster
ilian (hth Iiki4y |;ru\vl)i ral^ nfiiuniinat CiDP. Drnmikl
for ITIOIH'V lulanL"fb% was Mi|ifKJrdi] hy ilrrlicirs in 111• opportunitycost ofholding money relative loother
financial assets and by strongdemand for safe and
liquid assets amid volatility and strains in linan cial
nuiki-iN. Mnnry ni.itkii iriDin.i] fund hliar^s I-JI-1.1. pan
liiuliirly nipully in lilt- tirM IJIJIUII-F. Ilimi'Vff. jinmih
lit iiiiiiHY [iiarkel iiiiLiu.ii Ininh tirtt|iprii n>HMdprah|y in
the second quarter, and small time deputies rontractedi
M2 slowed accordingly. Demand for currency conlinued to be lackluster for the most of t he first half-year,
bul it picked up noticeably lale in the second quarter as
domestic demand grew and foreign demand was estini.Ht'c] HJ IH1 \v\\ weak.
I'lii' M M ins in h.uik liuitiiiti; itiiirkriMj'.i-t tCOBfll
niunlhs have posed challenges for the implementalkin
of monetary policy. Banks generally have seemed more
caulious in their activity in Ihe federal funds market
and less willing to lake advantage of potential arbitrage
opport unities in thai market over ihe course of a day
and across the days of a reserve itiainsetianc EPERIOD.
In (his environment, the Open Markel Desk's d e c i s i
CMcihal financial markets uTiuirn <\ iliMresvfl n\vr the
tint hall «f 2[H)Hr prinurilv liccauw nf enncrrns ,IIK>LI1
weakness in real estate and slowing global economic
growth. Amid heightened market turbulence In March,
Ihe European Central Bank (ECB)> Bank of England,
Bank of Canada, and Swiss National Bank (SNB)
amiuunivd ,i further set tif joint arlitinswitli the t'edt'rai
Rc^erV'i1 Lo hrlp improve ttie li][3{li[>riLiig n\ short term
luiiiliitii, nurkets. The Federal {J[K'n M.trkcl C ommillee
increased Us temporary' swap line tothe ECB in March
from S20 billion to $30 billion and ils line to the SNB
from S1 billion lo S6 billion. In May, these amounts
were increased further to S5D bitlion and $12 billion,
respectively, and the lines were extended through Janu
ary Z009, Meanwhile, the Bank of England and ihe
K.mk MM .IM.ILI.I I-:H h Liiri,nli]i rd iL.-•.•_ ii-rui funding
arrangenients in their domestic currencies, and the Bank
of England also established a facility to swap government bonds for banks' mortgage-backed securities for a
term of one to three yearv the EC B has also continued
looffer longer- term funding in euros, auc tioning threemonth funds k i l l i n g €27G billion in the JirM purler
and €250 billion in the second quarter and adding a
new long-term refinancing operation with a six-month
maturity.
Market volatility has persisted in recent mouths,
\MIII ongoing [ iniuiir-. a^Kint the habnte sheets ol
financial institutions. Sinceth e middle of last year,
Hurnpean Iwuks have announcetl akmt 5200 hiEhmi in
WTite-downs—largely as a result of indirect exposure
to U.S. credil markets through both sponsorship of and
investments in structured credit products—and further
81
Bosmi of Governors of the Feffcrnl Reserve System
Equity indexes in selected advanced foreign economics.
2007OS
Equity indexes in selected emerging market «ononiics H
3007 OS
v\
Apr.
Jul)
Apr.
Ort.
itofK Tkdtfj K duly The tul o b c n * « far tub me* H July *.
MOS. H ^ u r l t r T[A>tr tAcbMpr
ll
Dt
31 3UTV
Jjpw q*dn PI * « W w Ifc* (V
ML
STOXX | n * V Aw
SanCE l(« <VP MM. n™ Jut* |
T « H M Stock kutunfe WO C'onpMHr i r t i foe Jifwi. T<*
L Sfc l
I u h u p LTIHiVp, *kl hir tV I nil(J
|FTSfc IWi. B Kporkd b> Ukvmtvfy
s may br rccogni?xd tn second-quartrr finiinfial
SttteOKafe In ^tliijticHi. n i » n ^ ^ Irntlcrs in thp
Lj ii il-ccl K i ni^ch m ti hiivr IHI'II alTn'lrd by ivriiknc*\& in
propeny pricts ilii-n- jmJ l>v ntluifd aetou to i j p i u l
market Funding. In general, ihe instilulionsthat have
recngnized slgniliranl losses have laken [irtirnpi
step* lo replenish rapiial from a variety of «jurces;
mare tlun SI40 lnlln.ui hjd IH.-ITI ruivii by [lie CIHI of
June.
t nit hcrKnniirie gtrt cmmtfi L hands in s
XC<I tiireign cvimomin. 20(li7-Olt
10-jrM h n h , MV dul>. T b bu
iuh
2W1
i:
Oel.
Sim: 11K<1U m «lut> 11Ktaiobwnatmfor«ch wm n Jury ».
JOOH, bctwr Ike SJUi£hii Mttk Kuhtf«r Ttfc <k**d « lltttrtfct l l .
100 IV LHIA
tiomotrbt* ate Ai^auu. Bn/il, Chile,
e ^JittiUL^ AIUB CV^VHTBO ^K C'HIOJ.
II. ihf PhNp^K^ Sowh Kor». TAIVM.
ftmrpng Atu. ^ V ^ H I Sunb> t'iprt
* i n t v CiV C'htru, Slurgtui C'tidAptniV Lr*t.t.
rcpo*tal by Btemhrf.
CJu nc1!. IIKIM tiujor n^nilv i n i l r x i ^ in ihc t t ( l \ i i n nJ
fori'i^n itcmfnitii-i slartd IZ percent i » i!s perctnt l o ^ r r
in local currency terms compared with me end of 2007,
European slnck indexes were led lower by the slock
prices ni lui.iiK i,il li;m*. whkh clerlined 24 pcrrfjil
liiic.iMin. i.i in I'uros}; Japaneu1 Mum L.tl MtHrks an1 duwn
9 percent on the year. The linancial turbulence has had
]ess impact on Latin American stock prices. Equity
indexes in Mexico acid Brazil wm? virtually unchanged,
on balance OVerihe first half of 2008. However Chinew stijclt prices have ;lumbled A4 percenl since the end
of 2007. virtually erasing last year'sgains, and oltier
major emerging Asian equity indexes are also down, bul
to a lesser extent,
L.iijLiicIily in Ruropejin ^nernnient btmtt markets
was impaired in MJFI'II liul sifins in \IAW imprcned in
111 --I: i monchs. 1 ^ HI-.- ill iii bond vields in the advanced
foreign economies fell in the firs! quarter but have more
lhan reversed Ihese declines as investors no longer
expect the F-CB anil ilie Bank nf t'ughnil let rase their
policy Mirv Siim- ihe CJIL! of 2007. Icin^ Eenn rat«
\ut\y risen, on net, 1 1 basis points in Germany, 38 basis
points in the United Kingdom, and 12 basis poinls in
japan, and nominal yield curves have flattened. Meanwhile, implied Inug'term m:!.i[iuu rnrnpensviiion has
Increased in hasis points in Japan and nearly 30 basis
points in G erma ny and Canada,
82
'.M MOHttn Fiiliry Report toIlie Congress
July 200&
U.S. dollar noni ina I cxctungt:rate,broad IIKJC^. 2WI (it!
3001
\«ri:
3XU
MOJ 2004
ZOO*
2006
Change in consumer prices far major Curtign
2004-08
2W?
I V AMX, WTIKII w tnfaKipieun«k:> unila per Joiltp. ut J
TV UM otMc^umiforIbr t a i n ts Jul> <>. : « t f Tbr Ivrud index
th-cithicxl A^ crave H^F EW
l Fnvrhi^i s:ii/tun£c u h m nF EFK L- S L1II| IJT ajb
khe cofKKKi- rf J l n f piwp of ita m m impofunf L'.S. (ratting pan
TV miss ni;i;hiv wliivh i-hjnpf ii^vi time, JF? Jfn^cd Fmm L'.S. cn
vharo mA ftntn t U JmJ U^njiii imfun ^haro.
I ft
Ihc tbti art nwmhly, jnd cfainp n fm
eli
May 200R.
ih tmtim
l Hty
The Federal Reserve's broadest measure of [he nominal iradc -wcighlcd foreign exchange value of Che dollar
has declined about 3 percent, on net, since Ihe end of
last year. Over the tame period, llir ajtsr L-nrrencips
index of Ihe dollar has aku ditlini'd alxiui 3 percenl.
MLitl sJi^rfaK ,i;;iiin\t I hi1 {hLir[} ;iin1 [fir
y and March but has recovered some
HI ni( [-in nionrli-, (in iii-1 rluK f.n tliis w,\\ ilir ilnh.it
is down about 4 percent against the yen and 7 percent
against theeuro. The dollar Is 2 percent higher against
ihe Canadian dollar ami silghtlv higher a^ain&t M i• 11: i- -•.
V. S. dol \if t\c tun^o rat
cies. 2007-Q8
Apr-
fftiTI: TFx J J U . *
The Lbi obKiviuin f
StUKI
July
^ i iiirmv> unilM [HT thhllii. ire JJIIJ.
ts Juh 4,2F)tW.
The dollar has declined 6 percent agalnsl the Chinese
MTiniinhi since ihe end Q[ 2W11,
Advanced Foreign Economies
Economic grawlh in the major advanced foreign
economies appears to have slowed somewhat thisyear
Although bctili the euni area And Japan poSKtl slruug
(ir^t-quartiT GDfgrciulh rdtL-%, rrcrnl nituillily indi
i^nars luvr heen more1 MIIMIIIC^]. In mlifi (ninifrirv
^rciwih ni(E*s cleclinnl in ihe lii\( {|Li,ir[rr, LIIHI firstquarter real GDP even contracted slightly in Canada,
where trade and financial lies to ihe Unlled Stales are
strong. Surveys of banks in Europe show a further
Ii^rilfiling (ij [Ti'dil strtiwhj-tJs in ilu> i\r\[ half uf 20(IS
I Ml' IJIHIJ liouvillirlih . I • i • 1 hllSLIH^U'S t.rlL(lill!^ 1(1 hlisi
nesses appriirs to have rrniiditird solid, BUT household
hoiTowing has slewed. Housing markets in a number
of counlrles—including Ireland. Spain, and the United
Kingdom—have continued to soflen.
Since the beginning of the year, headline rates of
flirtation have continued to move up, on halancer In
tiH]si ttt]FKmiii's. IIIRIIIEV lnk("«iiisp iif inrrrasmg prjres
Tw RMKI nnd energy, The IZmunlh change in consumer
prices in bolh Ihc euro area and the United Kingdom
increased Further Trorn Januar>r to mid-2008, while core
inflation rates [which exclude the changes in the prices
of energy and unprocessed food) have increased much
less. In Canada, where food price Increases have been
muted, inhibition i% link11 han^ecl, un r•=• I-.:i:•. • since ML..i -: -•- •=i ^ 11 •• i; • o i [hi
1
year hi;! 11.; -. risen in I he |inst i Eiuple
of months Japanese consumer prices are roughly
83
Board of Governors of the Federal Reserve System
Oflickil or tirjecoJ iniervM me* in Kfoc
foreign economies, 2004-OS
33
exuorl ^fowlli slowed, domestic ilrmLiml ,ip|h,ir> Iti
have accelerated.
! \w\: Ih'tc in i-nlM^ilt^ \vin. m.CJH [H'Mtn irl.int i1 llJS
varied but, on balance, indicators suggest that activity
has remained solid in the region. In the first quarter
real GDPgrowth moderated in Korea, Malaysia, and
Thailand but was strong in Hong Kong and Singapore.
Exports of the region have generally slowed along
with the deceleration in globaE economic activity:
however, domestic demand strengdiencd in a number
of countries.
E-icTjnciiiiii dc[Lvil> JIMS \W< clrr-in-il in I al in A m e r i c a .
In Mexico, output {yowlh slowed to about 2 percent in
Ihe first quarter, in Une wilh the step-down En the pace
of activlly in ine United Stales thai began toward ihe
•H
end of last year In other Latin American countries,
)
^ h
1.MAn T V LIJU J ^ n
notably Brazil and Venezuela, growth also moderated.
wn. tot ( w d a , the v r c m ^rate,for*c *mv n n Ihc i m n w n hiJ m «n
Higher prices For food and energy have continued
nuii KfkuKng cprmwiH. fix JjfUfL. thr call natty ntr r lad. far (far
I. nrtfJ ktrr^om. Lhf 4.11 IK U( t\uiL rale pj*J fw t^nMnfiVnl (VKTtn.
toexert upward pressures on inflation <uttr*\ emergS " n v Thf cranl book *fc*:b no w ccunuy i k n n
ing market economies. In China, headline Inflation has
risen, reaching roughly S percenl in recent months.
unchanged on a 12-month basis when both Food and
In response to the inflationary pressures, the Chinese
energy prices art
1 p
authorities have atiowed the renminbt to appreciate
r
( h e r i h r lirsl h a l F u f l h i s M'.u llu fctrus u5 1111• in:i|iii
ata more rapid pace, and the People's Bank of China
furpi^n i f i i l r . i l l u n k s ;i|>|Hj.us lei have* shifted MMiirutLil
has further tightened monetary polity. The Bank has
I [ > • I i I ihc1 llll[i..L( ( u\ NlkblK Inil iriiil ki"1 MrilJllS Dll •; 111 \h. L h CO
raised the required reserve ratio five times this year hy
ihc CITIHI {>f hij;lHT tuinmodiiy prices on inflaiiun. Afitr
a total of 300 basis points, lo l7l--> percent. Elsewhere
initially lowering oflicial interest rales, the Bank of
in emerging nittrkei eccinumicv. 12-monlh hraiiline
Canada and Ihe Bank of England have held Iheir target
iiiElijcioci in a number of cnunlries COIUJUUIKI [o rise in
rales steady since April, and ihe Bank of japan has kept
recent niuiiliiv dieretiy pnimpling many cenlrLil iiaTtks
its policy rale unchanged at 0,5 percent all year. Reecnl
id Lighten monetary policy. In some cases, governments
in fla tion rates and statements from all of these central
also instituted export restrictions or reduced import
banks have led market participant lo expect potiry
duties Forsome food products. The rising cost ofenergy
Mif\ (n increase slightly ar lafrmaiii <m bolii. On
subsidies has led governments fn China4 India. MalayJuly 3. llie Ft-Brai%e<Jiis pci]icy rjie 25 IJKK pfiini%,
sia. Indonesia, and Taiwan to raise administered gasoIn I !J |;I h I m IHJI il IMJII'.I.I llial furthrr rale htkra were
line prices roughly 10 percent to 40 percent in recent
nol in t he offing,
months.
Emerging Market Economics
Recent data suggest (hat real CDP growth n
i China
remained strong in the tim half of this year. Alt hough
84
Part 3
Monetary Policy over the First Half of 2008
A l i n easing iIn- sumc of monetary policy 100 basis
poinls over the second half uf 2007, Ihe Federal Open
Market Committee (FOMO lowered the t o g a federa]
funds rale 225 basis poinls further in the first half of
2008." The Federal Reserve also took a number of additional actions to increase liquidity and to improve the
functioning of financial markets.
In a conference call on January 9. the Committee
reviewed n-i mi economic if.ti.i and lir^inu.il nur
Ki"l developments. The in format ion, whic h included
weaker -lhan- expccled data on home sales and employment for December as well as a sharp decline in equity
prices since the beginning of the year, suggested that
Nir downside risks [o growth had increased signific antly
sini'i' thr time of the Disri'mbtT K)M( milling. I'.'i
ticipants cited concerns that thes lowing of economic
growth could lead to a further lightening of financial
conditions, which In turn could reinforce the economic
Slowdown However, core inflation had edged up in
recent months, and considerable uncertainly surrounded
the inflation outlook. On balance, participants were
generally of the view that substantial additional policy
easing might well be necessary to support economic
activity and reduce [he downside risks to growth, and
iluLv rliviissi't] lhe |M)ssil)N' timing thl stkh iinictnv
C)o January 21. the Committee held another con
Terence call. St rains in some financial markets had
intensified, and Incoming evidence had reinforced the
view that the outlook for economic activity was weak.
P^riififianls u l r t r m t i IKLLI kntSlOU ap|>dmilly HOB
bpenming iricrpisingly concemrd alxmi the rrniHiTiiit
outlook and downside risks to activity and that these
developments could lead to an excessive pull back in
credit availability. In light of these developments, all
members judged that a substantial easing in policy was
appmpnale (n fuster mcHirratr economic p i m l l i diu]
reduce Ihe downside ri s ks to economic activity. The
Committee decided to lower the target for the federal
funds rate 75 basis poinls. to 3'a percent, and judged
dial appreciable downside risks IO growth remained.
Although inHalion was expec ted to edge lower over
Ihe course of ZOOK, participants underscored their view
that this assessment was conditioned upon inflation
especialions remain ing well anchored and stressed that
11. Afrm*rr*oflhrF<lMt tit 2008 rtrtfaiu uf tttnilbrn o
Eluiril or tkn,niHjf s u\ [hr Knkril Rnn\ c S> Mnn plus i p
u\ llr Pnlrrjl Hrwrvr llaik% nf C Inrbrxl, M M , Minm J^ILV Xru
Vtwii. jnd PEiiljtHphij t'.irtiiifitnKil t-OMC nteriinjfs romia of
m«nbfrj gf ihe tVurd of Cwcnwrc and M Hn
1 • i• • i n i l . u n j n M M i . i t H J i i s t m u M { H J i H i r n i c \tt W- mci-nifii-rccl
careful I v
The data reviewed at Ihe regularly scheduled FOMC
meeting an January 29 and 30 confirmed a slurp decel-
—
i
j
The dill arc duly «nd »tcml h m g b My *t. WK. The 10-jle» T n c « ) me » OK nxntHC-mtirit)' )wU baed c* I be mmt K i n d ) ' Indtd vruntici.
l k hn*uimLil a%r* aftrihtn* <•( rr^-uLwt], vh^Juknl I C*T»] Open Mattel C UHMIUJVC mr^inp
Ucpanmcn efihe T H A I U > tad ik-1'tilted KCSCTHt.
35
85
36
Monetary Policy Report H i the Congress
July 2WH
(•ration in economic growlh during the fourth quarter oF
2007 and a continued lightening of linancia! conditions.
With the contract)™ In the housing sector Intensifying and a range n ! financial markets remaining under
pn'ssurv, vt unomk ^rmvil] was rxpK'k'd m Slav vtU in
[hr lir>i IIHIEOI ?.\WH Itrftin' |iirkhif; up strength in rhc
second half. H B V H V K I he ongoing weaknesses in home
sales and house prices, as well as the lightening of credit conditions fur households and businesses, were seen
as posing down side risks tu the near-term outlook for
= i •••_•: M 11 • •in 1 .-, ill Moreover, iin- ;niM-iif;-il
foradvcr\r
fri'iHwt k b e t w r r n Ihe l i n a n n n l markets ami ilu 1 •DODO'
my was a significant risk. Participants expressed some
concern about the disappointing inHalion data received
over the latter pan of 2007. Although many expected
thai a r< i Liliiiir 111! i nf p r k r s fur I I I I T ^ V -u-'l f\l\:-\ t o r n
miwliliE'v MJE'II as thai cinEn'ilifrd In liilmcs 111:11 ki'Ls.
and a period of below-trend growlh would contribute
to some moderation tn innation pressures over lime,
the Committee believed that It remained necessary to
monitor inHalIan developments carefully. Against ili.it
backdrop, the KOMI driidrd to louer the target for
Ehr lt'£l[hral funds rale M basis [ininls. Ki 3 piTt"(*nt. 1 In1
Committee believed that this policy aclion. combined
with those taken earlier, would help promote moderate
growth over lime and mitigate the risks to economic
activity. However, members judged that downside risks
to growth remained.
In a conference call on March 10. the Committee
reviewed linandaL tiiarkrl dev^Kipineuis JISII {unsidrEnl
I • 1 • • I •. •- • = I -^ . n i i n i l
al
-s 1 L 1 "• 1:1115 I 1 i_i •„ i l i i -
l n | i ) i i l n \
dcid
u r t l r r l v
functioning of those markets. In light of the sharp
deterioration of some key money and credit markets,
the Committee approved the establishment of the Term
Securities Lending Facility, under which primary dealers would hr able to borrow Treasury securities from
tlif S^U'in ( )|)CIL Markri Arnjinn Im ,-i IITIII IIE Jipj»r«»i
mately one month against any collateral eligible for
open market operations and the highest-quality private
residential mortgage-backed securities (MBS)." The
new facility was designed to alleviate pressures In
thr - -11.1 r 1: II: _• markrls im sirurllirs. In adthlkin,
[hi1 ("rinuniurr agn-n^ in c-xpiiml the existing rrclprocal currency agreements with the European Central
Bank and the Swiss National Bank to $30 billion and
56 billion, respectively, and to extend the terms of these
agreement sthrough September 2008. Over llit> iwxt few
tljys, Miuni'ial nurkE'l slniins irilcusillrci lurlhi'r. (hi
March 16. the Federal Reserve announced emergency
measures to bolster liquidity and promote orderly func\Z. By iKHallon vcnc compldnl on Maich 20. AAA ralrd commw
cEat MBS Hfrr aiWfd In Ihr I N uf arr
Honing In financial markets, including the approval of
the financing arrangement associated with the aquisi
tion of The Bear Steams Companies. Inc.. by JPMorgan
ClNusi1 & Ho. and I lie establish riu'iic ol ilu' Primary
Dealer Credit Facility to improve the ability of primary
dealers to provide financing to participants in securilizatlon markets. In addition, the primary credit rale was
loUE'red 25 basis point*, and the ii,i\uiiiirn term of primary credit loans was extended TO 911[ lays.
When the Committee met on March 18, financial
markets continued to be under great stress, particularly
the markets for short-term collateralIzcd and um utl.n
erali/ed funding. Spreads on Interbank loans and lowerrLni.Lii 1 (Hiiiiirnial jhifn-i hail widened over llir intermrrliFlg prrioO. and cidlaiuii^ rrrclil ihruugh rt'purchiist*
agreements backed by agency and private-label MBS
had become more difficult amid reports of increased
margin, or "haircuts." being required by lenders. Yields
on Treasury bills and repurchase agreements backed by
luMMirv securities had uEiiiurnrlHl, rfOnllng IHVOtOn*
heightened demand for the safest assets.
Participants at Iho March 18 FOMC meeting noted
I lh.it |>MJ^|)I-( i\ dn Inil3i i'[ i.fh 11113111 ,n l i ^ \t\ .Hill tii'.n letIS
inHation liad deteriorated since January, and many
thought that some contraction in economic activity in
the first half of ZOOS was likely. Although lite economy
was expected to recover In the second half and togrow
further in ZOOS, considerable uncertainly surrounded
[his ftirrtast. Sunlc parti[rijianls rxprvssrd njimcrn
that falling HOUSE prices and financial market stress
niififn lead \u a tmnc \?\ nc .md JHIIH.IL t<d do\Miiiiin
than anticipated. Recent readings on inflation had been
elevated, and some indicators of Inflation expectations
had risen. However, a Rattening. out of prices for oil and
other {(intmiHfilirs as Implied by futures prices mid
the projected casing of pressures on resour ces were
expected to contribute tosome moderation in inflation
All in all. most members judged that a 75 basis point
reduction in the target federal funds rate, to Z'A percent,
••'i .i^ .i]i|iin|M i: 1 n• Eo adilrthss thr fiiniliiitaliun of risks of
sluwingf'coriiMiiii" ^»iuw ill. inlliili(niiir\ pressures, Lsml
financial market disruptions. In its statement, the Committee highlighted the further weakening In the outlook
for economic activity, but It also emphasized the Importance of monitoring inflation developments carefully
] In 1 f l . i u i r \ ii w i l l ,i[ Ihi 1 11 n -1 • 11 c i: •; i m \ | i i i[ 29 a n d
30 indicated that economic growlh had been weak in
the first three months of 2008 and that core consumer
price hi Hal ion had slowed, but that overall inflation had
remained elevated. FOMC participants Indicated that
these developments had been broadly consistent with
i iii -1 r expri'laliiins. t^oiidiiiuns arrn%^ 3 11 • 111 i 1: • 1 • •: liiuu<
cial markets were judged to have improved since the
86
rfit' Fetkr;tl A w n r S\ \tvm
March meeting* buE financial markets remained under
considerable Stress. Although the likelihood thai economic activity would be severely disrupted by a sharp
deterioration in IULIILC i\A nidrkcls had upparenllv u-tnl
ctl must jh.ic 1 iL ipanls IIUHLJJIH that lln1 risks tn i^cinomic
growth were Mill \kv\\red Mi the downside. All panic]
pants expressed roncem ABOUT upside risks lo inflation
posed by rising commodity prices and ihc deprecialion of C he dollar but sonic partic ipants noted thai ihe
downside risks to economic activity also implied lhat
there were downside risks to price pressures as welL
Participants expressed significant uncertainty concerniii1! [lir jjiprnpriiiie >i.niui cif in 'I.L]\ JHIIKV !TI I!M -V
dKumStaOCes, Some participants noted chat ihe level
of the federal funds target, especially when compared
with the current rate of inflation, was relatively low by
historical standards. Others noted lhat linanclal market
stminvancl i-lc\ ;iii-il risk spre^d^ hfld ciffsei nmrh nf |he
effects of policy easing on therosi of rredi l totiomm
ers. On Iwlance, most meml>ers agreed lliai thp isrgE'l
for Ihc federal funds rsle should be lowered 25 basis
points, to 2 percenl. The Comniiltee expecled thai the
policy easing would help lo foster moderate growth
over lime without impeding a moderation in initiation.
Ihe CniiiniiiTrr j^recd ili;ii. in ti^lit of I In1 MII}\[JTHJJI
piiliry ezisiiif; ic^cljite jincI the on^iiin^ measures |ci femef
financial umrkiE |i(|ui{lily. Lhe risks lo growth were m m
iiniri- closely haJartced by the risks lo inlialion.
In view of persisting strains in funding markets, ihc
FOMC also approved proposals toexpand the liquidLiv arrangements lhat had been put in place in previous
months. The reciprocal currency agreements with the
European Centra* Bank and Swiss National Bank weFe
inrrravrd (u $5(1 ti ill ion aiul SI? hillLEiii, respectively,
HIW! bcith were enti'ntletl thremjih Jantijry Z009r The c«llalefal accepted by the Term Seciirilics [ending Facility
M
was expanded to include all AAA-raled asset-backed
securities, in addition, Chairman Bernanke announced
his tnEenlion to expand the Term Auction Facility to
5I5U liillii.ui under Utburiiy ureviuusly dcli-^atnl by
1111• Ekhird (ij (^n\[b^J1C}^^.
A| lhe lime Of lhe meeling held June 24 and 25P the
availnhle jndicalnrs snggesie<l Ihnl ecnnon)ic acltvjiy
in Ihe iirsl half of ihc year had not been as weak as had
been expected in April. Nevertheless, several factors
were viewed as likely to restrain activity in the near
1I L IIII Lin luiEiiiL] [fir nmErLtiiinii in llu1 lum^in^ wt
tor, sharply higher energy prices, and continued tight
credit i nnnlili^jr-i. Milum^li MiiiiiuJLiI market cnntlkiotiis
^L'IHT.LII\ .\\I\-M .II rd [» have improved mnc]es|h \ince
Hie April meeting, paiiiripaiTCS noted Ihat the polcnnal
for advene •• ••
•• I market developn^encs slilL posed
sign if i cant downside risks lo economic activity. The
furltier large incrpase in energy prices ALSO prompted
,io upwHird re\ isimi n f p m j ^ tiims For nvcrall •• •: l.n i> 3-n
in Ihe seroiid half of 2008, Most participants expected
thai a leveling-oul of energy prices and continued slack
in resource utilization would lead inilation to moderate
In 2009 and 2010. bul the persistent tendency in recent
years for commodity prices lo exceed the trajectory
implied tiy Entun's nsjrkei prices en^endi'nul ccinsitler
nlile uiiciTljinlv unniEid lilt' pnijecti'il [ncHleriilion CJI
inHalitin. Members generally agreed that ihp downside
risks lo growth hail eased somewhat since the previous FOMC meeting while the upside risks to inflation
had intensified. Against this backdrop, mosl members
judged (hat maintaining the current stance of policy al
this meeting represented an appropriate balancing of the
risks lo Lhe economic outlook, Monelhelessr policymak
ers refo^ni/i'd that cirtiiinsLiiiLccs cnul-cl {lumge ijiiicklv
.nit] noted iliiir they might neeel [n responii prcimptt) 10
incoming information ahuui ihc evolution of risks.
87
Part 4
Summary of Economic Projections
Tito following material appears as ait addotttttna to tht*
miftuirs fifthfjttaf
24 25, 2008, ntfviing iif/tir
Frdrfiil
Open M
TableI. Economic projections or Federal Reserve Governors
and Reserve Bank presidents. June anon
Fnrrrt
am
emg
|
ZOIQ
ttril in.tr. i
Fn mnjunrlion with the Jane 2008 FOMC meeting, the
members or t HE Board or Governors and the presidents
orthe Federal Reserve Banks, all of wham participate
in deliberations of the FOMC. provided projections for
[ huvr in rrJ C.llf
Aprbt pf>^« iMw
1 Ota 1 E ZDlaZS
.
O3blJ
A p i l yn^n i k ^ .
Z.DMZ.J l f l b Z P
1
rtcinnmu- growth, oncmpltAiitt-M, aiul iullaiiim in ZtXJH,
:.T.
21KH). JIiicI £010. J'rujirimns i«*re tuisifl mi intnniLUinri
avai lable through the conclusion of Ihc June meeting,
on each participant's assumptions regarding a range
of factors likely to affect economic outcomes, and oti
his or her assessment of appropriate monetary poiky.
"Appropriate monetary policy" is defined as the future
[KJIH s lhal. based {HI currem inFunnalicm. \\ iffemrii
most likely to foster outcomes for economic activity and
Inflation that best satisfy the participant's interpretation
a\ ihc Federal Re serve's dual objectives or maximum
employment and price stability.
FOMC part icipants generally expected that, over the
remainder ofthis year, output would expand at a pace
appreciably L;ELMV its trend rate, owing primarily lo
f cinliiiui-d uraknesN in linn^iui1, Niarki-K. ihv Mibstaniidl
RISE in energy prices in recent mcinihs. n\u\ the reduction in the availability of household and business credit
resulting from continued strains in iinanclal markets. As
Indicated In lahle 1 and rigure U output growth further
ahead was projected to pick upsufficiently to begin
to RWtnc untie of THE increase in (he unemployment
rate by 2010. In light of the recent surge in the prices
of oil and agricultural commodities, lota! inflation was
expected to rise further in coming months and to lie elevated for 2008 as a whole. However, many participants
expected that persistent economic slack and a flattening
ciul tt\ i-m-r^Y iirnl OIIKT f ciirimiKliCY prices in linr wilh
Fuiures uiarkel prices ivciuld rauw* IIYCMII inil;nn:ni to
decline notia'sbh in 2009 and 2010. Most participants
judged that grealer- than-notmal uncertainly surrounded
their projections for both output growth and Inflation.
A signiflcanl majority of participants v iewed the risks
tu i In ii Fim-fasts furnutpul gTiiwth as un^lni-tl lc> ihe
cln^insicle, ami a similar IIIIIIIIHT saiv I he risks lei [he
inflation outlook as skewed to the upside.
JStoJO
Z.OlaZ.I ZAtoJLi
S.3l>S.ft SOto16
) ?
IfhiZ.I
Uitl
UtoU 1 .fig XV
O . O t l S I.SulO
ISMU U K U
WinM
April fHijAHfq
1 7to 19
:ato3 5
Uto3Ll
SflioSS
IkKh.it
l.7ia3.Ch 1S»?.O
I T la Z Z
1 3to?.Q
N<J:I ' hufrt Iwmi DI <ka^(r in irjl ppuw dunw-JK piodurE U--1J1'I a d iJ
tnftflloi Jlr fivnt thr fmtih qnriin of ihr prvkn^ > M in itv (HHUI^ ipuirf c J
iVhrjnmlji jlnJ f t > itinjtkKi j n l i ixr rt I in CMH n jrr Ihr prir rnttjfr TJ(*-L
LJ Ifcung^rin.rir^finlih T K. Ihr H k r indr v ruri pcrmnfti E umunvriiufi cAUMrttnMn
IPC h> iod dif pitct hdft hf K E n t U k i R roodjod « w j p . ?ntfHiiixp. tar tht
i ^ r a ^ o j w d nMt- JIT rw Ihr JH CTJJP1 cii Hun unrmphn mral ratr n to I D H I I I
njwin nf HIT i r « jpjk^Onl l > h p«ltdpB«"i pnjnrtkHn « r tudrf m te w
brr rtfl^vmM <rf juinMUIr innrlii^ notici
I [ h<-1 rnllJI Irratnx ^ r\x kiiJn Ibr 1hrir httfrU j n j 1htrr IIFHTM fit^ntlnn
rof f « b ^ u b k tn t * k \TM
fnm totnl to b^hnj ( o DM l a u U r ' u i 4m i n
The Outlook
The central tendency of participants' projections for
real GDPgrowth in 2008. at 1.0 percent to 1 .6 percent.
was noticeably higher than the central tendencyof
the projections provided in conjunction with the April
FOMC meeting, which was 0.3 percenl to 1.2 percent.
The upward revmtni tu the 2008 out look stemmed
[irimarilv from lMitli'r-[Jianexp(i."Uid tljta fin cnnsiimer
and business spending received between the April and
June FOMC meetings. Nonetheless, several participants
noted thai the recent firmness In consumer spending could well prove transitory and thait i n ' ongoing
housing market correction, tigh t credit conditions, and
i=U• •-.!Li• • I i b n e r g > ' p r n ••••• w m i l i i i l a r u p f l n i i H ^ l i c { k ' m a i u l
in the second halfof this year. Still, the substantial eas-
88
40
Moneiary Policy Repon to the Congress
July 2008
Central Hndtnda andrangesof economic projections. 2008-10
{."funge in FL'JI GDP
• U'nlral m t a Q
j
—
t
—
J
—
I
2OD1
20O4
MM
M»
2007
200t
2004
1
I
2010
PttWM
JOM
2004
IOW
2006
2007
1008
20W
—
*
—
J
—
4
2010
— 3
— 2
—
2'Hl.l
20«
1
MU5
Core P C E inflation
— 4
— 3
— 2
— 1
ll
IhlinilriHHDrviinihloarcinilK n:*?*Imuhk I. Thedi[ufortlwKliul vulucfttif Ihtf vanjhlcs j
89
Boanf of Governors of (he Federal Reserve System A I
i ng cif monetary p»l it"y s I I K T ] A\\ year -i m 11 he roii t i n LU -i I
strength in exports shcnilt] help to support i-ronomic
growlh; in addition, st rains had cased somewhat in
some financial markets since April. Real GDP growth
was expected lo increase in 2009 as [he adjuslmenE
in the housing sector ran its course, financial niarkels
gradually resumed more-normal functioning, and the
downward pressure on real incomes ste mming from
Increases in energy and food prices in t he lirst half of
2008 began lo fade. In 2010, economic activity was
projected Ki expand at or a link1 alxivc participanls
estimates of the rate of trend growth,
With oulpul growth continuing lo run below trend
in the second half of 2003, most participants expected
might remain slightly above its longer-run sustainable
level even in 2010: total inHalion in 2010 was also
judged likely lo continue to run a bit ABOVE levels that
IIHKI i•.11 Jii L|>.uii\ vaw avconsistrnl wilh ihe pricr sta
bility objersive of ihe Federal Reserve's dual nunuhiti'.
Most participants saw further declines in btnti nnE'niplovmcnl and inflation ss likely in the period beyond
the. forecast horizon. (Sec table 1 on page 39 and
figure 1 on page 40).
Risks to the Outlook
]KII 11L b|)JllLS |)luf(( UullS fllf till" <)\fMj.»r r Ll IL1 (hi llllt'JIl
Most participants viewed the risks to their projections for GDP growth as weighted lo the downside
and the associated risks lo their projections for the
unemployment rate as lilted lo the upside. The pos-
ployment in t he fourthi juarter of 20UH was 5.5 percent
sihiliu due Imute priies t mild CJL-I ILJLL*1 nmre sfrrph 1
t(t 5.7 p e n e m , unclunited I'mm the ft1rural tendency of
than aniicipatMl. rurihtir r«hicinn, htigsehcilds' V.L-.IIIIL
s t r i c t i n g their access to credit, and eroding ibr capital
of lending institutions, continued lo \K perceived as a
significant downside risfc to the outlook for economic
growth. Although financial markets had shown some
further improvement since April, conditions in those
markets remained strained: a number of participants
ifi.ii rln- liiirniplnh, inrin i ,i[i- would iimvi 1 ii[i ^unteuliHii
over the remainder of this year The central tendency of
projections that were provided in conjunction w i l h the
April F O M C meeting and consistent with some slack
in resource utilization. The central tendency of participants' projections was for the unemployment rate to stabilize in 2009 and toedge down in 2010 as output and
employment growth pick up.
The surge in the prices of oil and agricultural com-
also |xnnk(l lt> die risk dni[ further iruprcuernpiic {ciuid
nictdiiii's siiife April led pjirtLc*ipjinis to rt-visc up
hi- cjuile slmv and vubjnc Hi rc'ljpv. Ihr piitejilijil fur
noticeably Iheir projection* for t o u l inflation in ihe
(iirreui lighi credit ruTidiiiim* t» I'^eri an mirxperiedly
near temn. However, the central tendency of partici-
Lntu fnre icitiaiinn irter die w.xt U-\\ numilis R a i n of
large m l mini nn houvholii and business spending was
also viewer! as a significant downside risk to economir
activity. An adverse feedback loop, in which weaker
economic activity led to a further worsening of financial
conditions, which in turn could damp economicgrowth
even further, continued lo be viewed as a worrisome
possibility, though less so than in April Indeed, some
IHJ11 L DM't.til and ccirr inil.nnjii were L'\|M-( d'd |ci decline
parltfi|ijnls p^inn. il N) die ^pjiareul n^iltciir i1 nf ihe
pants' projections for core PCE inOalion in 2D08 was
2,2 percent to 2,4 percent, unchanged from ihc central
tendency in April, as !OW er-lhan -cxpecled rates of core
inflation over recent months offset the expectations of
some [iniss thruu^li of die reteni surge in energy prices
iiver MM* n^xt tMQ yearv relleciing n rtaneninj" ciui of
U.S. ercinmny in iho farr cifreteiu ticiam ial {liMrcs^ .sud
the prices of oil and oiher commodities consistent with
suggested that the adverse effects of financial developments on economic activity outside of the housing sector could prove tobe more modest than anticipated.
futures market prices, slack in resource ulilizalion. and
longer-term inflation expectations mat were expected to
remain generally well anchored.
sha|]rd \i\ their jutJ^niE'iiTs aljciui die measurcfl rales
Most participants viewed the risks to their inflation
projections as weighted lo ihe upside. Recent sharp
increases in energy and food prices and the pass through of dollar depreciation into import prices could
(hi imljfimi rcinsisteni wilh die Fedrnd Resen'c'i ilu.il
THKISI inflation in die uejir lenit by umre IILIII cunrnEly
mamlale tt> |jroinoie ni^ximuni emplciymenl and price
a substantial period of lime for output and in flation to
anlicipale<l AllJinugti parciripjnis grnemJIy assunie^l
that commodity prices will flatten out. roughly in line
with the trajectory implied by futures prices, the fart
that futures markets had persistently undcrpredicted
commodity prices in recent experience was viewed as
recover from the recent shocks, whEch had elevated
, n i LipsiUi- t i s k
The contour of participants' projections for output
gTuwth, miemptoyinenj, aiul inliaiioit iv^s importantly
stability and about the time horizon over which policy
should aim to attain those rates given current economic
conditions. Most participantsjudged that it might take
infl ATioni and damped economic activity. A number of
ji.n in. L|:uiiL\ ]»t)|L={ Li (I ili.it liter rate of unemployment
:
1
IL> 1311- •:11]111 II ik trir i i i i : , n i i i n . F a r i i i ij.uni -.
also saw a risk that inflation expectations could become
less llnnly anchored, particularly if the current elevated
42
Monetary Policy Report lo the Congress
July 2008
rates of headline Inflation did not moderate as quickly
as they expected
Participants continued to view uncertainty about the
outlook for economic activity as higher lhau normal,
with a number pointing to uncertainly about the duration and effects of the ongoing Hnancial strainson real
activity- In addition, participants expressed noticeably
Table 2. Average historical projectione rror
ZOOS
r
2MB
9±U
\< in: h(nn nantMhawi
ll.l
a w i t i H pkn M nitam thf- toot mrw M|iiJ(
nn ir i- mnriE.iHt;-'. atkiut thrii inflation pruJLtliuns than
they had In January anil April, a shift in perception thai
they attributed importantly to increased uncertainly
aboul Ibe future course of ENERGY and food prices and
(o greater uncertainly about the extent of pass through
of changes in [hose prices Into core inflation, ft able 2
provides estimates of forecast uncertainty for real (.DP
growth, umTii|jtuv[iHhi][, mill inflaiion since 1987.")
Ifi ibf bo\ "Fwcui LiKcrulm, uoiW • nUin t p
flbnC 170 prrrrnt pipbjhilJ^ itut «iui] auimnHT Iv ITJI t'Uf. wn mfil m>mnH.
jfd tmuinn p*wr% will br 1B rm&\ in^Jlrd Ih llv iirrap- ILFTJ pm)n4ian
n n n n y r t a i k pw. Fdihrf UTuiuiian ksii Hi^ hi Rtfu hvkW a d Prtn
Tvlipl2(»7L'tJi«ii*lbtliKrTtilA rfUtr Erqwmk UulwA from Nnlorittl
lonxill^I hnrn," flninr J«d hmxnHi Dnrin^un Snin ^OOJ M {EfciMtl
orGnrnM\or<brFAkfalRnnvrS^wnL Nm^tirtl
1. Fu nrJdrillUH. lrf« In ftntrMl AUr la LtMr I
2. Mf«MTh kfctmmll i m u n h pNkr tsdn. lb< pfkr I H W T ikM hn
bcra RHHt it-Mtty mrd la jpjifTumrft «ioJ pivitr nwHtntr rwrr-Jdtv ftnfrcitan h pnrnd i k ^ fmulh QBirtrr of Ibr prrtop jmr m (br fwrth quMln
f f a f t r f
Diversity of Participants' Views
Figures 2.A and 2.B provide more detail on the diversity of participants' views regarding likely economic
outcomes over the projection period. The dispersion of
participants' projections for real CDP growth in ZOOS
was noticeably narrower than In the forecasts provided
In April , reflecting primarily the accumulation of data
aboul the actual performance of Ibe economy in the
first half of the year; their views aboul output growth
In coming quarters and In M09 continued lo exhibit
appreciable dispersion. The dispersion of participants'
projections for real activity next year seemed largely to
retire! differing assessments of tile effects of adverse
financial market conditions on economic growlh. the
speed with which credit conditions might improve, and
Ihe depth and dunilion of thecorrection in the housing
market. Indeed, views differed notably on the paceat
l l . T V box "l-omriM UnrrftaLnEy' Jl llr rod of ihii vimnun
dLvrascrt the w u r m 3ml 1-iErrprrtai wtn of urn trlainly in rronomk"
f<xrra.\l\ and rxplalu^ ihr appnuch inei\ la l u r a ihr unrctiainfi And
Tisk-i JllmtLn^ pjii kipjni *" prnjrrliofn.
which {Hil|Mil nml i'mplcivmejil n{iii!{l recover in ^OdS),
w i l h w m p p^rtit i[wni\ rxpm%ingu c y n r r m Mini grciuih
illi'.llil In- ( onsCr.iilH i\ h\ t h r fM-lSJ^N-IH i- <M 1:11,1114 i.ll
strains over a considerable period. Thedispersion of
part icipants' longer-term projections was atso affceied
to some degree bydifferences in their judgments aboul
the economys trend growth rate and the unemployment
rate that would be consistent over time with maximum
employment. The dispersion of the projections for PCE
mHalion in the near term reflected in large part differing views on the extent to which recent increases in
energy and food prices would pass through inlo higher
consumer prices. In addition, participants held differ
tng views on the degree to which inHalion expectations
were anchored and the role that expectations might play
In the inflation process over the short and medium term.
Participants' Inflation projections furt her ahead were
shaped by the views of the rale of in Hal ion consistent
with the Federal Reserve's dual objectives and Ibe lime
it would lake to achieve these goats given current economic conditions and appropriate policy.
91
Board ofGovernors of 'tiw Federal Reserve System 43
Figure 2,A. Dislributfon of participants" projections for the change in real <JDP and for Ihc unemployment rule. 2QQB-1P
(h..;f iartiH.DP
L ntmnloi mmi raCi
— 14
— 11
— 10
— •
— I
4.3
4.9
S.Q 5.2
5.1 J.J
$.i
5.J
5ft 5.S
5.7 5.9
4.
5
I.I
S.J
5.0 J.S
5.7 V9
M
4^
^D
3 1
5.1
5J
$4
J.5
3.0 S.S
5.7 5Q
Ifi
— H
— 12
— 10
— •
— A
J
— 16
— N
— IZ
— 10
— >
— 6
— 4
intkjen^fJI IV.XC IUul
0.0
6.2
b.1
6i
AA
M o n r t a i y Policy Rep-url L» Ihe Congress
F i g u r e I K . l>Lh.[rihuiELi]-i
1
J u l y 2UH8
projections for PCE inflation and ihreorePOiinfla n f l a t i o n .
-OdK
HJ
< . I . PC1- inflation
— 16
B
Jlunc proJL-clion
«
l|-i i
— H
;•:•.• ii-iJiii-
"
Aprilp
— 15
— 10
—
1
— ft
.nil..
I.I
-
2 0 M
If,
—
-IJ
-
i:
-
ID
—
*
i
.
— 6
1.4
— 16
|J
L
J
— 6
— A
— 2
| J I.T FA 11 I I 1-i J-I 1 * J.L i J I.S 1.T v i j i .114iH. I K i\y i i IA U U U *.3 L t U U U U <+ - " .
Pncminiip
li HI; PcfimliLin* nl' vjnnhlcs. jf^ I \t Lfcf EflVniJ rwHc lii tqbk 1.
Id
L.h
U
U
JJ
14
93
Boaid of Covernors ofihe Federal Reserve System
Forecasi Uncertainty
The Konomic projections provided hy the
member of the Board of Governors and the
presidents of the Federal Reserve Banks inform
discussions of monetary policy ^.monp policymakera and can aid public understanding of the
haiis for policy act ions. Considerable uncertoiii-Ey attends threw projection^ hovwwr. The
economic and statistical models and relationships used to help produce economic forecasts
are necessarily Imperfect descriptions of ibe real
world. And the future path of ihe economy can
be affected by myriad unforeseen development
)nd evenK. Thuh, in M.'l1rnn ihe iiliirKt? cif riiurtetary policy. participa nts consider not only wftal
appears to be Ihe most Eikely economic outcome
as embodied in iheir projections, hut also ihe
i.ii ,,.• i..: .ii1iTii.i1ivf istts'.ihililii".. ill' 1 MtcliFinorl
of their occurring, and the polenltsl m>^ to the
economy shoutd they occur.
Table 2 (see pafie 42} summarizes the average historical accuracy of a range of forecasts,
including those rtC|i[»rtr-d in piist Mono-Mry Policy
Reports and those prepared by Federal Reserve
Board staff in advance of meetings of [he federal
Open Mcirkt-l Commitlec. The projection error
ranges shown bi ihe table illustrate the considerabJe uncertainty associated with economic
forecasts. For example, suppose a participant
projects that real uross domestic product (GDP)
and total consumer prices will rise steadily at
annual rates ofr respectively, 3 percent and
2 percent. If the uncertainly atlendiinji those
projections i-s similar to that experienced m ihe
\wA and the rista around the projections are
broadly balanced, the numbers reported in table
2 would imply a probability of about 70 percent
that ad HA l GDP would expand 2A percent l o
i.O percent in the current year, 1.7 percent lo
4,3 percent [n ihe second year, and 1 .h percent
to 4.4 percent in Ihe third year. The corresponding 70 percent confidence interval for overall
Inflation would b e 1 A percent to 2,fr percent in
the current year and 1.0 percent lo 3.0 percent
in the second and iliird years,
Bee Ltust-1 c LJITI'I.-JII condiiicins may differ from
those t hat prevailed on average over history,
participants provide judgments as to whether ihe
uncertainly attached to their projections of each
. I I i . i l i h ' is greater than, smaller than, or broadly
similar to lypicaI levels of forecast uncerlainly
in the past as shown in table 2. Participants
also provide judgments as lo whether ihe risks
to Iheir projections are weighted to Ihe upsidej
downside, or are broadly balanced. Thai is, partic ipants judge whe t he r each variable is more
likely to be above or below their protections of
the most likely outcome. These judgments about
Ifir inn r'M.iiriU ,in. I llit' rrk- .Mr
hnu. K-.H FI
participant's projections are distinct from ihe
diversity of partic ipants' views about ihe most
likely outcomes. Forecast uncertainty is concerned wilh the risks associated with a particular
projection, raiher ihan wilh divergences across a
number of different projections,.
45
@FedFRASER