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MONETARY POLICY AND THE
STATE OF THE ECONOMY
HEARING
BEFORE THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED THIRTEENTH CONGRESS
FIRST SESSION
FEBRUARY 27, 2013
Printed for the use of the Committee on Financial Services
Serial No. 113–3
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HOUSE COMMITTEE ON FINANCIAL SERVICES
JEB HENSARLING, Texas, Chairman
GARY G. MILLER, California, Vice Chairman
SPENCER BACHUS, Alabama, Chairman
Emeritus
PETER T. KING, New York
EDWARD R. ROYCE, California
FRANK D. LUCAS, Oklahoma
SHELLEY MOORE CAPITO, West Virginia
SCOTT GARRETT, New Jersey
RANDY NEUGEBAUER, Texas
PATRICK T. MCHENRY, North Carolina
JOHN CAMPBELL, California
MICHELE BACHMANN, Minnesota
KEVIN McCARTHY, California
STEVAN PEARCE, New Mexico
BILL POSEY, Florida
MICHAEL G. FITZPATRICK, Pennsylvania
LYNN A. WESTMORELAND, Georgia
BLAINE LUETKEMEYER, Missouri
BILL HUIZENGA, Michigan
SEAN P. DUFFY, Wisconsin
ROBERT HURT, Virginia
MICHAEL G. GRIMM, New York
STEVE STIVERS, Ohio
STEPHEN LEE FINCHER, Tennessee
MARLIN A. STUTZMAN, Indiana
MICK MULVANEY, South Carolina
RANDY HULTGREN, Illinois
DENNIS A. ROSS, Florida
ROBERT PITTENGER, North Carolina
ANN WAGNER, Missouri
ANDY BARR, Kentucky
TOM COTTON, Arkansas
MAXINE WATERS, California, Ranking
Member
CAROLYN B. MALONEY, New York
NYDIA M. VELÁZQUEZ, New York
MELVIN L. WATT, North Carolina
BRAD SHERMAN, California
GREGORY W. MEEKS, New York
MICHAEL E. CAPUANO, Massachusetts
RUBÉN HINOJOSA, Texas
WM. LACY CLAY, Missouri
CAROLYN MCCARTHY, New York
STEPHEN F. LYNCH, Massachusetts
DAVID SCOTT, Georgia
AL GREEN, Texas
EMANUEL CLEAVER, Missouri
GWEN MOORE, Wisconsin
KEITH ELLISON, Minnesota
ED PERLMUTTER, Colorado
JAMES A. HIMES, Connecticut
GARY C. PETERS, Michigan
JOHN C. CARNEY, JR., Delaware
TERRI A. SEWELL, Alabama
BILL FOSTER, Illinois
DANIEL T. KILDEE, Michigan
PATRICK MURPHY, Florida
JOHN K. DELANEY, Maryland
KYRSTEN SINEMA, Arizona
JOYCE BEATTY, Ohio
DENNY HECK, Washington
SHANNON MCGAHN, Staff Director
JAMES H. CLINGER, Chief Counsel
(II)
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CONTENTS
Page
Hearing held on:
February 27, 2013 ............................................................................................
Appendix:
February 27, 2013 ............................................................................................
1
57
WITNESSES
WEDNESDAY, FEBRUARY 27, 2013
Bernanke, Hon. Ben S., Chairman, Board of Governors of the Federal Reserve
System ...................................................................................................................
6
APPENDIX
Prepared statements:
Ross, Hon. Dennis ............................................................................................
Bernanke, Hon. Ben S. .....................................................................................
ADDITIONAL MATERIAL SUBMITTED
FOR THE
RECORD
Bernanke, Hon. Ben S.:
Monetary Policy Report to the Congress, dated February 26, 2013 .............
Written responses to questions submitted by Representative Bachus ........
Written responses to questions submitted by Representative Fitzpatrick ..
Written responses to questions submitted by Representative Garrett ........
Written responses to questions submitted by Representative Maloney ......
Written responses to questions submitted by Representative Mulvaney ....
Written responses to questions submitted by Representative Ross .............
Written responses to questions submitted by Representative Royce ...........
Written responses to questions submitted by Representative Stivers .........
(III)
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MONETARY POLICY AND THE
STATE OF THE ECONOMY
Wednesday, February 27, 2013
U.S. HOUSE OF REPRESENTATIVES,
COMMITTEE ON FINANCIAL SERVICES,
Washington, D.C.
The committee met, pursuant to notice, at 10 a.m., in room 2128,
Rayburn House Office Building, Hon. Jeb Hensarling [chairman of
the committee] presiding.
Members present: Representatives Hensarling, Miller, Bachus,
Royce, Capito, Garrett, Neugebauer, McHenry, Campbell,
Bachmann,
Pearce,
Posey,
Fitzpatrick,
Westmoreland,
Luetkemeyer, Huizenga, Duffy, Hurt, Grimm, Stivers, Fincher,
Stutzman, Mulvaney, Hultgren, Ross, Pittenger, Wagner, Barr,
Cotton; Waters, Maloney, Velazquez, Watt, Sherman, Meeks,
Capuano, Hinojosa, Clay, McCarthy of New York, Scott, Green,
Cleaver, Moore, Ellison, Perlmutter, Himes, Peters, Carney, Sewell,
Foster, Kildee, Murphy, Delaney, Sinema, Beatty, and Heck.
Chairman HENSARLING. The committee will come to order.
Without objection, the Chair is authorized to declare a recess of
the committee at any time.
The Chair now recognizes himself for an opening statement.
We are clearly in the midst of the slowest and weakest recovery
in the post-war era, notwithstanding what we have observed to be
the largest fiscal and monetary stimulus in our Nation’s history.
Although one quarter does not make a trend, having negative economic growth in the last quarter was not good news. Otherwise, we
appear to be mired in 11⁄2 to 2 percent economic growth, when 3
percent is the norm and, clearly, 4 percent is the potential. This
translates into millions of lost jobs and hundreds of billions of dollars of lost revenue to the Treasury.
But beyond the numbers, we have to look at the people. I look
at my constituents, I listen to them. They are concerned about how
they are going to fill up their pickup trucks, and how they are
going to afford groceries. Their health care premiums have gone
up. They are insecure in their paychecks. They are not getting
ahead.
So as we welcome Chairman Bernanke back for his semiannual
Humphrey-Hawkins testimony before our committee, many wonder, where do we find the road forward?
After quadrupling its balance sheet, engaging in unprecedented
mortgage-backed security asset purchases, and creating an extended negative real interest rate environment, there is a growing
consensus among economists that the Federal Reserve’s road has
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led us to the monetary ‘‘Outer Limits.’’ And if one remembers that
classic science fiction television program, typically the episodes did
not end well. They did not have happy endings, and I fear this may
prove true for the current Federal Reserve policy.
For diminishing marginal benefits, the Federal Reserve’s unconventional strategy creates considerable risk. If the balance sheet is
not unwound at the right time and at the right pace, we could be
looking at another deep recession, soaring inflation, or skyrocketing
interest rates, all of which could make us look longingly and nostalgically upon the Jimmy Carter era of stagflation.
All central bankers are familiar with Walter Bagehot’s dictum of
the central bank’s lender-of-last-resort function, ‘‘Lend freely at a
high rate on good collateral.’’ Many of us believe the Fed has gone
way beyond that. The extraordinary measures of 2008 appear to
have become the ordinary measures of 2013.
Walter Bagehot also said, ‘‘What impresses men is not mind, but
the result of mind.’’ And although the Federal Reserve contains
many impressive minds and many impressive public servants, currently millions of unemployed and underemployed Americans are
not impressed with the results. I believe that is because today the
economic challenges of our nature are essentially fiscal in nature,
not monetary. They cannot be solved by the Fed.
The reasons that the Nation is mired in the slowest, weakest recovery in the post-war era are simple. Under this President, we
have seen a 53 percent increase in job-harming Federal tape and
regulations. They tend to fall into two categories: those that create
uncertainty; and those that create certain harm. Under this President, we have witnessed a spending spree, including the $1 trillion
failed stimulus that has grown government from 20 percent of GDP
to 24 percent. Under this President, a long-threatened $1.6 trillion
tax increase has just been imposed upon small businesses and
many working families. And under this President, more debt has
been created in 4 years on a nominal basis than in our Nation’s
first 200 years, now weighing in at approximately $136,000 per
household.
So let’s examine the tale of two recoveries. The 1981–1982 recession was deeper in terms of GDP contraction, and unemployment
was higher, and the recession was similar in its financial nature.
And, in this case, the economy faced a dramatic contractionary
monetary policy that pushed interest rates over 20 percent. Yet, because President Reagan ushered in a pro-growth tax relief, established budget discipline, relieved much of the burden of foolish red
tape, and promoted and celebrated free-market capitalism, we witnessed one of the quickest and most powerful recoveries in the Nation’s history. President Obama and the U.S. Senate could certainly
profit from this example. Again, today, our challenges are primarily
fiscal in nature, not monetary.
Finally, as I close, since I know both the Chairman and many
Members will speak to the pending sequester, I have no doubt that
our President is quite capable of designing the meager budget savings represented in the sequester in such a way as to maximize
pain to the American people. But as a matter of fact, even after the
sequester, government outlays will be $15 billion more next year,
and 30 percent greater than the year President Obama was first
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elected. Meanwhile, the national debt clock to my right and to my
left continues to spin out of control, threatening our national security, our economic recovery, and our children’s future.
I now recognize the ranking member for 5 minutes for an opening statement.
Ms. WATERS. Thank you very much, Mr. Chairman. I am very
appreciative for the fact that you are holding this hearing.
But before I begin my statement today, I would like to take a
moment to recognize Mr. Dave Smith, the chief economist of the
Democratic staff of the Financial Services Committee, who will be
retiring at the end of this week. Dave has been an invaluable resource to the members of this committee, and we will certainly
miss having his counsel and guidance. We thank him for his dedication and extensive service and wish him all the best in his future
endeavors.
Mr. Dave Smith.
[applause]
Chairman HENSARLING. Can you please restart the clock for the
ranking member?
Ms. WATERS. And, with that, I am very pleased to welcome
Chairman Bernanke before the committee to present his report on
the conduct of monetary policy and the state of the economy, as required twice a year by the Humphrey-Hawkins Act.
First, I would like to commend Chairman Bernanke for his leadership and bold efforts, in cooperation with the Federal Open Market Committee (FOMC), to foster the conditions that stimulate
lending, economic activity, and private sector job creation.
While some have expressed concerns about the potential risk involved in the Fed’s aggressive quantitative easing programs, I sincerely believe our central bank’s actions have provided critical support for our Nation’s economic recovery. In fact, the Fed’s intervention may be one of the few actions protecting that recovery from
some of my colleagues’ ongoing pursuit of retractionary fiscal policies.
As we sit here today, yet another manufactured fiscal crisis
looms due to sequestration’s automatic spending cuts that are
scheduled to take effect in just 2 days. And despite those who wish
to downplay the impact of sequestration, the costs are real. The
CBO estimates that 750,000 jobs are at stake in 2013. The Bipartisan Policy Center projects the loss of at least a million jobs over
the next 2 years. And a recent George Mason University study put
the number at 2.14 million jobs, over 950,000 of which would be
attributable to losses by small businesses.
It is my hope that both Republicans and Democrats can come together to construct a more balanced approach to addressing the
deficit while protecting our Nation’s ongoing recovery from the
worst financial crisis since the Great Depression.
With that in mind, I wanted to use this opportunity to note a
GAO report released last month which outlined the enormous cost
of the financial crisis to the U.S. economy. The GAO found that the
financial crisis’ impact on economic output could be as much as $13
trillion, and, in addition, the amount of home equity wealth lost by
U.S. homeowners reached $9.1 trillion.
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And this is precisely why I believe it is imperative that we fully
implement the regulatory reforms within the Wall Street Reform
Act in order to ensure that we never again experience a crisis like
the one that occurred in 2008.
I look forward to Chairman Bernanke’s insight on all of these
matters and, in particular, his perspective on how the automatic
spending cuts scheduled to take effect this week will impact our
Nation’s recovery and economic growth.
Mr. Bernanke, members of this committee, and Chairman
Hensarling, I would like you to know that I take these HumphreyHawkins reports that are done twice a year seriously. As many of
you know, Gus Hawkins was my predecessor. And when I ran for
office, I ran for office at the time that Gus Hawkins was getting
involved with this dual mandate that is the essence of the Humphrey-Hawkins Act.
We know that Mr. Hawkins was concerned about jobs and he
was concerned about monetary policy. And because of his concern,
he worked very hard with Senator Hubert Humphrey to make sure
that jobs and monetary policy played an important role in the deliberations and the debate and the discussions that go on in the
Congress of the United States of America.
And so, as we are faced with sequestration, we must understand
the negative impact that sequestration and these cuts will have on
jobs and the economy. And your being here today, Mr. Bernanke,
is extremely important, because no one knows better than you
about the impact of sequestration and what it will do to our jobs
and our jobs potential in this country and, of course, the monetary
policy that you have so creatively and so expertly guided to help
get us back on the road to growth. And without what you are
doing, we would not have maintained growth, slow as it may be,
without what you have done and your leadership. I thank you very
much.
And I yield back the balance of my time.
Chairman HENSARLING. The Chair now recognizes the chairman
of the Monetary Policy and Trade Subcommittee, the gentleman
from California, Mr. Campbell, for 3 minutes.
Mr. CAMPBELL. Thank you, Mr. Chairman.
And welcome, Chairman Bernanke.
You said yesterday, and you will say today, that you believe the
short-term benefits of the current loose monetary policy exceed the
longer-term risks. We know from the release of the Federal Open
Market Committee minutes last week that there is some dissension
within the FOMC on that viewpoint. I am going to join in the chorus of dissension about that viewpoint. And I would like to just
quickly detail seven risks that I believe exist which, together, are
exceeding what I believe are now the meager benefits of the current monetary policy.
First of all, there are bubbles out there. I would argue that there
is one in high-yield bonds, perhaps in farmland, and certainly in
the Federal budget.
Second, where there are not bubbles, there are distortions, as
people are having a difficulty pricing risk, and there are distortions
in the economy. When these bubbles and distortions unwind, those
are going to create problems.
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Third, I hear all the time that the major investment and business strategy now is, don’t fight the Fed. That is not a real business strategy. That is not looking out at long-term vision. That is
not making decisions on where you think markets will go. That is
simply following the directive of an agency that unfortunately has
too great a footprint, in my opinion, in the economy today.
Fourth, all of this is actually not injecting certainty but, in my
view, injecting uncertainty into decision-making in the economy
today.
Fifth, savers and retirees are being forced into riskier assets in
the search for some sort of yield. When this unwinds, that is going
to be a problem for our savers and retirees. We all in economics
learned early on, as you get older, take less risk. But now what we
find is as people are getting older, they are having to violate that
principle, and in search of some kind of yield, are taking much,
much greater risks, which could be a problem in the future.
Sixth, for every 1 percent that the interest rates on Treasury
bills go up, it will add $1 billion of deficit to the Federal budget.
And, seventh, the Federal Reserve itself has risks now, with the
large balance sheet and the large number of holdings that the Federal Reserve has.
In this Member’s opinion, Mr. Chairman, we have gone too far
in the monetary policy and the monetary easing, and it is, in this
Member’s opinion, time to pull back.
I yield back.
Chairman HENSARLING. The gentleman yields back.
The Chair now recognizes the ranking member of the Monetary
Policy and Trade Subcommittee, the gentleman from Missouri, Mr.
Clay, for 3 minutes.
Mr. CLAY. Thank you, Chairman Hensarling, for holding this
hearing on monetary policy and the state of the economy.
Also, thank you, Chairman Bernanke, for appearing today.
The Full Employment and Balanced Growth Act of 1978, better
known as the Humphrey-Hawkins Act, set four benchmarks for the
economy: full employment; growth in production; price stability;
and the balance of trade and budget. To monitor progress toward
these goals, the Full Employment and Balanced Growth Act of
1978 mandated that the Board of Governors of the Federal Reserve
System present semiannual reports to Congress on the state of the
U.S. economy and the Nation’s financial welfare.
Humphrey-Hawkins charges the Federal Reserve with a dual
mandate: maintaining stable prices; and full employment. Currently, the unemployment rate is 7.9 percent, down from 8.3 percent a year ago. Still, millions in this country would like to work
but cannot find work. Consumer price inflation has increased as
prices of consumer food and energy have increased from the pace
seen in previous months. Recent price increases in retail gasoline
have increased the cost of food.
All of these factors play a very important role in getting America
back to economic growth and prosperity. And I look forward to
Chairman Bernanke’s comments.
Mr. Chairman, I yield back.
Chairman HENSARLING. The gentleman yields back.
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At this time, we will welcome our distinguished witness, one of
Washington’s ablest public servants, Ben Bernanke, the Chairman
of the Board of Governors of the Federal Reserve System. And, as
the phrase goes, he needs no further introduction.
Chairman Bernanke, you will be recognized for 5 minutes to give
an oral presentation of your written testimony. Without objection,
your written statement will be made a part of the record.
Once you have finished presenting, each Member of the committee will have 5 minutes within which to ask any or all questions. I wish to inform all Members that Chairman Bernanke will
be allowed to exit at 1 p.m., and this chairman will ride the gavel
accordingly. So if you ask a question with 10 seconds to go on the
clock, do not expect an answer.
On the Republican side, I wish to inform our Members that,
should you not be able to ask questions of the Chairman today, you
will receive priority at the Chairman’s next appearance before our
committee.
Chairman Bernanke, at this time, please proceed.
STATEMENT OF THE HONORABLE BEN S. BERNANKE, CHAIRMAN, BOARD OF GOVERNORS OF THE FEDERAL RESERVE
SYSTEM
Mr. BERNANKE. Thank you, Mr. Chairman, Ranking Member Waters, and members of the committee. I am pleased to present the
Federal Reserve’s semiannual monetary policy report. I will begin
with a short summary of current economic conditions and then discuss aspects of monetary and fiscal policy.
Since I last reported to this committee in mid-2012, economic activity in the United States has continued at a moderate, if somewhat uneven, pace. In particular, real GDP is estimated to have
risen at an annual rate of about 3 percent in the third quarter but
to have been essentially flat in the fourth quarter.
The pause in real GDP growth last quarter does not appear to
reflect a stalling out of the recovery. Rather, economic activity was
temporarily restrained by weather-related disruptions and by transitory declines in a few volatile categories of spending, even as demand by U.S. households and businesses continued to expand.
Available information suggests that economic growth has picked up
again this year.
Consistent with the moderate pace of economic growth, conditions in the labor market have been improving gradually. Since
July, non-farm payroll employment has increased by 175,000 jobs
per month on average and the unemployment rate has declined
three-tenths of a percentage point to 7.9 percent over the same period. Cumulatively, private sector payrolls have now grown by
about 6.1 million jobs since their low point in early 2010 and the
unemployment rate has fallen a bit more than 2 percentage points
since its cyclical peak in late 2009.
Despite these gains, however, the job market remains generally
weak, with the unemployment rate well above its longer-run normal level. About 4.7 million of the unemployed have been without
a job for 6 months or more, and millions more would like full-time
employment but are able to find only part-time work.
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High unemployment has substantial costs, including not only the
hardship faced by the unemployed and their families but also the
harm done to the vitality and productive potential of our economy
as a whole. Lengthy periods of unemployment and underemployment can erode workers’ skills and attachment to the labor force
or prevent young people from gaining skills and experience in the
first place, developments that could significantly reduce their productivity and earnings in the longer term. The loss of output and
earnings associated with high unemployment also reduces government revenue and increases spending, thereby leading to larger
deficits and debts.
The recent increase in gasoline prices, which reflects both higher
crude oil prices and wider refining margins, is hitting family budgets. However, overall inflation remains low. Over the second half
of 2012, the price index for personal consumption expenditures rose
at an annual rate of 11⁄2 percent, similar to the rate of increase in
the first half of the year. Measures of longer-term inflation expectations have remained in the narrow ranges seen over the past several years. Against this backdrop, the FOMC anticipates that inflation over the medium term will likely run at or below its 2 percent
objective.
With unemployment well above normal levels and inflation subdued, progress toward the Federal Reserve’s mandated objectives of
maximum employment and price stability has required a highly accommodative monetary policy. Under normal circumstances, policy
accommodation would be provided through reductions in the
FOMC’s target for the Federal funds rate, the interest rate on overnight loans between banks. However, as this rate has been close
to zero since December 2008, the Federal Reserve has had to use
alternative policy tools.
These alternative tools have fallen into two categories. The first
is forward guidance regarding the FOMC’s anticipated path for the
Federal funds rate.
At its December 2012 meeting, the FOMC provided more explicit
guidance on how it expects the policy rate to respond to economic
developments. Specifically, the December post-meeting statement
indicated that the current exceptionally low range for the Federal
funds rates ‘‘will be appropriate as long as the unemployment rate
remains above 61⁄2 percent, inflation between 1 and 2 years ahead
is projected to be no more than half a percentage point above the
Committee’s 2 percent longer-run goal, and longer-term inflation
expectations continue to be well-anchored.’’
An advantage of the new formulation relative to the previous
date-based guidance is that it allows market participants and the
public to update their monetary policy expectations more accurately in response to new information about the economic outlook.
The new guidance also serves to underscore the Committee’s intention to maintain accommodation as long as needed to promote a
stronger economic recovery with stable prices.
The second type of nontraditional policy tool employed by the
FOMC is large-scale purchases of longer-term securities, which,
like our forward guidance, are intended to support economic growth
by putting downward pressure on longer-term interest rates. The
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Federal Reserve has engaged in several rounds of such purchases
since 2008.
Last September, the FOMC announced that it would purchase
agency mortgage-backed securities at a pace of $40 billion per
month. And in December, the Committee stated that, in addition,
beginning in January, it would purchase longer-term Treasury securities at an initial pace of $45 billion per month.
These additional purchases of longer-term Treasury securities replace the purchases we were conducting under our now-completed
Maturity Extension Program, which lengthened the maturity of our
securities portfolio without increasing its size. The FOMC has indicated that it will continue purchases until it observes a substantial
improvement in the outlook for the labor market in a context of
price stability.
The Committee also stated that in determining the size, pace,
and composition of its asset purchases, it will take appropriate account of their likely efficacy and costs. In other words, as with all
of its policy decisions, the Committee continues to assess its program of asset purchases within a cost-benefit framework.
In the current economic environment, the benefits of asset purchases and of policy accommodation more generally are clear. Monetary policy is providing important support to the recovery while
keeping inflation close to the FOMC’s 2 percent objective. Notably,
keeping longer-term interest rates low has helped spark recovery
in the housing market and led to increased sales and production
of automobiles and other durable goods. By raising employment
and household wealth—for example, through higher home prices—
these developments have, in turn, supported consumer sentiment
and spending.
Highly accommodative monetary policy also has several potential
costs and risks, which the Committee is monitoring closely. For example, if further expansion of the Federal Reserve’s balance sheet
were to undermine public confidence in our ability to exit smoothly
from our accommodative policies at the appropriate time, inflation
expectations could rise, putting the FOMC’s price stability objective
at risk.
However, the Committee remains confident that it has the tools
necessary to tighten monetary policy when the time comes to do so.
As I noted, inflation is currently subdued and inflation expectations
appear well-anchored. Neither the FOMC nor private forecasters
are projecting the development of significant inflation pressures.
Another potential cost that the Committee takes very seriously
is the possibility that very low interest rates, if maintained for a
considerable time, could impair financial stability. For example,
portfolio managers dissatisfied with low returns may reach for
yield by taking on more credit risk, duration risk, or leverage. On
the other hand, some risk-taking, such as when an entrepreneur
takes out a loan to start a new business or an existing firm expands capacity, is a necessary element of a healthy economic recovery.
Moreover, although accommodative monetary policies may increase certain types of risk-taking, in the present circumstances
they also serve in some ways to reduce risk in the system, most
importantly by strengthening the overall economy, but also by en-
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couraging firms to rely more on longer-term funding and by reducing debt service costs for households and businesses.
In any case, the Federal Reserve is responding actively to financial stability concerns through substantially expanded monitoring
of emerging risks in the financial system, an approach to the supervision of financial firms that takes a more systemic perspective,
and the ongoing implementation of reforms to make the financial
system more transparent and resilient.
Although a long period of low rates could encourage excessive
risk-taking, and continued close attention to such developments is
certainly warranted, to this point we do not see the potential cost
of the increased risk-taking in some financial markets as outweighing the benefits of promoting a stronger economic recovery
and more rapid job creation.
Another aspect of the Federal Reserve’s policies that has been
discussed is their implications for the Federal budget. The Federal
Reserve earns substantial interest on the assets it holds in its portfolio, and other than the amount needed to fund our cost of operations, all net income is remitted to the Treasury. With the expansion of the Federal Reserve’s balance sheet, yearly remittances
have roughly tripled in recent years, with payments to the Treasury totaling approximately $290 billion between 2009 and 2012.
However, if the economy continues to strengthen, as we anticipate, and policy accommodation is accordingly reduced, these remittances will likely decline in coming years. Federal Reserve analysis shows that remittances to the Treasury could be quite low for
a time in some scenarios, particularly if interest rates were to rise
quickly.
However, even in such scenarios, it is highly likely that average
annual remittances over the period affected by the Federal Reserve’s purchases will remain higher than the pre-crisis norm, perhaps substantially so. Moreover, to the extent that monetary policy
promotes growth and job creation, the resulting reduction in the
Federal deficit would dwarf any variation in the Federal Reserve’s
remittances to the Treasury.
Mr. Chairman, I have a couple more pages on fiscal policy. Will
you allow me to complete it, or should I stop?
Chairman HENSARLING. You can proceed, Mr. Chairman.
Mr. BERNANKE. Thank you, Mr. Chairman.
Although monetary policy is working to promote a more robust
recovery, it cannot carry the entire burden of ensuring a speedier
return to economic health. The economy’s performance, both over
the near term and in the longer run, will depend importantly on
the course of fiscal policy. The challenge for the Congress and the
Administration is to put the Federal budget on a sustainable longrun path that promotes economic growth and stability without unnecessarily impeding the current recovery.
Significant progress has been made recently toward reducing the
Federal budget deficit over the next few years. The projections released earlier this month by the CBO indicate that under current
law, the Federal deficit will narrow from 7 percent of GDP last
year to 21⁄2 percent in Fiscal Year 2015. As a result, the Federal
debt held by the public, including that held by the Federal Reserve,
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is projected to remain roughly 75 percent of GDP through much of
the current decade.
However, a substantial portion of the recent progress in lowering
the deficit has been concentrated in near-term budget changes,
which, taken together, could create a significant headwind for the
economic recovery. The CBO estimates that deficit-reduction policies in current law will slow the pace of real GDP growth by about
11⁄2 percentage points this year relative to what it would have been
otherwise.
A significant portion of this effect is related to the automatic
spending sequestration that is scheduled to begin on March 1st,
which, according to the CBO’s estimates, will contribute about sixtenths of a percentage point to the fiscal drag on economic growth
this year.
Given the still moderate underlying pace of economic growth,
this additional near-term burden on the recovery is significant.
Moreover, besides having adverse effects on jobs and income, a
slower recovery would lead to less actual deficit reduction in the
short run for any given set of fiscal actions.
At the same time, and despite progress in reducing near-term
budget deficits, the difficult process of addressing longer-term fiscal
imbalances has only begun. Indeed, the CBO projects that the Federal deficit and debt as a percentage of GDP will begin rising again
in the latter half of this decade, reflecting in large part the aging
of the population and fast-rising health care costs.
To promote economic growth in the longer term, and to preserve
economic and financial stability, fiscal policymakers will have to
put the Federal budget on a sustainable long-run path that first
stabilizes the ratio of Federal debt to GDP and, given the current
elevated level of debt, eventually places that ratio on a downward
trajectory.
Between 1960 and the onset of the financial crisis, Federal debt
averaged less than 40 percent of GDP. This relatively low level of
debt provided the Nation much-needed flexibility to meet the economic challenges of the past few years. Replenishing this fiscal capacity will give future Congresses and Administrations greater
scope to deal with unforeseen events.
To address both the near- and longer-term issues, the Congress
and the Administration should consider replacing the sharp, frontloaded spending cuts required by the sequestration with policies
that reduce the Federal deficit more gradually in the near term but
more substantially in the longer run. Such an approach could lessen the near-term fiscal headwinds facing the recovery while more
effectively addressing the longer-term imbalances in the Federal
budget.
The sizes of deficits and debt matter, of course, but not all tax
and spending programs are created equal with respect to their effects on the economy. To the greatest extent possible, in their efforts to achieve sound public finances, fiscal policymakers should
not lose sight of the need for Federal tax and spending policies that
increase incentives to work and save, encourage investment and
workforce skills, advance private capital formation, promote research and development, and provide necessary and productive
public infrastructure.
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Although economic growth alone cannot eliminate Federal budget
imbalances in either the short or longer term, a more rapidly expanding economic pie will ease the difficult choices we face.
Thank you for your indulgence, Mr. Chairman.
[The prepared statement of Chairman Bernanke can be found on
page 61 of the appendix.]
Chairman HENSARLING. Thank you, Mr. Chairman.
And the Chair will now recognize himself for 5 minutes for questions.
Chairman Bernanke, I have both privately and publicly complimented you and the Fed for much of what you did in 2008, but,
as you heard in my opening statement, I have a great fear that the
extraordinary has become ordinary and, indeed, we need to examine these policies in, as you put it, a cost-benefit framework. So,
briefly, I want to inquire about the risks, the benefits, and the cost.
In your testimony, you said, ‘‘The Committee remains confident
that it has the tools necessary to tighten monetary policy when the
time comes to do so.’’ But, Mr. Chairman, I think you know that
other predictions have not proven valid. In May of 2006, you
seemed to be confident that we were witnessing ‘‘an orderly decline
in the housing market,’’ and in 2007 you predicted ‘‘a soft landing
for the economy,’’ neither of which happened. The Fed has been
fairly off on its GDP projections, and as of 2 months ago, you stated, ‘‘Well, I think it is fair to say that we have overestimated the
pace of growth.’’
So, Chairman Bernanke, I guess I recall Casey Stengel’s quote,
‘‘Never make predictions, especially about the future.’’ I assume
you will admit to being human and being fallible?
Mr. BERNANKE. Yes, sir.
Chairman HENSARLING. So that causes some of us to question
how much confidence we should have.
And as the gentleman from California, Mr. Campbell, pointed
out, it is not just members of this committee, but apparently the
voices of doubt and dissent within the Fed are growing more vocal.
Jeffrey Lacker, President of the Richmond Fed: ‘‘I think that further monetary stimulus is unlikely to materially increase the pace
of economic expansion and that these actions will test the limits of
our credibility.’’
Bloomberg has reported of Charles Plosser, Philadelphia Fed
President: ‘‘Plosser said he favored halting additional bond purchases because their benefits are pretty meager and there are lots
of risk.’’
Closer to home, Richard Fisher, President of the Dallas Fed: ‘‘I
will be asking myself, what good would it do to buy more mortgagebacked securities or more treasuries when we have so much money
sitting on the sidelines and yet have no sense of direction for the
future of the Federal Government’s tax and spending policy? How
could additional monetary policy be stimulative?’’
I clearly believe you disagree with these Fed Presidents; is that
correct?
Mr. BERNANKE. Yes, sir.
Chairman HENSARLING. Let’s examine the benefits of your current policy. Again, we know we are in a slow and weak recovery.
Here is the question I have, Mr. Chairman.
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According to Fed data, banks are sitting on $1.6 trillion in excess
reserves, and in the latest quarter for which I have data, the third
quarter of 2012, non-financial corporations are sitting on $1.7 trillion in liquid assets. So, arguably, that is over $3 trillion of capital
sitting on the sidelines. I believe I have this right, at least for the
last data I have on, I believe, QE2: 80 percent of that QE ended
up as excess reserves.
So, given as much capital is sitting on the sidelines and since we
are essentially in a zero to negative real interest rate environment,
why do you believe that further quantitative easing is somehow
going to cause entrepreneurs and job creators to put all this capital
to work?
Mr. BERNANKE. Thank you, Mr. Chairman.
First, on the disagreements on the committee, we have our debates more or less in public, as you know. And I hope you would
take some comfort from the fact that a wide range of views and
points of view are represented on the committee. And we—
Chairman HENSARLING. I do take solace, and I hope you listen
to them carefully.
Mr. BERNANKE. And we do discuss all these issues. Of course, the
significant majority of the committee is supportive of the policies
that we are taking.
You are absolutely also right that predicting the future is always
dangerous. But we are not talking here about a forecast of the future. What we are talking about are the tools that we have to unwind the balance sheet. And we have a variety of different tools,
including not just selling assets, but raising the interest rate we
pay on excess reserves and the use of other draining tools, which,
based on the experience of other central banks, would be effective
in allowing us to unwind that policy.
Of course, doing it at the exact right moment is always difficult,
but—
Chairman HENSARLING. Chairman, I am about out of time. I am
going to attempt to set a good example here. I want to ask one last
question, but you can submit the answer in writing.
You mentioned earlier that—or as I understand it from data or
reports from the Fed—you will cease remitting profits to the U.S.
Treasury and that, under your own analysis, the size of deferred
assets—I am always curious how a loss is a deferred asset—could
peak at $120 billion, but other economists say it is closer to $372
billion of taxpayer money that could exacerbate the debt.
So, in writing, I would like for you to respond whether or not,
indeed, the debt could be exacerbated by $372 billion under a
worst-case scenario.
At this time, I will recognize the ranking member for 5 minutes.
Ms. WATERS. Thank you very much, Mr. Chairman.
Again, Mr. Bernanke, I would like to thank you for further explaining and educating this committee on quantitative easing, the
policy that you have provided leadership on.
And I would like to make sure that the members of this committee understand that this discussion about all of this dissent is
overblown. As I look at the voting on this action, it appears that
you, Mr. Bernanke—William C. Dudley, James Bullard, Elizabeth
Duke, Charles L. Evans, Jerome H. Powell, Sarah Bloom Raskin,
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Eric Rosengren, Jeremy C. Stein, Daniel K. Tarullo, and Janet L.
Yellen all voted to support you and the policies. There was only one
person dissenting, and that was Esther George.
So it seems to me you have strong support for the actions that
you are taking and the leadership that you are giving. And I am
very appreciative for that.
I am surprised at myself for the confidence and support that I
am showing, because you know I have disagreed with you in the
past on a number of things. But I also find myself a little bit surprised that I am focused a lot on what happened with a recent research note that was released last Friday by the Bank of America’s
chief economist, Ethan Harris, where he warned that harsh budget
cuts due to start taking effect this week would hammer the economy, potentially dragging the country back down into a recession.
Mr. Harris wrote that he expects this painful shot of austerity to
slow GDP growth to just 1 percent in the second quarter, with job
growth averaging less than 100,000 per month for those 3 months.
We also know that many Republican and Democratic State Governors are demanding immediate action to stop the automatic
spending cuts, expressing concerns that sequestration would force
their State economies back into a recession.
So, while you have explained to us monetary policy that you are
providing this leadership on and while you have given us great information today about what you feel would happen with this economy if we did not stimulate it, somewhat in the way that you are
doing, I want to ask you, can you offer any insight or more insight
into what the potential impact would be to our economy’s recovery
if the sequester were to take place as scheduled on March 1st?
And can you elaborate on why you believe it is more important
to focus, as you have said today, on deficit reduction over the long
term rather than blunt austerity measures in the short term? I
would like to hear more about this.
Mr. BERNANKE. Yes, ma’am. I cited in my testimony just the
numbers from the Congressional Budget Office, which suggest that
fiscal measures will reduce growth this year by 1.5 percentage
points, which is very significant.
If you look at the path of the deficit projected by the CBO, you
see that for the next few years, progress has been made, and the
debt-to-GDP ratio, in particular, doesn’t look like it is going to be
rising for the next few years. Where the problems arise which are
the most serious are further out, when our aging society, rising
health care costs, and so on, together with other costs, begin to
bite.
My suggestion for your consideration is to align the timing of
your fiscal consolidation better with the problem. That is, to do
somewhat less in the very near term when it will have the greatest
impact on growth and jobs and where the Federal Reserve doesn’t
have any scope to offset it, and instead to focus on the longer term
where the real problems, I think, still remain.
Ms. WATERS. So, you are not against cuts and you are not saying
that we should not be involved in making cuts where we can make
them. But what you are talking about is the level and the amount
of the cuts that perhaps are being made which will slow down the
growth in the economy.
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And you think that if we concentrate more on job development
and stimulating the economy, that we should take a long-term approach to the cuts. Is that basically what you are saying?
Mr. BERNANKE. I am very much in favor of getting our fiscal
house in order, but I think it is a long-run issue and I would be
supportive of a less front-loaded set of measures.
Ms. WATERS. I think it is important to get that on the record because I have heard some discussion about your statement, even as
it was made yesterday, and I think some people were confused and
thought you were saying we shouldn’t make any cuts. I think you
are very clear about what you are proposing. And I thank you very
much.
And I yield back the balance of my time.
Mr. BERNANKE. Thank you.
Chairman HENSARLING. The Chair now recognizes the gentleman
from California, Mr. Campbell, for 5 minutes.
Mr. CAMPBELL. Thank you, Mr. Chairman.
And, unlike the ranking member, I have generally agreed with
what you have said in the past, but now we diverge. So, it is funny
how that happens.
In the January 2013 FOMC meeting minutes which were just released, it reads, in part, ‘‘A number of participants stated that an
ongoing evaluation of the efficacy, costs, and risks of asset purchases might well lead the committee to taper or end its purchases
before it judged that a substantial improvement in the outlook for
the labor market had occurred.’’
If these voices are right and the unemployment does not drop
significantly or below your target and inflation does not rise above
your target, at what point do you decide to wind this down, call it
quits, and try something else?
Mr. BERNANKE. As I said in my remarks, we have a cost-benefit
framework, and we are going to be looking at both sides of that
equation.
We will be looking at benefits, trying to assess whether we are
getting traction, whether the economy is benefiting from these policy moves, whether we are seeing a stronger economy, particularly
in the labor market. On the cost side, we will be looking at inflation concerns and financial stability concerns that you mentioned
in your opening remarks, Congressman.
They are perhaps less important than the first two, but the remittances issue and perhaps some market functioning issues. We
will be looking at the whole set of these concerns and trying to assess whether those costs are sufficient to induce a less aggressive
policy or whether there are alternative measures—say, regulatory,
supervisory, or other measures—that could more effectively or in a
more precise way address those issues.
So that will continue. We plan to have a continual discussion and
review of both the costs and the benefits and try to make sure that
we are taking the right steps, given those costs and benefits.
Mr. CAMPBELL. Is it safe to say that if the unemployment rate
does not drop further as a result of these asset purchases, that is
an indication that the benefits are declining?
Mr. BERNANKE. If we see no progress for an extended period,
which I don’t expect because we have already seen some progress,
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then I think we will want to discuss the efficacy side of the equation, is it working.
My sense at this point—and it is very early—is that we are getting some traction in the housing market, which has shown some
strength in the last few days, some of the data most recently. In
automobiles and other durable goods, to some extent in investment,
to some extent perhaps in commercial real estate, we have seen
some signs of improvement. But we want to keep evaluating and
seeing if, in fact, we are getting benefits from this policy.
Mr. CAMPBELL. There seems to be, towards that end, the benefits, a lot of evidence out there that the benefits of the low interest
rate and quantitative easing are accruing primarily to the Federal
Government, foreign governments, and large banks. Now, I think,
clearly, those are not the entities that need to or that are doing the
lion’s share of hiring or need to do the majority of hiring.
But do you agree with that view? And how do you rationalize the
QE, given that view out there that is who is benefiting primarily
from—
Mr. BERNANKE. I completely disagree with that. This is very
much focused at the average American citizen. Our estimates are
that we have helped create many private sector jobs. Government
jobs, of course, have been declining quite significantly. People are
able to buy houses at very low mortgage rates or refinance at low
mortgage rates. People are able to get car loans at low rates. Their
house values have gone up so that they feel more financially secure. So in a lot of dimensions we have, I think, benefited Main
Street, and that is certainly our objective.
From the other sectors, we often get complaints. For example,
banks have complained about the low interest rates squeezing their
interest margin. I think the main benefits are those that are affecting the broader economy, and that is the broad group of Americans.
Mr. CAMPBELL. In the final 30 seconds, there is some concern
that the agency MBS market is losing liquidity because I believe
you are on pace to own, the Fed is, 20 percent of outstanding agency MBS and you are purchasing 40 percent of new issuance and
that you are the market, there is no other market. Is that a concern?
Mr. BERNANKE. The market functioning, the Treasury and MBS
market functioning, is something we do I wouldn’t say every day
but every hour, because we are heavily engaged in those markets,
obviously. And, to this point, we don’t see any significant problems
with those markets. But if we do see problems, obviously we will
react to that. But, to this point, we haven’t seen anything significant.
Mr. CAMPBELL. I yield back.
Chairman HENSARLING. The time of the gentleman has expired.
The Chair now recognizes the gentleman from Missouri, Mr.
Clay, for 5 minutes.
Mr. CLAY. Thank you, Mr. Chairman.
Chairman Bernanke, how would you describe the current condition of the U.S. housing market? Have we bounced back? And do
you predict that we will witness significant employment gains if
and when the housing market rebounds?
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Mr. BERNANKE. As you know, the housing market took a tremendous blow: about 30 percent or more declines in prices; a massive
decline in construction and sales. And that was a major factor, obviously, in the severity of the recession.
As the chairman reminds me, it is difficult to make predictions,
but the evidence thus far is that the housing market has hit the
bottom and is recovering. We have seen rising prices over the last
year or so. We have seen some significant increases in starts and
sales. Foreclosures are still too high, but they are coming down.
The number of people underwater in their mortgages is coming
down.
So we are still far from where we would like to be, but the evidence is that the housing market is strengthening and that low
mortgage rates are one reason for that strengthening.
And that should put people to work in several ways. It will put
construction workers back to work, obviously, and people who work
in factories that build appliances or other things that are related
to housing. But, in addition, the increase in house prices and the
increase in general economic activity should benefit other industries as well.
Mr. CLAY. Thank you for that response.
Another area that seems to be ahead of pace of our economy is
health care and the spiraling costs of health care. Do you foresee
prices stabilizing there, or will it just continue to spiral out of control and hit consumers the hardest?
Mr. BERNANKE. This is a critically important issue because one
of the main sources of our long-term budget problems is the fact
that health care costs have gone up a lot faster than other costs
over the last 40 years or so.
Recently, in the last 4 or 5 years, health care costs have actually
gone up somewhat more slowly. Part of that may be due to the recession and the fact that fewer people are able to afford or seek
care.
So I think it remains to be seen whether this relative decline in
the pace of increase of health care costs is going to persist or not.
If it does, it will be very good news, not only for Americans who
are trying to afford health care, but also for the Federal budget.
But I think there remains a lot to be done in the health care area
to improve incentives, to improve quality, and to improve access.
Mr. CLAY. Thank you for that response. And I am sure we could
have an entire hearing on just the cost of health care and the longterm and short-term goals for that area.
Currently, the unemployment rate, according to the Labor Department, is 7.9 percent. What can the Federal Reserve and Congress do to put Americans back to work? I heard you say in your
testimony that we should continue investing in job training and retraining. Any other suggestions?
Mr. BERNANKE. On the fiscal side, I mentioned, first, the notion
of taking a longer-run perspective on addressing our fiscal sustainability issues to avoid some of the adverse effects in the near term
of very sharp cuts and job losses.
And the second point, as you noted, is that I think everyone
would agree on both sides of the aisle that the money we do spend
and the taxes we do collect should be done in the best way possible.
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We should be thinking about each program and is it achieving the
objectives that we set for it and is it creating a better trained workforce, is it creating a more productive economy, is it creating a
more fair and equitable and efficient Tax Code. Those are the kinds
of issues that need to be addressed, as well as simply the total
spending and revenue numbers.
Mr. CLAY. And, as you are aware, the Dodd-Frank Wall Street
Reform and Consumer Protection Act required that Offices of Minority and Women Inclusion (OMWI) be established within agencies regulating financial institutions.
What action has the Federal Reserve System taken to meet these
requirements?
Mr. BERNANKE. We have followed everything required by the
law. We have established an OMWI in the Fed and in each of the
12 Federal Reserve Banks. We are pursuing the supplier diversity
and other requirements of the law. And we are working collectively, as we have been told to do, with the other agencies to develop some criteria for assessment of diversity practices in regulated institutions.
Mr. CLAY. Thank you, Mr. Chairman.
Chairman HENSARLING. The time of the gentleman has expired.
The Chair now recognizes the vice chairman of the committee,
the gentleman from California, Mr. Miller, for 5 minutes.
Mr. MILLER. Thank you, Mr. Chairman.
It is good to have you here, Chairman Bernanke.
I know you care about unemployment and inflation. You have expressed that in your statements over and over. And I know you
care about the economy. But I am having some concerns with some
of the regulations being proposed by the Fed right now.
You did state that the housing market is recovering, and I agree
with that, but it is very fragile, in my opinion. Some of the new
housing regulations are very concerning. The QM was meant to
protect consumers, but, as finalized, it really prevents creditworthy
consumers from getting a mortgage, in my opinion. A recent study
by CoreLogic says that 48 percent of the 2010 mortgage originations would be eligible under QM. And perhaps some of those
shouldn’t have been made, but that is a scary number.
And I am concerned about the Federal Reserve’s proposed rule
on ability to repay as defined as qualified mortgage. Any loan that
does not meet this requirement basically will not be made in the
marketplace. And a recent study by CoreLogic says that is a huge
problem.
On QRM, it is meant to make sure that lenders have skin in the
game. But, as drafted, the field will be so small that I am not sure
there is going to be a field by the time you get through with it.
We sent a letter to you—I think 208 Members signed—complaining about the 20 percent down. If QRM is too narrow, I believe first-time home buyers will be driven out of the marketplace,
which will cause another dip in the housing market. And Congress
intended for mortgage insurance to be a qualifying factor in QRM.
Could you please speak to that?
Mr. BERNANKE. Certainly. As you know, we couldn’t finalize the
QRM rules until the QM rules were completed because QRM can
be no broader than QM.
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We have heard comments from Congress. We are considering
them very carefully. I would say that the idea that QRM should be
as broad or nearly as broad as QM is very much on the table. And
we appreciate the concerns of Congress that these criteria should
not so constraining as to prevent creditworthy borrowers from obtaining a mortgage.
Mr. MILLER. But you have lenders right now who are really keeping capital out of the marketplace because they don’t know what
is going to happen. At some point in time, we need to be very
proactive in getting some form of a message out as to what the situation will be. Because it is really creating havoc in the industry,
in my opinion. Do you agree with that?
Mr. BERNANKE. The uncertainty is certainly a problem, and it is
one of the reasons why we haven’t seen a resurgence of the privatelabel MBS market. But, again, now that QM is done, the agencies
can work quickly to finalize the QRM rule.
Mr. MILLER. Okay.
Another concern I have is bank capital standards are one issue,
and insurance companies are completely different. The U.S. insurance companies hold about $5 trillion in assets today. And the
Fed’s proposed rule on capital standards based on Basel III, the
rule is designed by bank regulators, which makes sense for banks,
but they also apply to insurance companies. Insurance and banking
are very different, as I know you agree. Strong capital standards
are important, but they must be appropriate for the business model
to which they apply.
Will the Feds perform a qualitative impact study specific to insurance before you finalize the standard rules, like the QIS you do
for banks?
Mr. BERNANKE. We are discussing the feasibility of such a study.
And we recognize that there are important differences between
banks and insurance companies. At the same time, of course, we
have statutory constraints, the Collins Amendment, for example,
that say that a certain amount of capital is necessary. But we have
also heard from Congress about this insurance-banking distinction,
and we are looking at it very seriously.
We have been consulting, I should say, with the State insurance
regulators, with the Federal Insurance Office, with the industry,
and with a lot of other stakeholders to make sure we understand
these issues.
Mr. MILLER. There is a tremendous amount of havoc in that industry today because of what they don’t know. And, again, I think
some action is pretty necessary in the immediate rather than in
the long term on that, wouldn’t you agree?
Mr. BERNANKE. Certainly. We want to get these rules out as
quickly as possible. But on the other hand, as you point out, we
need to make sure that they are appropriately set for the insurance
business model, and that will take some time to study and understand.
Mr. MILLER. Okay.
The last question you might not have time to answer, but you
announced the QE3 last September. You said you would keep buying assets until there was substantial improvement in the labor
market. I think you addressed it earlier. You said that mortgage-
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backed security purchases will boost economy by driving down
long-term interest rates.
But looking at the impact that QE3 has had on the mortgage
market rates, we are at historically low levels right now. I am not
seeing much change, but maybe that was the intent. But the Fed’s
balance sheet, like you said, had $3 trillion of holdings.
Do you think that the mortgage interest rates are where they
should be to meet the objectives of QE3, or do you think they need
to be lower?
Mr. BERNANKE. I think they are low enough that they are providing a lot of assistance, a lot of help to homeowners.
The low mortgage rates are a product not just of our latest program but of all the previous programs and our policies regarding
short-term rates and the like. One of the paradoxes is that the best
way to get interest rates up is to have low interest rates, because
that promotes a stronger growing economy and that causes interest
rates to rise. In some ways, the fact that interest rates have gone
up a bit, and it happens on the real, not the inflation side, is actually indicative of a stronger economy, which, again, suggests that
maybe this is having some benefit.
Chairman HENSARLING. The time of the gentleman has expired.
The Chair now recognizes the gentlelady from New York, Mrs.
Maloney, for 5 minutes.
Mrs. MALONEY. Thank you. Welcome, Chairman Bernanke. I believe this country owes you a debt of gratitude. Thank you for your
leadership during one of the worst recessions in my lifetime. You
took unprecedented measures which took our economy that was in
a total freefall, and we are now on the road to recovery; however,
I am deeply concerned about housing.
As we all know, the housing market and the foreclosure crisis
continues to be a major impediment to our economic growth. Some
economists have estimated that housing and its related industries
are 25 percent of our economy. So until we get this straight, we are
not going to really fully and strongly recover, and that is why I
want to spend my time this morning asking you about the Federal
Reserve’s role in the independent foreclosure review process. As
you may know, I have written you and the OCC 3 letters over the
past 2 months, and I would like permission if I may, Mr. Chairman, to place them in the record.
Chairman HENSARLING. Without objection, it is so ordered.
Mrs. MALONEY. I know the deadline that I gave your office was
March 1st, but since we are only 48 hours away from that, I
thought I would take this opportunity to get some clarity.
First of all, how is it that in the past 18 months, over $1.5 billion
has been given to independent consultants, but absolutely nothing
has been given to the up to 4 million injured homeowners, some of
whom have lost their homes unjustly during this 18-month review
process? We have $9.3 billion in aid that is not helping any distressed homeowners.
I have been told by parties involved in the process that there was
an agreement between all the institutions that no aid would be
given to help injured homeowners until all the institutions were
ready and able to make payments.
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So first, who gave this order that no money would be paid to borrowers, to the people who were injured, while at the same time
nearly $2 billion was generated in fees to private contractors?
Mr. BERNANKE. We agreed with you that plan was not working.
As you know, the way it was set up was that the private consultants would evaluate the files and determine how much damages
were warranted. They had not made all that much progress, frankly, and it was a very expensive cost per file evaluated, and we were
on a track—and we take responsibility for this—where the money
going to the consultants would be some multiple of the money
going to the borrowers. So as you know, we have changed the process to a much quicker, more streamlined process, which is going to
cut out the consultants and which will have checks going out to
borrowers very, very shortly, within weeks.
Mrs. MALONEY. Don’t you think that it would have been a better
process if you had, and certainly more effective, to compensate borrowers whose harm was found and documented rather than wait
for the entire process to be completed or to make this adjustment
at midterm? We can put a person on the Moon. Why in the world
can’t we solve this? This whole foreclosure process is really dragging down the whole housing industry, because no one knows what
to do.
If you are going to send out checks soon, which I am glad to
hear, how did you make the determination of who should receive
these checks, and where are they going and what was the criteria?
And what are you going to do to clean up this backlog and take
this whole problem off and help the homeowners, which was the intention of the settlement to begin with, yet 2 years later no one has
been helped?
Mr. BERNANKE. No. You are absolutely right.
Mrs. MALONEY. I can’t tell you the stories I have heard of people
who have lost their homes, and no one even knows who owns their
home; it just sits there vacant. We have to get this straightened
out. Can you just give me some timeframe and how we are going
to fix this?
Mr. BERNANKE. Yes. We have agreements with most of the
servicers, which will be made public shortly, because they are being
incorporated into the enforcement orders under which they are operating. As you know, we have about a $9 billion agreement, all of
which will be reflected either in cash payments or in mortgage relief to borrowers, none going to consultants. That is very much
under way.
My guess as to why the payments hadn’t occurred until now is
that it was just such a slow, ungainly process, but I will get you
more information on that. On the criteria, we are going to have to
use some shortcuts, because we don’t have a full analysis.
Mrs. MALONEY. Do you think we should fall back—
Chairman HENSARLING. The time of the gentlelady has expired.
And the Chair now recognizes the chairman emeritus, the gentleman from Alabama, Mr. Bachus, for 5 minutes.
Mr. BACHUS. Thank you, Chairman Bernanke. Chairman
Bernanke, I am going to ask you to reconsider the Fed’s Proposed
Rule 165 as it relates to foreign banking organizations which don’t
have a U.S. bank, but here in the United States only operate a
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broker-dealer. And let me give you four reasons. I don’t want to engage you in a debate at this time, but first, to have that approach
is different from any other regulatory regime that would apply to
U.S. broker-dealers of our American companies. So you are using
a different approach, but their broker-dealer doesn’t have to be
placed in that.
Second, it is discriminatory, in my mind, because the securities
broker-dealer of the foreign banking organization could have a
higher capital standard because of the standard imposed on the intermediate bank holding company.
We also have the longstanding principle of, I guess, national
treatment where you don’t have disparate treatment, and I think
this violates that.
Also, you have an expressed statutory provision that prohibits
the Federal Reserve from overriding the capital requirements of a
functionally regulated subsidiary of a bank holding company such
as a broker-dealer subsidy whose capital requirements are established by the SEC. So to me, it would violate that.
Now, I would also tell you to look at Section 165(b)(3) of DoddFrank, which says that in prescribing standards, the Fed should
also take into account whether a foreign bank owns an insured
bank as well as whether it has another primary regulator.
So I would ask you, and I would think that you consulted with
the SEC, that you consulted with the foreign regulators, but I just
got back from Germany, and this was brought up on three different
occasions by both government officials and European banks as to
why are you treating us differently. I know you have extended the
comment period of this rule to April 20th, but I would like to just
exchange a series of letters and point out this in more detail.
Mr. BERNANKE. Thank you for calling that to my attention.
Mr. BACHUS. Thank you. And it is—there are over 100 foreign
banks that are operating here that would be under—or could be
under a different capital requirement than our local banks, and I
think that could cause problems with our international regulators.
And I am sure you have heard from some of them.
Let me say to the membership, both Republicans and Democrats,
and particularly those who have come here just in the past 5 years,
Chairman Bernanke told us today exactly what he has told us for
the last 5 years, and that is he has told us to focus on long-term
structural changes to our mandatory spending programs, most of
which are entitlements. And that ought to be our focus, and he said
that today. He said that it will have a beneficial effect, a long-term
beneficial effect, it will not retard economic recovery.
Now, what have we done as opposed to what he has—and I have
asked that same question to you for 5 years. You have always responded, focus on long-term structural changes, because of the demographics.
What have we done? Last year, we had some success. This Congress doesn’t get the benefit of—we had $2.5 trillion worth of cuts
and revenue measures that reduced our debt for the next 10 years
$2.5 trillion, and most people are saying we have about another
trillion, $1.5 trillion to go.
And I will say this. I know your hand is on the clock. This sequestration was a bipartisan mistake by Members of both parties.
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We were told it wouldn’t go into effect. That is a gamble we will
lose on March 1st.
What we need to do is substitute these short-term changes for
maybe going up on the retirement age 2 months or some means
testing. This is not rocket science. And I say to the President and
to this Congress, quit fiddling around, get to work, and let us come
up with $85 trillion worth of long-term structural changes.
Chairman HENSARLING. The time of the gentleman has expired.
The Chair now recognizes the gentlelady from New York, Ms.
Velazquez, for 5 minutes.
Ms. VELAZQUEZ. Thank you, Mr. Chairman. Chairman Bernanke,
will you please help me out? Did you state in your testimony that
we need to make structural changes to entitlement programs or did
you say that front-loaded spending cuts required by the sequestration with policies that reduce the Federal deficit more gradually in
the near term, but more substantially in the longer run?
Mr. BERNANKE. Yes. Congresswoman, I said that you need to be
looking at the long run—
Ms. VELAZQUEZ. Okay.
Mr. BERNANKE. —which is where the problems are most serious.
Ms. VELAZQUEZ. Mr. Chairman, as it has been stated, the housing sector has continued to see improvement with increased construction activity and higher home prices. As you know, the rate
of economic recovery relies heavily on a robust housing market.
And I am interested in hearing from you what will be the impact
or the effect to the economy if Fannie Mae, Freddie Mac, and the
FHA were scaled back or abolished, as some policymakers have
proposed?
Mr. BERNANKE. Currently, Fannie, Freddie, and FHA are pretty
much the whole mortgage market. Other than portfolio lending by
banks, there is not much in the way of alternative securitization.
So simply shutting them down without doing anything else would
no doubt restrict credit quite considerably, but I think we all
agree—
Ms. VELAZQUEZ. And it would have an impact on job creation?
Mr. BERNANKE. Yes. I think we all agree that over the longer
run, we need to come to a more acceptable set of institutions, but
right now, of course, they are providing most of the support for the
mortgage market.
Ms. VELAZQUEZ. Thank you. Mr. Chairman, past iterations of the
Basel allowed exemptions for community banks from the complex
capital rules imposed on large multinational banks. Was that approach considered for this round of Basel?
Mr. BERNANKE. I am not sure I quite understood. The—
Ms. VELAZQUEZ. In Basel I and Basel II, small banks, community
banks were exempted from those rules. Now in Basel III, they were
not. They were not the ones that created the economic crisis.
Mr. BERNANKE. Of course. The community banks have always
been subject to capital rules, of course. They are exempt from
many, many of the more complex rules which apply to large internationally active banks, and that will continue to be the case. And
I am sure you are alluding to concerns that small banks have
raised about—
Ms. VELAZQUEZ. Right.
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Mr. BERNANKE. —the recent proposed rule. We have heard that
from Members on both sides of the aisle as well as from the industry and other stakeholders, and we are looking at that very carefully.
Ms. VELAZQUEZ. I am concerned about that, because when we
look at the survey of loan officers, it still shows that access to capital for small businesses continues to hinder economic growth, and
community banks are the one that lend to small businesses. I am
concerned to know whether or not someone was advocating for community banks when it comes to imposing regulations on Basel III.
Mr. BERNANKE. We are looking carefully both at community
banks and at small business lending, and we recognize the importance of those two institutions.
Ms. VELAZQUEZ. Thank you.
Mr. CAMPBELL [presiding]. Does the gentlelady yield back her
time?
Ms. VELAZQUEZ. I do.
Mr. CAMPBELL. The gentlelady yields back her time.
Now, the chairwoman of the Financial Institutions and Consumer Credit Subcommittee, the gentlelady from West Virginia,
Mrs. Capito, is recognized for 5 minutes.
Mrs. CAPITO. Thank you, Mr. Chairman. And thank you, Chairman Bernanke, for being with us today. I would like to add my
voice of concern to the previous questioner, Ms. Velazquez, on the
issue of the Basel III and the effect it is having on and could have
on our community banks. We had a hearing several months ago,
and it was pretty unanimous in the hearing from all voices that
there is a serious concern on what impact this could have on lending for small businesses and the ability really for community banks
to survive and flourish. I know you have already answered that
question, so I appreciate the fact that you are keeping that in mind
as we move forward on this regulatory issue.
You talked about the sequester and talked about how you would
prefer it to go at a more gradual pace rather than the more dramatic pace that it appears that it could be going at this point, because of the influence of jobs.
I have a great idea. I live in an energy State. If we would unleash the power of this country to really have a full and flourishing
energy economy, both including in my State, coal and natural gas,
but Keystone Pipeline and others, we would have thousands of people, more people working, we would have energy independence, we
could have availability of natural gas as a transportation fuel. It
fuels our chemical industry and our power generation.
So I would like, from your perspective, and I am very frustrated
by the regulatory issues and, I think the inability of the Administration to move forward in full-out energy independent policies that
I think could create many, many jobs.
Where do you see energy as a part of the whole national economy, energy independence and the job effects that an energy economy can bring?
Mr. BERNANKE. Energy has been one of the bright spots in our
economy in the last couple of years. We have seen tremendous increases of production of natural gas, increasing oil production.
There is talk of coming close to energy independence over the next
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few years. That has created a lot of jobs and has been a positive
factor in many parts of our country.
Of course, there are always environmental issues which arise,
and I am frankly not qualified—
Mrs. CAPITO. Right.
Mr. BERNANKE. —to give you a sense of how those balance out
against each other. I hope that solutions can be found which will
preserve the environment and also allow for the development of our
resources, because as you say, it creates jobs and reduces our vulnerability to foreign energy sources.
Mrs. CAPITO. You mentioned gas prices as a reason that is hurting our economy in general, and certainly all of our constituents
are feeling this very much. I think energy economy, there again,
could answer in a small way and maybe a large way the issue of
gasoline as we move towards energy independence. So, I would like
to hear you talk about the energy economy more as part of our
broader economy, because I think you said it is a bright spot; let’s
feature it as a way for us to pull ourselves out of a slower recovery.
So I would encourage you to do that.
My other question is on seniors. Many of us are in that sandwich
generation trying to help our parents, and our parents are doing
a pretty good job trying to help themselves, but they are relying on
their good planning and investments, if they have been lucky
enough to invest. The dividend and interest availabilities to them
are crushing our seniors as they see their health care costs go up.
And some of the policies that you have put forward, I think, and
that the Fed has caused concern for those of us who are concerned
about seniors who don’t have the ability to get another job—that
is played out for them.
What can I tell my seniors back home that is going to give them
some optimism that they are going to be able to rely on that good
planning that they had to carry them through to their senior
years?
Mr. BERNANKE. I would say first that savers have many hats.
They may own fixed-income instruments like bonds, but they also
may own stocks or a house or a business. All of those other assets
benefit when the economy strengthens.
Mrs. CAPITO. Right.
Mr. BERNANKE. And those values have gone up. The stock market has roughly doubled, as you know, in the past 2 years. So from
an investment perspective, there are alternatives.
I think more importantly, though, you are not going to get strong
returns in an economy that is fundamentally weak. The best way
to get sustainable high returns to savers is to get the economy back
to running on all cylinders. And it is somewhat paradoxical, but in
some ways the best way to get interest rates up is not to raise
them too quickly, because by keeping rates low now, we can help
the economy get stronger, we can create more jobs, we can create
more momentum in the economy. That is the way to get a sustainable higher set of interest rates.
It is very striking that if you look at every other industrial country around the world, interest rates are about exactly where they
are here, and that says something about the fundamentals, which
are very weak in most of these industrial countries. And until we
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can get greater forward momentum, we are not going to be able to
see sustainable higher returns.
Mrs. CAPITO. All right. Thank you very much.
Mr. CAMPBELL. The gentlelady’s time has expired.
The gentleman from California, Mr. Sherman, is recognized for
5 minutes.
Mr. SHERMAN. Chairman Bernanke, I want to thank you for the
wisdom to recognize that our country needs an expansionary monetary policy, the fortitude to stick with it when apparently you have
some critics, and the creativity to go beyond your traditional tools
in carrying out that policy.
I listened carefully to my California Republican colleagues. I
want to associate myself with Mr. Miller in his comments about a
QRM definition that isn’t too far from the QM definition. I heard
Mr. Campbell criticize the Fed because he hears people saying that
you shouldn’t fight the Fed and it is hard to price risk.
I am pretty old. I have seen your predecessors carry out just
about every kind of Fed policy I can imagine. Everybody is always
muttering, don’t fight the Fed. And the only time they ever say it
is easy to price risk is when they are wrong. So the mutterings that
the gentleman from California hears are fully consistent with not
only your monetary policy, but every other monetary policy you
could imagine.
And Ms. Velazquez points out how important Fannie Mae and
Freddie Mac are, and FHA. We heard testimony here from Moody’s
Analytics that if FHA hadn’t been there, we would have seen another 25 percent decline in home prices. In my view, if that had
happened, America would look somewhere between Greece and
Thunderdome. So it is fortunate that we have those institutions.
We have a lot of capital on the sidelines, as the gentleman from
California pointed out. Investment needs funds, but it also needs
people willing to take a risk. Some criticize that as reaching for
yield, but if everybody is only willing to invest in investments
where the appropriate yield is 2 or 3 percent, we are not going to
have any small business lending. I have never seen a small business with a 98 percent chance of success. We have banks out there,
they have a lot of capital, they face a lot of pressure to invest at
2 and 3 and 4 percent.
I am told by bankers that if they invest in something that has,
say, an 8 percent likelihood of default, they don’t face an 8 percent
reserve or a 10 percent reserve or a 12 percent reserve, they get
100 percent charge to capital.
What can the Fed do so that loans that are a bit—they are not
just the 2 or 3 percent loans, are valued conservatively and the
portfolio is valued conservatively, but not with a penalty valuation?
Mr. BERNANKE. I would like to continue that discussion with you.
The reserving practices are mostly tied to actual problems with
loans, not with loans that are made that may be risky, ex ante.
And, in fact, one of the issues that has been an issue for a while
is can banks put aside reserves against general risk of credit loss
as opposed to losses in specific loans.
So we have generally been supportive actually of banks doing
more reserving so they would have some reserves available against
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losses not yet seen or understood, but I think maybe we need to
have a further conversation about this.
Mr. SHERMAN. I look forward to that. Timing is everything in a
lot of fields. This is a pretty ideological city right now, and an ideologue either believes that it is always the right time to cut taxes,
always the right time to cut spending, or always the right time to
increase spending, or always the right time to increase taxes, or always the right time to do whatever their ideology requires.
In your opening statement, you point out that the Fed is adopting a different approach. You actually have different policies for
different business conditions and your line is 61⁄2 percent unemployment, along with some other factors.
The national debt is a growing cancer, but this is an economy
that suffered a heart attack in 2008. And you don’t administer
chemotherapy while a patient is still in the cardiac ICU.
Would the markets have confidence in Congress, and it is hard
to think of whether they would ever have confidence in Congress,
if we have statutory provisions which, like your policies, had a trigger and moved toward a more contractionary fiscal policy with, say,
a 61⁄2 percent unemployment rate?
Chairman HENSARLING. The time of the gentleman has expired,
and the Chairman can answer the question in writing.
The Chair now recognizes the gentleman from New Jersey, Mr.
Garrett, for 5 minutes.
Mr. GARRETT. I thank the chairman and I thank Chairman
Bernanke. Let me just try to run through in 5 minutes three areas,
what you talked about on remittances, what you talked about as
far as some of the positive results, and if we have time, some of
the effects of the somewhat current loose monetary policy on an
international state.
So on remittances, I think you already said that the remittances
are here, but they are potentially to go down in the future. If you
look at the consolidated balance sheet of the Federal Reserve, we
have capital of less than $55 billion, and assets of more than $3
trillion, so that means that all you need is about a 1 quarter of 1
percent increase in the interest rates, and you basically wipe out
what you basically have right now, which is a 55 to 1 ratio, and
you wipe that out.
So what is your prediction actually on that going forward with
regard to interest rates wiping that ratio out and the effect on remittances to Congress? Can you be more specific on the numbers?
Mr. BERNANKE. Certainly. So currently, as I have said, we have
in the last 4 years, remitted $290 billion, we currently have more
than $200 billion of unrealized capital gains on our balance sheet.
The capital issue is irrelevant. We have additional funding behind
the capital. We have $3 trillion of liabilities which are not callable
liabilities, like cash, for example.
Mr. GARRETT. I guess I would just ask you if you could follow up
on detail on that, because that is not the way I understand it, but
I would ask you to put that in writing.
Mr. BERNANKE. The main reality here is that if interest rates
rise very quickly, then there may be a period where we don’t pay
any remittances at all to the Treasury. That is the actual outcome.
That is important.
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Under most, and I would say virtually all scenarios, we will be
sending remittances to the Treasury substantially higher than the
norms established before the crisis.
Mr. GARRETT. Since my time is limited, what we are looking at
here is around $90 billion in remittances if—you said we could actually see that almost go down to eliminate it. Right now, we are
trying to do a sequester at $85 billion. So it sort of puts us in perspective as to what the effect could be as far as your policies there.
With regard to the positive indications that you have indicated,
you said the stock market and the housing market have gone up
because of your monetary policy, but previously you said that the
Fed’s monetary policy actions earlier this decade, in 2003–2005, did
not contribute to the housing bubble in the United States. So which
is it? Is monetary policy by the Fed not a cause of inflationary
prices of housing, as you have said in the past, or is it a cause of
inflating prices of housing? Can you have it both ways?
Mr. BERNANKE. Yes.
Mr. GARRETT. You can?
Mr. BERNANKE. Yes, we can have it both ways, because they are
different phenomena.
The mortgage rate is a quantitative thing. House prices are going
up a reasonable amount, given the strengthening of the housing
market, given the strengthening of the economy, given where mortgage rates are. But mortgage rates in the early part of this last
decade were around 6 percent. That can’t explain why house prices
rose as much as they did. Maybe it was a small contribution, but
it certainly can’t explain the big run-up and then decline.
Mr. GARRETT. But now it is.
So the other area you indicated why we should say your policies
are working in a cost-benefit analysis is the stock market. I am
sure you are familiar with Milton Friedman’s work that says that
people only really consume off of their permanent income, which
basically means that you don’t consume increased consumption because your stocks have gone up in the marketplace.
And to that point, I know Mrs. Capito asked the question as to
what seniors should do in this situation, and you said, take it out
of some fixed assets and put it into the stock market. Heaven forbid that my 90-year-old mother would take her money out of fixed
markets and put it in the stock market. I think that is probably
the worst advice that is out there. And when you consider that a
1 percent increase in the stock market only has infinitesimal,
maybe a 100 percent increase in GDP, I really don’t understand:
first, how you can give that advice; or second, how you can suggest
that an increase in the stock market is a positive indicator of your
work in a cost-benefit analysis to the rest of the economy.
Mr. BERNANKE. I was not giving financial advice. I apologize if
I gave that impression. I was just saying—
Mr. GARRETT. But she was asking you—
Mr. BERNANKE. —that generally—
Mr. GARRETT. She was asking you the question, what should you
be doing to benefit the seniors, what should we say to the seniors.
And your comments were—
Mr. BERNANKE. What I was saying was that the economy will get
stronger because of good policies and that in turn will cause rates
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to rise in a sustainable way. If we were to raise rates prematurely,
we would kill the recovery and rates would come down and we
would have a long-term situation with very low rates.
Mr. GARRETT. But wouldn’t you have provided for the certainty
in the marketplace so you could have more price transparency?
Earlier, you said that some risk-taking in the market is appropriate. That was one of your opening comments. Sure, risk-taking
is appropriate, but it is appropriate when there is actual price discovery. When you have a market that is distorted, as it is right
now by the Fed’s monetary policy, you really don’t have true price
discovery. And so when you do risk-taking now, it is based upon
not really knowing what the appropriate value is of land prices, equity markets prices, so risk-taking now is worse than risk-taking
is when the Fed’s actions do not distort the marketplace. If you
would say—thank you.
Chairman HENSARLING. The time of the gentleman has expired.
The Chair now recognizes the gentleman from New York, Mr.
Meeks, for 5 minutes.
Mr. MEEKS. Thank you, Mr. Chairman. Chairman Bernanke,
more of us thank you for all of your work and what you do with
reference to our great country.
In your opening statement, you talked a lot and you indicated
about jobs, and I think that is the going subject matter. Everybody
is concerned about jobs on both sides of the aisle, and the creation
of jobs, yet we have had 35 straight months of private sector job
growth, but we are continuing to have, as you said, high, and stubbornly high, unemployment rates. And as I look at it, with that
steady growth, we have shed over 600,000 public sector jobs since
the beginning of the financial crisis in late 2008. In fact, The Wall
Street Journal estimated last year that the unemployment rate
would be at least one full percentage point lower if we still had
those jobs, those 600,000 jobs.
So my question to you is, what strains have these massive public
sector layoffs put on your ability to stabilize the employment sector, and what do you think we need to do in regards to that to replace those jobs?
Mr. BERNANKE. Let me first say that I understand why States
and localities in particular laid off a lot of workers, because their
tax revenues went down, they had to balance their budgets, and
that was the only option they had, but it is true that State and
local governments, their retrenchment during the recovery and
their layoffs were a headwind for the broader economic recovery. In
fact, the fiscal retrenchment at the State and local level in this recovery has been much more severe than in virtually any other recovery.
So the good news, I guess, and one of the reasons why I think
we may have a somewhat stronger economy going forward is that
State and local governments seem now to have stabilized their
budgets, and as a result we don’t expect to see those ongoing layoffs to the extent that we have seen them in the past.
But, yes, it is true that the contraction of State and local government budgets, together with more recent cuts in the Federal budget, has resulted in job loss certainly in those sectors and in the
economy more broadly.
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Mr. MEEKS. And sequestration as we see it right now on a Federal level could exacerbate that with—
Mr. BERNANKE. I have cited the Congressional Budget Office,
which I think has reasonable estimates, yes.
Mr. MEEKS. Let me also go to a question, because you have been
asked about banks and banks lending, and Alan Blinder had an op
ed in The Wall Street Journal last year, if I recall, pointing out
that in an effort to spur lending by banks, central banks in Europe
are cutting their interest, cutting the interest they pay on excess
reserves to zero. In fact, the Danish cut it to a negative 0.2 percent,
meaning banks would have to pay the central bank to keep reserves with them.
Now, this seems to me to be a powerful incentive to either lend
or put money to work in the markets. So my question is, do you
believe that this policy, if implemented here, would it benefit the
U.S. economy? And if not, why not?
Mr. BERNANKE. Banks are currently being paid on their reserves
25 basis points, one-fourth of 1 percent. They are actually receiving
less than that on net, because they also have to pay FDIC premiums on the deposits that they hold on the other side of their balance sheet, so they are receiving just a few basis point on their reserves.
If we cut the interest on reserves, say, to zero or slightly negative, which is possible, it would have a very, very small effect in
the right direction, but a very, very small effect on the incentives
of banks to make loans. Basically, they are not finding as many
loans as they would like to make when they are earning 8 basis
points on their reserves. Would it help to get it down to zero? It
is in the right direction, as I said, but one of the reasons that we
have hesitated to do that is because it would also lower returns
throughout the money markets in our economy and would create
some problems in terms of the functioning of money markets, the
Federal funds market, and other short-term cash markets. So it is
not clear that the benefits in terms of more stimulus outweigh the
costs in terms of market functioning. That being said, it has always
been something that we have kept on the table and talked about
periodically.
Mr. MEEKS. So it is something that is still on the table and you
are still talking about? Because I like movement in the right direction.
Mr. BERNANKE. It is not a powerful tool, though, in any sense.
Mr. MEEKS. I have 10 seconds left, I don’t think I am going to
get my next question in, but the—because my next question was
basically what you were told—told Senator—
Chairman HENSARLING. No, no. The gentleman cannot get his
next question in. The time of the gentleman has expired.
The Chair now recognizes the gentleman from Texas, Mr.
Neugebauer, for 5 minutes.
Mr. NEUGEBAUER. Thank you, Mr. Chairman. And, Chairman
Bernanke, thank you for being here this morning. Mr. Chairman,
I want to walk through the proposed exit strategy that I think was
put forward in June of 2011 and see if you foresee taking any different steps. I believe in that exit strategy you said we would begin
to cease reinvesting payments of principal on security holdings, I
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guess as they matured. The second part of that was raising the Fed
funds rate while adjusting the interest rate on excess reserves and
levels of reserves in the banking system to kind of bring those
funds towards a targeted rate. And then I think the third part of
that was selling off some of the Fed securities after the first increase in the target for the Federal funds rate.
So according, though, to the most recent FOMC minutes released, a number of participants discussed the possibility of providing monetary accommodation by holding securities for a longer
period of time than what was originally envisioned by the committee’s exit principles, either to supplement or to replace other asset
purchases. This kind of suggests a deviation from the course put
forward in 2011, and I would suspect there may be other changes
that are being discussed from the June 20th exit strategy as well.
So you have laid out this exit strategy, and now based on these
subsequent conversations and discussions that are going on, how
confident should investors and the business community be that this
exit strategy will be the same 6 months from now or 3 years from
now? And given the huge size of your balance sheet and the potential uncertainty that changes in this exit strategy could cause, are
you concerned that we are creating some additional uncertainty in
an already uncertain economy?
Mr. BERNANKE. No, I don’t think so. We haven’t done a new review of the exit strategy yet. I think we will have to do that some
time soon. I am pretty confident the basic outline that you just described would still be in force.
The one thing we could do differently, as you pointed out, is hold
some of the securities a little longer. We could even let them just
run off. I just want to be clear that even if we don’t sell any securities, it doesn’t mean that our balance sheet is going to be large for
many years. It just would be maybe an extra year. That is all it
would take to get back down to a more normal size.
So that is one issue, how long to hold the securities and whether
to use that as a substitute, an alternative to asset purchases. I
think that is something worth discussing, but I don’t see any radical shift in the way this is going to happen.
And, again, as I said earlier, we are quite comfortable that we
can exit in a way that is both smooth and in which we provide lots
of information to markets in advance so they will know what is
coming and be able to anticipate it.
Mr. NEUGEBAUER. I thought it was kind of interesting when you
said that we need to take a slower approach to deficit reduction
and that the economy couldn’t withstand a major reduction in government spending. Don’t you find it a little disconcerting that we
have let the government become so much of the economy that cutting our deficit so that we don’t mortgage the future of our children
and grandchildren should be even a consideration in deficit reduction?
Mr. BERNANKE. Government is an important part of every advanced economy now. And I am not by any means saying that we
should not deal with the deficit problem. I am just saying we
should take a longer-term perspective.
Mr. NEUGEBAUER. When people talk about fiscal policy and monetary policy, you always say, I am in charge of monetary policy, not
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fiscal policy, but Mr. Chairman, I almost find the Fed to be a deficit enabler in the environment that we are in right now. And the
reason I would say that is the fact that last year, I think you transferred about $90 billion back to the Treasury. So basically, whatever securities that they yield, you buy down their yield to almost
zero. You have put $90 billion additional money in the hands of the
government, yet we still ran a $1.2 trillion deficit. So we are almost
enabling the government to continue to spend, because we are allowing them to have this borrowing habit at a very cheap price because of the actions that you are taking at the Fed to buy those
yields down.
Chairman HENSARLING. The time of the gentleman has—
Mr. NEUGEBAUER. You can follow up and answer in writing.
Mr. BERNANKE. Okay. I will follow up.
Chairman HENSARLING. If you can follow up in writing, please.
The gentleman from Massachusetts, Mr. Capuano, is recognized
for 5 minutes.
Mr. CAPUANO. Thank you, Mr. Chairman. And thank you, Chairman Bernanke, for being here again. Mr. Chairman, I have read
most of the 57-page report and I have read your 9 pages, and honestly every time any Fed Chairman has ever come before here, it
is like I get a headache before, during, and afterwards. I love you
dearly, but trying to parse all these things that everybody is saying
is very difficult for average people, including me.
And I guess I want to read one sentence from your testimony to
make sure that I understand it correctly. This is from your testimony: ‘‘To address both the near and long-term issues, the Congress and the Administration should consider replacing the sharp
front-loaded spending cuts required by the sequestration with policies that reduce the Federal deficit more gradually in the near
term, but more substantially in the longer run.’’
I think I read this correctly, but would it be fair for me to paraphrase this to average people that the Chairman of the Federal Reserve thinks that sequestration is stupid?
Mr. BERNANKE. I wish you wouldn’t do that. What I am saying—
Mr. CAPUANO. But would it be fair?
Mr. BERNANKE. What I am saying is that by a more gradual approach but with more cuts in the longer term achieves both objectives, not slowing the recovery by too much, but on the other hand
addressing these long-term issues that Congressman—
Mr. CAPUANO. Like I said, I am getting a headache again. From
what I just heard, you said, again to paraphrase, not to quote, that
you think sequestration is stupid. And I agree with you. Don’t
worry. It is okay. Sequestration is going to get its fair share of attention today and this week and next week, but I want to focus on
something that is a little bit more closely related to directly what
the Fed does, and that is the too-big-to-fail.
I was reading your testimony from yesterday, and the written
testimony, and again I want to read your words as reported relative to too-big-to-fail on the subsidy, relative to the too-big-to-fail
thing. And you say, the subsidy is coming because of market expectations that the government would bail out these firms if they
failed, period. Those expectations are incorrect.
That is a quote from you. Is that a fair—
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Mr. BERNANKE. Yes.
Mr. CAPUANO. Okay. So am I reading this correctly that you believe that at least through legislative purposes, that too-big-to-fail
is just nonexistent anymore, not through the market, but through
the law?
Mr. BERNANKE. We don’t have—the tools that were used in 2008
are gone now. What we have instead is the Orderly Liquidation
Authority, which among other things would wipe out all the shareholders of the company being liquidated.
Now, if we had a systemically large important firm fail tomorrow, it still could be very damaging to our economy. And we are
working—
Mr. CAPUANO. I understand. We could do something—
Mr. BERNANKE. —working in that direction.
Mr. CAPUANO. —but the law currently as drafted, after DoddFrank and after all of the things we have been through, today we
do not have the tools that we used to implement too-big-to-fail as
it was in 2008.
Mr. BERNANKE. The tools that the Federal Reserve used are no
longer available to us.
Mr. CAPUANO. I am glad to hear that. And I also agree with you
that regardless of what the law says, some people in the marketplace, especially some of my friends on the other side of the aisle,
like to believe that it is still in existence. And I accept that, not
as a legal point, but as a fact of reality. Some people think that
the Moon is made of cheese, and that is fine. To them, that is real.
So for some people, too-big-to-fail is still there, though there is no
scientific or legal proof that it is.
I guess what I am asking is, what do you suggest that we do to
address that misconception of the market and the misconception of
some of my own colleagues that too-big-to-fail is still here? Because
I think we all agree that we don’t want it to be here, it is not here.
How do we address that misconception to make it a reality?
Mr. BERNANKE. Dodd-Frank as a strategy involves making big
institutions internalize, take account of their systemic costs by
tougher regulation, higher capital charges, and so on, the Orderly
Liquidation Authority and strengthening the entire system. So
there are steps that we are taking that are moving in that direction. I think the markets will come to see that these steps are effective. Of course, we can communicate it, we can say it, but—
Mr. CAPUANO. But we have been saying it for years now, and
some people refuse to believe it. Do you accept the general—and,
again, not for the dollar, but there have been some studies that put
the subsidy that—the alleged subsidy that is there for the too-bigto-fail that doesn’t exist anyway, but that market perception of a
subsidy—
Mr. BERNANKE. Yes. No. There still is some—I am sure there is
still some—
Mr. CAPUANO. And I accept that.
Mr. BERNANKE. —market perception. It is declining, but we need
to be working in the direction of eliminating it entirely.
Mr. CAPUANO. And do you think that subsidy can be quantified
in a reasonable way?
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Mr. BERNANKE. With lots of assumptions and so on, you can compare what large banks pay in the market to what small banks pay,
and that gives you some sense—
Mr. CAPUANO. Be prepared to get a request from me later on to
try to do that quantification.
Mr. BERNANKE. Senator Warren cited some studies to me yesterday, so maybe—
Mr. CAPUANO. Yes, but that is not your study. I want yours.
Thank you.
Chairman HENSARLING. The time of the gentleman has expired.
The Chair now recognizes the gentleman from North Carolina,
Mr. McHenry, for 5 minutes.
Mr. MCHENRY. Thank you, Mr. Chairman. And, Chairman
Bernanke, thank you for your service to our government, and to
our people.
To follow up on my colleague from Texas’ question about Fed policy masking the true cost of our fiscal profligacy, now, the question
is, would the Fed buying 48 percent of U.S. debt for Fiscal Year
2013 and with a zero or negative real interest rate, isn’t the Fed
the great enabler of our debt? I understand Congress and the
President make fiscal policy, but isn’t the Fed’s policy in essence
masking the true cost of our debt?
Mr. BERNANKE. If I can make three points. The first is that as
a share of all the debt outstanding, the Fed’s ownership is actually
lower today than it was before the crisis. We own about 15, 16 percent of all the debt outstanding. So those interest rates you see on
the debt comes from actual market trading between private sector
individuals.
The second point is that, as I have emphasized today, there is
a very long-term problem here. What is going to matter is the interest rate not today, but the interest rate 5 years from now, 10
years from now, 15 years from now. Congress, I hope, has the foresight to see that interest rates will not be this low forever and,
therefore, they should take that into account.
And then, finally, I ask, what is the alternative? If we raised interest rates substantially just to make it harder for the Congress
to borrow, if at the same time we do damage to the economy and
lower revenues and make the deficit even worse, I don’t see how
that is really helpful to our fiscal situation. So my hope is that
Congress will recognize that interest rates will rise over time as
our economy recovers and that this is a long-term proposition and
they should take that into account in their decisions.
Mr. MCHENRY. So in the short run, yes?
Mr. BERNANKE. No. And, again, we only have about 15, 17 percent of the total debt outstanding. It is not the case that we are
buying, all the debt being—
Mr. MCHENRY. No, no. Just 48 percent this fiscal year.
Mr. BERNANKE. Of the new debt—
Mr. MCHENRY. Yes.
Mr. BERNANKE. —but not on average. Again, 85 percent of it is
circulating in private hands.
Mr. MCHENRY. Okay. Now, to go to a separate point, Bloomberg
reported that at your recent meeting of the Treasury Borrowing
Advisory Committee, which is a group of senior bankers and inves-
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tors, they received a presentation that warned that the central
bank’s policies, and I am quoting from Bloomberg News, may be inflating bubbles and speculative grade bonds and other asset classes.
Is this an acceptable side effect of the Fed’s expansionary policies?
Mr. BERNANKE. As I have mentioned, it is a cost of these policies
and it is one that we take very seriously. We look at these possible
mispricings and we ask ourselves, are they in fact mispricings, how
large are they? And if they are mispricings, what is the vulnerability? For example, if an asset is mispriced, is it being purchased
using a lot of leverage? Who is owning it? Would its change in its
price severely endanger our financial institutions? Those kinds of
things.
So we are examining this with a great of a deal of care. And
again, I ask, what is the alternative? Interest rates are low for a
good reason, but if in fact we have come to the conclusion that the
cost of these mispricings are sufficient, then obviously we have to
take that into account.
Mr. MCHENRY. So to this point about inflation, many of us have
this concern about how you are going to unwind this unprecedented
portfolio that you preside over, or how your successor will unwind
this, or your successor’s successor. And the concern that we have
is that you only can see inflation with hindsight.
And the question I have for you concerns the record of the 1970s:
in 1973 expected inflation was 3.75 percent, that was the market
expectation, the Fed said 3.9 percent, the actual was 6.2 percent;
in 1974 expected inflation was 6.7 percent, the Fed said 8 percent,
yet the actual inflation was 11 percent; in 1979 expected inflation
was 8.3 percent, the Fed said 7.75 percent, the actual was 11.3 percent. And in 1980, expected inflation was predicted at 11 percent,
the Fed said 7.5 percent, yet the actual was 131⁄2 percent.
The Fed has consistently gotten it wrong. Are your tools better
now to see inflation than they were then when we had this great
period of inflation?
Mr. BERNANKE. Our tools are better, but the environment is
much better, because we now have 25 years of success in keeping
inflation low and stable, and not just in the United States but
around the world. Inflation expectations are very well-anchored
and wages are growing very slowly.
Chairman HENSARLING. The tme of the gentleman has expired.
The Chair now recognizes the gentleman from Georgia, Mr.
Scott, for 5 minutes.
Mr. SCOTT. Thank you very much, Mr. Chairman. Over here,
Chairman Bernanke. How are you? It is good to see you again.
First, I want to commend you for the very courageous and bold
work that you have done in the aggressive quantitative easing in
which you have moved very forthrightly to strengthen our economy
with the purchasing of Treasury and GSA securities, and I want
to commend you for that.
But, Chairman, I have always known you to be a straight shooter. I have great respect for you. We are on the eve of a very, very
dramatic moment in American history dealing with this sequestration. And the President of the United States has said it is a terrible
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thing to do. The Democrats have said it is a terrible thing to do.
We are fighting to avoid it. The Secretary of Defense has come before us and said it is threatening our national security, we better
not do it. We have had our Transportation Secretary, we have had
Homeland Security Secretaries, but yet we have Republicans who
are saying, and who are determined to move ahead and say, let’s
do it.
I want you to tell us today, who is right here? Who is telling the
truth here? Is sequestration something that we should not do, as
Democrats feel, or is it something we should do, as Republicans
feel? What is in the best interest of America?
Mr. BERNANKE. Congressman, you are asking me to make decisions which are not mine to make. Those are congressional decisions. Congress has to make those choices.
What I am advising is a more gradual approach. I am not saying
that we should ignore the deficit. I am not saying we shouldn’t deal
with long-term fiscal issues, but I think from the perspective of our
recovery, a more gradual approach would be constructive.
Mr. SCOTT. When you say ‘‘gradual,’’ what specifically would
gradual mean? Give us an example.
Mr. BERNANKE. It works all in the same direction. The more
gradual this is, as long as there are offsetting changes in the further horizon, the less the immediate impact will be on jobs and
growth in this recovery in 2013.
Mr. SCOTT. And do you agree that gradual approach should contain both spending cuts and additional revenue?
Mr. BERNANKE. That, again, comes back to what Congress is responsible for. I am not going to comment on that.
Mr. SCOTT. I am very, very concerned about this, because my
home State of Georgia will suffer tremendously on this. I represent
a district that has Lockheed Martin, for example, which has already come under tremendous job loss pressure. We are looking at
over 60,000 jobs immediately. We are looking—and those jobs are
teachers being laid off, firefighters being laid off, critical, critical
manpower that is needed.
Let me ask you: Friday comes, we go over the cliff with sequestration. What should we do next? Should we then try to consistently move to put something in place? How would you advise us
to do that, and what would that step entail?
Mr. BERNANKE. Again, the specifics are up to you, but what I
would suggest would be replacing the sequester with something
that is smaller, takes hold more slowly, but is compensated for by
changes further out in the horizon.
Mr. SCOTT. And do you see a complicating factor with the approaching deadline of the March CR? If, for example, we are unable
to reach an agreement in 4 months, what impact would we have
with sequestration moving rapidly through the system, massive job
layoffs, all of the predictions coming true that we feel and then
with our failure to reach agreement on the CR at the end of
March?
Mr. BERNANKE. The CR, I guess, would continue government
services. I think there is some cost to the economy of these repeated, I don’t want to say crises, but these repeated episodes
where Congress is unable to come to some agreement, and there-
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fore some automatic thing kicks in. I think that is on the whole not
a good thing for confidence.
And, again, as I said yesterday, I realize that finding bipartisan
agreement is very difficult, but I hope that you will work together
to try to develop a less bumpy fiscal path in the near term.
Mr. SCOTT. Thank you, Mr. Chairman.
Mr. CAMPBELL. We now turn to the other gentleman from Georgia, Mr. Westmoreland. He is recognized for 5 minutes.
Mr. WESTMORELAND. Thank you, Mr. Chairman.
Chairman Bernanke, the Federal Reserve at this point is buying
$85 billion worth of mortgage-backed securities a month, is that
correct?
Mr. BERNANKE. No, sir, it is 40 of mortgage backed and 45 of
treasuries.
Mr. WESTMORELAND. Okay, but a total of 85.
Mr. BERNANKE. Yes, sir.
Mr. WESTMORELAND. Because all the talk we have had about the
sequester being $85 billion over a year for the whole Federal Government, I think when you realize what we are doing with these
mortgage-backed securities, it kind of puts it in a perspective that
do we really need to be buying that kind of securities every month?
Mr. BERNANKE. This doesn’t involve any new spending or revenue.
Mr. WESTMORELAND. I understand. Just printing money, right?
Mr. BERNANKE. It is acquiring securities in order to reduce interest rates and ease financial conditions in the economy.
Mr. WESTMORELAND. Let me ask you, I know that you make the
decisions as far as what you think it will take, and I guess the
Board of Governors, for what you think it will take to run the Federal Reserve, and as my colleague from Georgia mentioned, we represent a State that has had more bank failures than I think any
other. I know my congressional district has more than any other
congressional district.
What is the Federal Reserve doing to let these banks which are
community banks and they know their communities and they know
their borrowers, what is the Federal Reserve doing to let them
have more latitude in making some of the decisions about the
banking needs of the community and how they can best solve that?
Because what we basically hear is that the regulators, the FDIC,
OCC, Federal Reserve, State regulators, are not really letting them
answer the needs of the community.
Mr. BERNANKE. We are very interested in the success of small
community banks. We agree that they play a very important role
in communities. We have a whole list of things, I won’t have time,
but we have a Community Bank Council that comes and meets
with the Board and gives their views. We have a special subcommittee of our Supervision Committee that is particularly focused on how rules can be made appropriate for smaller banks. We
train our examiners to take into account the size of banks and
their particular business models. We have all kinds of outreach. We
are looking at our rules with the understanding that community
banks can’t manage the same level of regulatory burden that large
banks can handle.
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So we are very committed to helping small community banks
succeed in this environment. You have my assurance that is something we pay a lot of attention to.
Mr. WESTMORELAND. I know that as I meet with my community
bankers, and we have a little advisory board for the bank, and they
are very concerned about Basel III, they are very concerned about
the writedowns that they are having to do immediately rather than
having some time period to do it. And I understand that you have
all these things evidently in place to try to help the community
banks. I just haven’t seen it. Nobody, none of my community bankers have said, hey, the Federal Reserve or the FDIC or anybody
else is trying to help us stay open, they are giving us some latitude.
So I just don’t see a big help going there.
But I wanted to follow up on one of the questions that has already been asked. What do you think the amount is for a bank to
be too-big-to-fail? Or is there an amount?
Mr. BERNANKE. No. First of all, again, we are working again to
get rid of too-big-to-fail, so any bank that fails would be subject to
this Orderly Liquidation Authority. But in designating firms, for
example, as systemically important, which is not the same as toobig-to-fail, we look at not just the size, but also the complexity, the
interconnectedness to other banks, the kinds of activities they have
and so on. So a simple dollar number is not really adequate to describe whether a bank is systemically critical or not.
Mr. WESTMORELAND. I hope that as we continue to talk about
too-big-to-fail, we will also look at the banks that are too-small-tosave.
I yield back.
Mr. CAMPBELL. The gentleman yields back.
The gentlelady from Wisconsin, Ms. Moore, is recognized for 5
minutes.
Ms. MOORE. Thank you so much, Mr. Chairman, and thank you,
Chairman Bernanke, for appearing today and tolerating this long
testimony.
I have a couple of questions for you. One of the consequences of
our almost defaulting on our debt and the whole debt crisis, raising
the debt limit, was we saw a lot of chatter around the world about
abandoning the U.S. dollar as a reserve currency, and I am wondering what your outlook is on the economic growth or contraction
of our economy were that to occur, that we would lose our status,
that the U.S. dollar would lose the status of a reserve currency?
Mr. BERNANKE. Let me say first that I don’t see any sign that
is happening. The amount of reserves held in dollars is actually
growing, not shrinking. So I think that reserve currency status at
least for the foreseeable future is very much intact. If we lost that,
it would probably have some effect on the interest rates that we
pay because we would have fewer holders for our bonds and that
in turn might have some impact on our economy. But, again, I
don’t think that this is a very likely prospect in the foreseeable future.
Ms. MOORE. Why did we have all the chatter about it, with the
larger economies, Latin America, China?
Mr. BERNANKE. Of course, the world is evolving. The Chinese
would like their currency at some point to become a reserve cur-
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rency. There is some distance for them to go before they can get
to that point. But, as I said, at least in the near term, pretty close
to two-thirds of all global reserves are held in dollars, and that
doesn’t seem to be changing very much.
Ms. MOORE. Thank you.
Listen, I want to talk about too-big-to-fail as well, global too-bigto-fail, and I want to say that I was really pleased to see the FDIC
and the European Commission working together to establish a
legal framework to create a global system for unwinding large systemically important firms similar to our Orderly Liquidation Authority that we created in Dodd-Frank.
Is there more that this committee and Congress can do towards
this effort or other cross-border efforts? And I would be interested
in hearing about other efforts that the Fed is undertaking to further coordinate global monetary policy, particularly with bank regulation standards, and anti-money laundering efforts. What other
things are you doing?
Mr. BERNANKE. On an Orderly Liquidation Authority, as you
mentioned the FDIC, which is leading this effort, has been working
with European counterparts. They published a paper with the U.K.
authorities, I believe it was a few months ago. The Fed has been
working very closely with the FDIC. Recently, for example, I attended a table top exercise where we pretended that there was a
bank failing and asked ourselves what we would do under the laws
that Orderly Liquidation Authority provides. The Financial Stability Board, which is an international body of regulators, and
other international bodies like the Basel Committee and so on,
have been discussing the issues related to international banks and
how they might be liquidated in a crisis.
That is the most difficult issue, I think, that we still have to
work on. But we are making progress, and there is a lot of international interest in finding ways to work together to deal with the
institution which crosses many borders. More generally, the level
of international cooperation in regulatory matters is quite high.
There are a number of international bodies. The U.S., the U.K. and
the other major banking centers cooperate quite extensively on
these issues. The CFTC and the SEC are working on derivatives
issues. So there is a lot of work going on.
On monetary policy, we exchange ideas and discuss the economy
quite frequently in different settings, but we don’t directly coordinate monetary policy in the sense that we agree as a general matter to take actions together or in some sequence.
Ms. MOORE. Thank you, Mr. Chairman. My time is limited so I
just want to make a comment. You may not have time to respond
to it. I did notice in your testimony that you noted that all taxing
and spending decisions that Congress makes, and I know you don’t
like to comment on what we do, but that they are not equal. So,
for example, lowering taxes on the wealthy does not necessarily
have the same impact on our economy as giving unemployment
benefits to the unemployed. Yes or no?
Mr. BERNANKE. Different taxes and different spending have different implications.
Ms. MOORE. Right.
Chairman HENSARLING. The time of the gentlelady has expired.
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The Chair now recognizes the gentlelady from Minnesota, Mrs.
Bachmann, for 5 minutes.
Mrs. BACHMANN. Thank you, Mr. Chairman, and thank you,
Chairman Bernanke, for being here today. I was reading your testimony, and I thank you for giving it, especially on pages 7 and 8.
On page 7, you talked about the sequestration and the impact of
the sequestration and your concerns about that impact currently on
the short term and the economic drag that could bring about. Then
on page 8, you talked about the fact that at some point down the
road we have to deal with our current debt and our current overspending. You had also said in your comments before us that we
need to align our solutions with the problem, meaning I take it
that the spending reductions shouldn’t happen today, they should
wait until tomorrow when we really start to have problems.
So is that how you would quantify that, yes or no?
Mr. BERNANKE. I didn’t say we have to get rid of the spending
cuts today, but just more gradual introduction combined with
longer-term measures.
Mrs. BACHMANN. So let me ask you—some very quick kind of
technical answers is what I am looking for. What was the United
States’ deficit last year?
Mr. BERNANKE. I have it right here. It was $1.09 trillion.
Mrs. BACHMANN. $1.09 trillion. And what was our total national
debt for last year, or currently?
Mr. BERNANKE. About $11 trillion.
Mrs. BACHMANN. And what is our current total national debt this
year?
Mr. BERNANKE. It is currently, I think, about $11.5 trillion.
Mrs. BACHMANN. Not 16.5 trillion?
Mr. BERNANKE. The $16 trillion includes intra-governmental debt
like the Social Security Trust Fund. But debt held by the public as
opposed to debt held between different parts of the government is
about $11.5 trillion.
Mrs. BACHMANN. So you are saying the debt is about $11.5 trillion. And what are the unfunded net liabilities?
Mr. BERNANKE. They are very large, particularly in the Medicare
area. I don’t have a number, but they are probably some greater
than the actual official debt held by the public.
Mrs. BACHMANN. And how much debt do we buy every day from
the Treasury, from the Federal Reserve?
Mr. BERNANKE. Every day? About $1.5 billion?
Mrs. BACHMANN. About $1.5 billion. So without the Fed purchases of our debt from the Treasury, would we be able to continue
the spending level?
Mr. BERNANKE. Yes, you could. As I said before, the Fed only
owns about 15 percent of the outstanding U.S. Government debt.
Mrs. BACHMANN. Where would we go? If we didn’t have the Fed
buying that debt, where would we go?
Mr. BERNANKE. Our debt is in great demand. Foreigners hold
about half of it. People think of U.S. Treasury debt as a safe haven
and as a secure investment. That is why, notwithstanding what the
Fed is doing, we can sell it at low interest rates.
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Mrs. BACHMANN. So the Fed wouldn’t need to be buying all these
Treasuries then, we could find other buyers for our debt, is that
true?
Mr. BERNANKE. Yes.
Mrs. BACHMANN. So then why are we doing it?
Mr. BERNANKE. To keep rates a little bit lower, to help support
housing, automobiles, and other parts of the economy that need
more support.
Mrs. BACHMANN. But if there are other buyers, why the Fed?
Mr. BERNANKE. To get rates a little bit lower than they otherwise
would be.
Mrs. BACHMANN. So if my 18-year-old daughter was spending 40
percent more than what my husband and I were giving her, and
she didn’t do that just this month, but she did it next month and
the next month and the next month, and finally my husband and
I said we are just not going to bail you out anymore, we are just
not going to continue to finance the overspending that you are
doing, and she said to me, mother, we need to align our solution
with the problem, in other words, you need to keep giving me that
money because it is really not a problem yet. I would say I think
you have a problem today. And the reason why I would say that
is because the analogy with the Federal Government, in January
of 2007 our debt was $8.67 trillion. That debt today is closer to
$16.5 trillion, with the intra-government debts, according to your
calculation.
Do you think that is a problem, that in 6 years we have gone
from $8.67 trillion to $16.5 trillion?
Mr. BERNANKE. Certainly that is a problem, and that is why I
think it is important to have measures to bring it down over time.
Mrs. BACHMANN. But you said we need to align the solution with
the problem. It seems to me we have a big problem, and I will tell
you why. When I was home last week and talking to a lot of
women, they were telling me, ‘‘I don’t get this. Gasoline at Christmastime was $2.99 a gallon. Now, it is $4 a gallon.’’ They said, ‘‘I
can’t keep up with the price increases at the grocery store. And we
just got our health insurance premium and it is going to be $300
a month more than what it was.’’
So all I want to say, Mr. Chairman, is that what I am hearing
from the people is that they are having to deal with the inflationary problem.
Chairman HENSARLING. The time of the gentlelady has expired.
The Chair now recognizes the gentleman from Texas, Mr.
Hinojosa, for 5 minutes.
Mr. HINOJOSA. Thank you, Mr. Chairman.
Chairman Bernanke, thank you for coming to visit with our committee and thank you for your leadership and for your foresight in
the handling of our fiscal policy. Your testimony comes at a pivotal
time in our Nation’s Capital.
While we want to address the long-term health of the Federal
balance sheet, the sequester cuts are so drastic and so immediate
that they greatly threaten economic growth. In your remarks, you
suggest Congress consider a longer-term horizon for targeted fiscal
changes, and I completely agree with you. The sequester is totally
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unnecessary and illustrates a lack of political courage by Members
of Congress.
We have spent a lot of time in this committee attempting to reduce uncertainty in the economy. We have done it by reducing uncertainty for banks, by finalizing rules, and we have done it by reducing uncertainty for small businesses by encouraging lending.
Uncertainty around effects of the sequester is no doubt already
chilling the economy and confusion over the continuance of quantitative easing also creates uncertainty. For example, when word
spread on Wall Street that the Federal Open Market Committee
was considering ending or altering QE3, the Dow Jones dropped
significantly. We cannot throw more uncertainty into such a fragile
economy and have consumer confidence erode.
Many of my friends across the aisle will argue that current fiscal
policy is causing the economy to overheat. At the same time, all of
us are concerned about still too high unemployment. How can a socalled overheating economy see employment grow so slowly? And
furthermore, Chairman Bernanke, I would like to ask you, do you
think that our economy is indeed overheating, and can you give us
a sense of where the economy would be had you not implemented
quantitative easing? Also discuss with us the impact of a sudden
fiscal contraction on economic uncertainty, and ultimately tell us
about the recovery that you foresee.
Mr. BERNANKE. I don’t think the economy is overheating. There
still seems to be quite a bit of unused resources, a lot of people out
of work who could be working, capital that could be used that is
not being used. So, again, I don’t see any overheating.
We believe that the monetary policies that we have conducted
have helped get stronger recovery and more jobs than we otherwise
would have had. There have been different studies that give different numbers, but most of them do find a pretty significant effect.
On the fiscal side, as I mentioned, the CBO attributes to the sequester about six-tenths of a percentage point of growth in 2013
which they connect to the full-time equivalent of about 750,000
jobs. So from the CBO’s perspective, there is an important job component or job effect arising from fiscal contraction which, again, as
I have said many times, the Federal Reserve really can’t overcome.
We don’t really have tools sufficiently powerful to overcome the impact of those types of fiscal actions.
Mr. HINOJOSA. Do you believe that the sequester kicking in on
Friday would lead the markets to tumble?
Mr. BERNANKE. The markets already know about the sequester.
It isn’t news to them. So I don’t think necessarily that the markets
will respond to the beginning of the sequester. But, again, I think
a good policy, one that would be good for the economy and probably
good for markets, would be one that, again, takes a longer-term
perspective and takes some significant steps to address our longerterm fiscal imbalances while phasing in more slowly some of the
changes occurring at the present time.
Mr. HINOJOSA. I ask that question because I spoke to a lot of
teachers, a lot of people who have 401(k)s and saw what happened
in 2008 when the markets tumbled about 40 percent and they lost
so much equity, and they are concerned that might happen again.
Chairman HENSARLING. The time of the gentleman has expired.
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The Chair now recognizes the gentleman from New Mexico, Mr.
Pearce, for 5 minutes.
Mr. PEARCE. Thank you, Mr. Chairman.
Thank you, Chairman Bernanke, for being here, and for your
presentation today. I would like to echo what Mrs. Capito said
about the energy economy, and the three counties in the southeast
part of New Mexico where $100,000 jobs driving a truck are going
wanting. The Occupy People say they don’t have jobs, but they
don’t come out where they are. And they are good paying jobs. At
my last job fair, we were trying to bring people and put them together with folks who were looking for workers, and 14 driving jobs
in one company went without being filled, and 3,000 jobs at another job fair went wanting, and the Nation treats this like it is
some sort of secondary effect. Nationwide, I would point out that
the Bureau of Labor Statistics shows 3.6 million jobs are available
right now in America, and yet we have 8 percent, 7.5 percent,
whatever percent unemployment, and I think at some point, the
country needs to deal with that.
I would also like to echo what Mrs. Capito said about the seniors.
Her seniors seem to be a little more gentle than mine. I just had
a telephone town hall last night and Susan from Los Ninos and
Leone from my district also were quite energized about the whole
concept of quantitative easing. And I know that the price of gasoline and the price of groceries don’t rise to the level of importance
to where the Feds would actually measure those in the computations, but we are 47th per capita income, and when we are told
that inflation is not going up at all, it is eating the lunch of our
seniors who can’t afford to fill their fuel tanks and buy groceries.
Now, I would invite you to come and sit with me in an open town
hall in New Mexico. Would you be open to that? We could contact
your scheduler maybe.
Mr. BERNANKE. You can talk to the scheduler to see if it is possible.
Mr. PEARCE. I would take that as a very positive sign that you
would be interested in talking to people on that end of the economic ladder. But they don’t buy these explanations that quantitative easing is this great miracle that I am hearing today, but
they understand the creation of money out of thin air depreciates
what they have, and as always, inflation hurts the poor worse than
anyone else, and that is our district.
So Susan asked, would you put all your money—just so you get
the full benefit of zero interest rates, why don’t you put all of your
money in savings accounts? Because many of these people are unsophisticated investors, like Chairman Garrett suggested. They are
not comfortable. They don’t know all these risky things. They see
Wall Street and they see all the derivatives and all this jazz that
got everybody hyped up and cost us several trillion dollars to pay
back those people who took those risks, but they don’t buy it.
And they are furious with the government. They say, ‘‘We lived
our life right. We paid off our homes. We put money into the bank.
We had a nest egg that was sufficient at the going rate of interest.
And now our government is bragging that we have zero interest
and we are being punished after living our lives correctly.’’ My
mom is in that category. She is 80-something; I hope that she
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doesn’t go out and start finding a stock investor right now. So I
think at some point it would be nice for you to get out among people who have manure on the bottom of their boots like we do in
New Mexico.
You spend a lot of time on page 7 quoting the CBO about the
effects of the sequester. You even talked about it. But I was unsure
if you agree with the CBO or if you simply are quoting the CBO.
Are you in full agreement with the effects that you have put into
your paper?
Mr. BERNANKE. Broadly speaking, yes.
Mr. PEARCE. Fairly speaking, I am wondering, you also say that
there were temporary interruptions to the economy, the weatherrelated interruptions to the economy. That is page one of your testimony. I am seeing in the Financial Times that Wal-Mart and all
the other retailers are worrying about that price increase or the
payroll tax increase that was passed along at the end of last year
as being maybe as big an effect. The cost is about the same, $95
billion more or less. And yet I don’t find any reference, I don’t find
a reference to the penalizing effect that that tax increase had.
Mr. BERNANKE. I did mention that the overall effect of all the
changes is about 1.5 percentage points, and that includes the payroll.
Mr. PEARCE. But you do mention the sequester. You use a little
bit different language. You don’t actually come out and say ‘‘the sequester,’’ but you do mention that our solutions are going to cause
great headwinds, but you don’t mention the headwinds from that
other decision there to raise taxes.
Mr. BERNANKE. I did mention those, yes.
Mr. PEARCE. I find the omission very curious.
Chairman HENSARLING. The time of the gentleman has expired.
The Chair now recognizes the gentleman from North Carolina,
Mr. Watt, for 5 minutes.
Mr. WATT. Thank you, Mr. Chairman, and I thank Chairman
Bernanke for being here. I apologize for being late. I was over in
the Supreme Court listening to the arguments on the voting rights
case. Sometimes, it is kind of difficult to be in two places at one
time, I have found.
I want to go back to the prior questioner because my constituents
obviously are living in a slightly different world than his and are
getting ready to live apparently in a more significantly different
world than his unless we do something between now and Friday.
We spent a lot of time in yesterday’s hearing talking about the impact of sequestration, and it is really vexing a lot of people, although I confess that most people don’t know what a sequester is.
You say at the top of page 7 that monetary policy is working to
promote a more robust recovery but it can’t carry the entire burden
of ensuring a speedier return to economic health. The economy’s
performance, both over the near term and in the longer run, will
depend importantly on the course of fiscal policy. That is something
which is under the Congress’ control, as opposed to monetary policy, which is under the Fed’s control. And you make some observations about the short- and long-term impact.
I am wondering if you have some views about the impact, the
likely impact, notwithstanding the monetary policies that the Fed
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has implemented, of sequester in the form that it is about to take
effect if we don’t do anything between now and Friday?
Mr. BERNANKE. I haven’t made any comment about the specific
allocation of cuts across different departments. Those are issues for
the Congress to debate. What I did was cite the CBO numbers,
which again I think are reasonable, which suggest that all of the
fiscal measures, including the payroll tax increase, are equal to
about 1.5 percentage points of drag this year, and that the sequester by itself is about six-tenths of drag according to the CBO and
according to I think most standard analyses.
Mr. WATT. And you said you generally agreed with the CBO’s
analysis of that?
Mr. BERNANKE. Yes.
Mr. WATT. All right. So you are saying that sequestration could
have six-tenths of one percentage impact—
Mr. BERNANKE. On the growth rate. It brings the growth rate
down.
Mr. WATT. On the growth rate. Okay. And in this kind of economy that is fragile, what would you project would be the consequences of that?
Mr. BERNANKE. The CBO suggests that the job impact in full
time equivalents would be about 750,000.
Mr. WATT. So that is 750,000 more people unemployed than
would otherwise be.
Mr. BERNANKE. Than would otherwise be the case. Or an unemployment rate that might stay where it is or go up a little rather
than coming down by the end of the year.
Mr. WATT. And what about the uncertainty associated from a
business and economic perspective? What would you project there?
Mr. BERNANKE. It is hard to measure the uncertainty effects, but
there has been a whole sequence of events going back to the 2011
debt ceiling debate, and now we have had the fiscal cliff and sequester and all these things, and what we hear at least anecdotally
from people around the country is that it does create uncertainty
and makes it more difficult for them to plan, to hire, to invest.
Mr. WATT. More difficult for them to hire and invest. I wanted
to reemphasize that. So you think—
Chairman HENSARLING. The time of the gentleman has expired.
Mr. WATT. I yield back.
Chairman HENSARLING. The chairman recognizes the gentleman
from Pennsylvania, Mr. Fitzpatrick, for 5 minutes.
Mr. FITZPATRICK. Thank you, Mr. Chairman.
Mr. Bernanke, thank you for your time and your insight here
and your service to the people. When you were here last year, the
Bureau of Labor Statistics (BLS) indicated that the unemployment
rate was higher than it is today. Today, I think the BLS is saying
it is about 7.9 percent, although most people throughout the country believe it is much higher, including people in Bucks County,
Pennsylvania, which I represent, especially among younger workers, especially recent graduates, just graduating from high school
trying to get in the market.
I spoke earlier today on the other side of the city to the American
Legion about the increasing number of returning veterans from Afghanistan, and some believe that the unemployment rate among
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veterans is twice the national average, and, of course, all of this is
unacceptable. So from 2001 to the present, our country has had a
significant increase in population. We have increasing numbers of
veterans coming home looking for work in a very difficult economy.
Some are suggesting because there are fewer people working
today than were working, employed today than were working in
2001, that our country may have just experienced a lost decade
similar to what Japan went through in the 1990s and the 2000s.
Do you agree with that? Are there any differences between what
happened in Japan and what is happening here in our country, and
if so, what policy suggestions would you make to address it?
Mr. BERNANKE. There obviously has been a very severe, difficult,
economic period. I don’t know about calling it a lost decade. There
are important differences between the United States and Japan.
Japan has an even more rapidly aging society than we do. Their
workforce is actually declining. They have had more difficulties
with their banking sector. We were more rapid in getting our
banks up and running again, so to speak. And, very importantly,
the Federal Reserve has kept inflation close to 2 percent and we
have avoided deflation, which was the major problem for the Japanese.
In terms of what to do about it, first of all, there are many things
that could be done to address our long-run economic prosperity in
terms of good tax policy, and good decisions about encouraging public and private infrastructure, things that I mentioned at the end
of my testimony.
In the short term, it is our view that there is still a good bit of
slack in the economy, that we are not using all the resources we
have. As you mentioned, we have very high unemployment in certain categories, and that is the basis both for the accommodative
monetary policy that we have, keeping interests rates low and trying to stimulate housing and durable goods and so on, and also for
the recommendation that fiscal policy go gradually as Congress
tries to address the long-term deficit issues.
Mr. FITZPATRICK. The Fed has indicated that it believes in the
long term, unemployment rates will settle at around 5.2 or 6 percent?
Mr. BERNANKE. That is our best guess.
Mr. FITZPATRICK. I understand, and I heard testimony earlier
about predicting the future, but when would you say we might get
to around 6 percent? And also, the American people believe natural
unemployment is actually much lower than that, given what we experienced in the 1990s, and maybe your suggestion as to how we
address that expectation?
Mr. BERNANKE. Again, it is hard to predict, but a reasonable
guess for 6 percent would be around 2016, about 3 more years.
Mr. FITZPATRICK. In my remaining time, I just wanted to address
the issue of the Fed’s bond buying program. You said in your testimony last September that the FOMC announced it would purchase
agency-backed mortgage securities at the pace of $40 billion per
month, additionally $45 billion per month for Treasury securities.
The FOMC has indicated it will continue purchases until it observes a substantial improvement in the outlook for the labor market in the context of price stability.
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First of all, what would be the target improvement for the slowdown?
Mr. BERNANKE. We haven’t given a specific number. We are looking for improvements in terms of employment, in terms of unemployment, in terms of a stronger economy that can deliver more
jobs. The reason we haven’t given a specific number, besides all the
uncertainties involved, is that we are also looking at the efficacy
and costs as I have described in my testimony. If all else is equal,
if there are costs being generated by this policy that are concerning, that would, all else equal, make us do less. If it is more
efficacious, then we might do more.
Mr. FITZPATRICK. In my remaining 20 seconds, can you give us
what a proposed strategy would be for the acquired positions that
the Fed has right now, sales strategy?
Mr. BERNANKE. For the assets?
Mr. FITZPATRICK. For the assets, right.
Mr. BERNANKE. We have been clear that at the time we decide
to begin sales, we will give plenty of notice and proceed slowly and
do so in a way consistent with our macro objectives.
Mr. FITZPATRICK. I thank the chairman.
Chairman HENSARLING. The time of the gentleman has expired.
The Chair now recognizes the gentleman from Connecticut, Mr.
Himes, for 5 minutes.
Mr. HIMES. Thank you, Mr. Chairman.
Mr. Chairman, let me add my voice to those who have complimented you and thank you for your efforts over the last years
to restore our economy to vitality. I suspect that when the history
books are written, we will look at the twin engines of monetary and
fiscal policy in this country and you will emerge as somebody who
acted wisely and in good faith, and those of us charged with fiscal
policy certainly in the last 2 years will be regarded at best as having dithered and at worst as having acted counterproductively to
economic recovery. And I appreciate that throughout your testimony as well as throughout this report, you warn us of the dangers
of premature sizable fiscal contraction, something which I have
heard from the other side of the aisle over the course of the last
2 years is regarded by them as essential to our recovery. We have
a theoretical discussion about that around Keynesianism and this
and that.
I do want to ask you a question though. In this report on monetary policy, you talk about the Euro area, and the report reads,
‘‘The Euro area fell further into recession as fiscal austerity and
other things led it a reduction in spending.’’
To take this discussion out of the theoretical, any number of
countries in the Euro area, Ireland, the U.K., Italy, Spain, pursued
fiscal policies significantly more contractionary than our own. I
wonder as you contemplate the Euro area, and here we are looking
at sort of a real-time experiment and policy response, is there any
country in the Euro area that pursued more aggressively
contractionary fiscal policies than our own that has seen economic
expansion, job creation, and meaningful reduction in debt to GDP?
Mr. BERNANKE. I don’t think so.
Mr. HIMES. So there is really no country that has pursued the
kind of austerity policies that we have heard some in this institu-
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tion call for that have experienced economic growth or a reduction
in the debt to their economy?
Mr. BERNANKE. I think Germany has had the best experience,
but even there they have had a shrinking economy recently.
Mr. HIMES. Thank you. I appreciate that answer.
To change topics here, I was very interested in the exchange that
you had in the Senate, I believe yesterday, on the topic of DoddFrank. Senator Crapo, I think, asked to you reflect on what elements of that legislation you thought were good and perhaps which
elements could stand improvement or that this institution should
perhaps revisit, and I think you specifically highlighted Section 716
as an area that you thought perhaps we could revisit.
I wonder, could you elaborate a little bit on Section 716, but also
I would love to have you extend that discussion just based on what
you have done in the last couple of years. What other areas do you
think perhaps we may have gotten wrong or where perhaps we are
experiencing unintended consequences or have created problems for
the regulators in terms of implementation?
Mr. BERNANKE. Section 716 requires the push-out of certain
kinds of derivatives, which means that banks can’t manage those
derivatives, they have to be in a separate company, a separate affiliate, and it is not evident why that makes the company as a whole
safer. What we do see is that it will likely increase costs of people
who use the derivatives and make it more difficult for the bank to
compete with foreign competitors who can provide a more complete
set of services. So there are some concerns about that particular
rule.
I think more generally though we want to ask the question, can
we achieve the same objectives more efficiently, and more cheaply,
and I think a review of some of the different elements would be
useful. A number of people have mentioned concerns about community banks and small institutions, and I think an inventory, a
broad inventory of the regulations affecting small banks would be
worth doing in order to try to assess whether there are places
where we can simplify and reduce the burden for those banks.
Mr. HIMES. Thanks. That is helpful. Would you be willing to
comment in this context, Dodd-Frank and its subsequent regulatory implementation, how you think about the extent to which
the broader too-big-to-fail problem has been addressed and are
there areas where you think we could do better or differently?
Mr. BERNANKE. Dodd-Frank has a pretty comprehensive strategy
for addressing too-big-to-fail. I think it is too early to say. I think
we have made some progress, but I think it is too early to make
a definitive conclusion because many of the relevant regulations
are not even in effect yet. But, again, I think there is a strategy
here and I think we ought to continue to pursue it and see how
it shakes out. If it doesn’t achieve the objective of eliminating toobig-to-fail, I think we ought to come back and decide or ask Congress whether they might take additional steps.
Mr. HIMES. Thank you, Mr. Chairman.
Chairman HENSARLING. The time of the gentleman has expired.
As a process point, the chairman will be the bearer of bad news
to some Members on our current schedule. To respect the Chairman’s schedule, it is likely that Representatives Luetkemeyer, Car-
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ney, Huizenga, and Kildee will likely be the last Members to be
able to ask questions.
At this point, the Chair will recognize Mr. Luetkemeyer of Missouri for 5 minutes.
Mr. LUETKEMEYER. Thank you. Thank you, Mr. Chairman, and
thank you, Chairman Bernanke, for being here and enduring 3
hours of this again.
I have some concerns with regards to the way we are going with
quantitative easing from the standpoint that even in your own report here you talk about Japan, you talk about England, and you
talk about China. All three have used quantitative easing and yet
all three of them have, even in your own document here, their
growth has continued to go the wrong direction. And I am curious
about that.
Even in The Wall Street Journal yesterday, it said that China
now has it its own debt bomb. And one of the statements that it
made in there is that through 2007, creating a dollar of economic
growth in China required just over a dollar of debt. Since then, it
is now taking $3 of debt to generate a dollar’s worth of growth.
This is what you normally see in the late stages of a credit binge
as more debt goes into increasing less productive investments.
So I guess my question is, while we are heading down the same
path as these other countries, and my neighbor here, my friend to
the left a while ago mentioned about Japan and their 20 years of
trying this quantitative easing and now they have a stagnant economy, they have weak industries, they have little growth, and yet
they have 200 percent of debt to GDP. We are headed down that
same road, and obviously even your own documentation shows it
is questionable whether it even works. What would be your response?
Mr. BERNANKE. I think the evidence for the United States is that
while it is not incredibly powerful that it does work, we have seen
a recovery that is not as fast as we would like, but it is nevertheless stronger and more meaningful than many other industrial
countries.
One way of interpreting Japan on the monetary side is that they
were too cautious in that one of the most salient facts about Japan
is that they have had deflation, falling prices now for quite a few
years, and that is suggestive of a monetary policy which is not
achieving price stability. And, as you know, the new prime minister
and new governor of the Bank of Japan are promising more aggressive policies to try to eliminate deflation. So you could look at that
either way.
It is a problem for us that our normal short-term interest rate
policies are no longer available because short rates are close to zero
and so we have had to go to different methods as I described. But,
again, our best estimates suggest that it has had a meaningful beneficial effect, and I have tried to be completely frank with this committee and talk about the downside as well because I would like
you to understand the kind of cost-benefit analysis that we are
doing.
Mr. LUETKEMEYER. I have some concerns from the standpoint
that I don’t know that we are doing things differently than other
countries here, but hopefully you feel that we do.
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The other thing is you mentioned an exit strategy, and I understood what you were saying a while ago when you were talking
about how there are different ways of going about it. Has any other
country ever done this, had this large increase in the central bank’s
portfolio and then unwound it so that we know that this is a tested
strategy that would work?
Mr. BERNANKE. Not in a precisely analogous way, because Japan,
after all, which is really the only other country prior to the crisis
which had used quantitative easing is still in that situation. But
the tools that we are using or propose to use, such as the interest
on reserves, for example, or the draining of reserve tools that we
have, those have been used quite frequently by other central banks
and they seem to work in their context.
Mr. LUETKEMEYER. Okay, one more quick question here before
my time runs out, and it is with regards to a statement or comment you made in your opening statement, that the Federal Reserve is responding accurately to the financial stability concerns
throughout substantially expanded monitoring of emerging risks in
the financial system and approach to the supervision of financial
firms that takes a more systemic perspective and the ongoing implementation of reforms to make the financial system more transparent and resilient.
Can you give me some examples of things that you are doing
with regards to systemic supervision, implementation of reforms,
give me some specific examples?
Mr. BERNANKE. Sure. On the monitoring, we have greatly increased resources just to monitor all the different sectors of the financial markets. Both the Fed and the Financial Stability Oversight Council are doing that.
In terms of macro-potential oversight, one good example is the
stress testing that we now do, where we ask the largest banks to
figure out what would happen to their capital if there was a very
severe downturn in the economy and a very big decline in financial—
Mr. LUETKEMEYER. Let me interrupt for one second. I am running out of time here. Can you give me examples of reforms to
make the system more transparent and resilient?
Mr. BERNANKE. The Basel rules, for example, require more disclosure. Our stress tests, we publish the results so that the markets know what the results are for each individual bank.
Mr. LUETKEMEYER. Thank you very much. My time has expired.
Thank you very much for your answers.
Chairman HENSARLING. The time of the gentleman has indeed
expired.
The Chair now recognizes the gentleman from Delaware, Mr.
Carney, for 5 minutes.
Mr. CARNEY. Thank you, Mr. Chairman, and thank you, Chairman Bernanke, for your testimony today, for your report, and really for your great leadership on monetary policy for our country over
the last several years. I think you are the right person at the right
time for what we needed. And you have given us, frankly, great advice. We haven’t really followed it with respect to smart fiscal policy. We appreciate your comments on that. You have consistently
said that we need to be careful in the short term, do no harm in
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the short term, if I may, and address our long-term imbalances, fiscal imbalances in the outyears.
In your testimony, you say specifically that the Federal deficit
and debt as a percentage of GDP will begin rising again in the latter part of this decade, reflecting in large part the aging of the population and fast rising health care costs.
Do you believe as I do that health care costs are the primary
driver of our outyear deficits?
Mr. BERNANKE. They are. Yes.
Mr. CARNEY. From our perspective, we have Medicare, Medicaid,
Federal employees, military health care. What should be our goal?
What we should be focusing on? Have you thought much about this
as it relates to what the country needs to do with these fiscal challenges?
Mr. BERNANKE. As you know, health care is a very complicated
subject and nobody has a single answer. I think one way of describing our problem is we have fee-for-service and third-party pay together, which means that doctors can order as many tests as they
want and the patient doesn’t care because they know somebody
else will pay for it. There are many different ways to address that.
One way is to have the consumer bear some of the financial costs.
Another way is to have tighter controls from the government which
is paying the cost. So there are many different approaches. Certainly, we want to be rewarding doctors and hospitals for quality.
We want to have more transparency about their processes.
Mr. CARNEY. How about health care as a sector? Should we be
looking at—we have these debates in my State of Delaware all the
time about somebody is expanding and building a new hospital
right down the street from where I live, a new surgery center put
here. And we talk a lot about economic development. I think you
could also see it as frankly an increase in overhead. Those costs are
going to be borne by somebody, and they are either employers or
the government it seems to me.
How would an economist look at that in terms of the health care
sector writ large and health care employment?
Mr. BERNANKE. That is exactly right. We have scarce resources.
We don’t have infinite amounts of money to spend on health care.
We want to deploy it in ways that have the greatest benefit for the
least cost, and there are different ways to go about doing that. But
clearly, getting the per capita cost of health care under control
would not only be very good for the Federal budget, but it would
be a terrific thing for our economy more broadly because, of course,
individuals and companies also pay health care costs.
Mr. CARNEY. So you may not want to comment on this, but one
of the specific ideas that have been floated is to increase the age
for Medicare eligibility, which doesn’t do anything for the cost of
the people who have that. As I see it, it just shifts that cost from
the government frankly or from that system to the private sector
or private payors. Do you have any thoughts on that generally?
Mr. BERNANKE. It relates to what I just said, which is this is not
just a Federal fiscal problem, it is an economy-wide problem, and
so the real solutions, the real lasting solutions will involve changing the way we pay doctors and hospitals so that they will have
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the incentives to keep costs under control, whether it is the government paying it or whether it is a private sector person paying it.
Mr. CARNEY. Thank you. One last question. You mentioned earlier when we were talking about too-big-to-fail with Representative
Capuano that you no longer, under Dodd-Frank, have the tools that
were available to you in 2008. Do you need additional tools? There
has been a lot of discussion among people that I have talked to
about in addition maybe to Orderly Liquidation Authority, which
I guess a district judge would order having some sort of enhanced
financial bankruptcy, that might be an option as well. Do you have
any thoughts on additional tools?
Mr. BERNANKE. No, we are not asking for any additional tools at
this juncture. We continue to work on the Orderly Liquidation Authority with the FDIC, and at some point it would be a good idea
for Congress to review that process and see if you are comfortable
with the approach that the FDIC in particular has suggested for
dealing with a failing firm.
Mr. CARNEY. Thank you, Chairman Bernanke.
I yield back.
Chairman HENSARLING. The Chair recognizes the gentleman
from Michigan, Mr. Huizenga, for 5 minutes.
Mr. HUIZENGA. Thank you, Mr. Chairman. I appreciate that.
Chairman Bernanke, I appreciate you being here as well. I am
going to try to move quickly and express some opinions, but I also
have a couple of questions, and I too want to sort of log my caution
on what we have been doing with our monetary policy and the easing that we have had.
There has been lots of discussion about this economy being very
fragile, I have heard a number of my friends and colleagues over
there, and why we ‘‘can’t allow the across-the-board cuts to go in
place.’’ But it seems to me that no one is really commenting on the
tax increases proposed by the White House or the increased regulation that we are seeing, whether it is through the EPA, certainly
through Dodd-Frank that this committee is dealing with, et cetera,
et cetera.
As one of my business owners back home put it to me, he said,
‘‘Look, it is not like this one little piece, this one grain of sand, is
going to stop the machine. But when you start adding 10 or 20 or
30 or 40 or 50 and then you start pounding it in with a mallet, suddenly that little grain of sand does start grinding on that machine
and it breaks it down.’’ I think that is exactly what we have seen
with much of the regulation.
But in addition to that, we haven’t talked about the hit from the
tax rate lapses, the so-called Bush/Obama tax rates that were
there, and I would like to see my friends have a greater conversation about that. At the time, Ernst & Young put out a study that
letting tax rates for the wealthiest Americans lapse would cost
about 700,000 jobs, the exact same numbers basically, and I am not
trying to compare apples and oranges. I think as one wise person
said, we might be talking about red apples versus green apples
here. But we have to look at that side of the equation as we are
moving forward.
The long term, I want to talk a little bit about that, and I have
a specific question. On page 5, to quote your report today, ‘‘How-
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ever, the committee remains—the committee being you all—confident that it has the tools necessary to tighten monetary policy
when the time comes to do so,’’ and I know you have laid out 2015,
2016, that timeframe.
Exactly what tools do you believe that you are going to employ
to put that restraint back in place?
Mr. BERNANKE. We earlier discussed the exit sequence. So, first,
we can simply allow securities on our balance sheet to run off and
not replace them as we currently are doing. Second, we have a
number of tools that can be used to drain reserves from the system,
such as reverse repos. Third, we can raise interest rates even without reducing our balance sheet by raising the interest rate we pay
on excess reserves which will in turn translate into higher interest
rates in money markets. And fourth and finally, and it is not the
first resort, but eventually we can sell the securities back into the
market in a slow predictable way.
Mr. HUIZENGA. This has not been done though, I think as we
talked about with Japan and others, correct? This is the theory of
how we are going to do this.
Mr. BERNANKE. Each of the elements is something that we have
tested, that we have seen other countries use, so we think we understand it pretty well.
Mr. HUIZENGA. So the thing I did appreciate is you laid out three
things that you wanted to have brought to light today, and interest
rates won’t be this low forever was something I think we were not
living with the reality of or the recognition of that. I am curious,
because you talk about there, and I am afraid that the headlines
tomorrow are going to be, ‘‘Bernanke blasts across-the-board cuts,’’
and/or, ‘‘Bernanke calls for a stoppage of the across-the-board cuts,’’
when frankly, based on what I read and what I have heard of the
testimony today, I think the headlines ought to be, ‘‘Bernanke calls
for long-term reforms.’’ And there is just a denial in this town in
so many ways about what is happening now and in the future.
What would you say to those who say we can’t or shouldn’t reform these long-term programs?
Mr. BERNANKE. I don’t think we have any choice. I think I have
tried throughout this discussion to always have two parts to the
recommendation.
Mr. HUIZENGA. You are a good economist. One hand or the other
hand.
Mr. BERNANKE. I have a third hand here, too. Anyway, with the
idea being that we want to reduce somewhat the fiscal drag in
2013. And I am not speaking only about the sequester. I talked
about all of the fiscal actions which collectively are about 1.5 percentage points, according to the CBO. But I am not here to recommend that we just kick the can indefinitely down the road. I still
think it is very important to address the long-range issues.
Mr. HUIZENGA. We have about 10 seconds. So this is Medicare,
Medicaid, Social Security reform?
Mr. BERNANKE. The specifics are up to Congress, but obviously—
Mr. HUIZENGA. Those are our long-term drivers of that. So there
you go, folks. The headline for tomorrow is, ‘‘Bernanke calls for
long-term fixes.’’
Chairman HENSARLING. The time of the gentleman has expired.
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The Chair now recognizes the gentleman from Michigan, Mr. Kildee, for 5 minutes.
Mr. KILDEE. Thank you, Mr. Chairman, and in respect for the
time that Chairman Bernanke has provided us, I will ask one I
think very important question, and then if allowable, yield the remainder of my time to my colleague, Mr. Ellison, to ask a question.
Before I came to Congress, as I mentioned to you before the hearing, I was in local government. I was the county treasurer of Genesee County, Michigan, which is home to Flint, Michigan. We have
seen recently over the last couple of years, but even in the last few
weeks, a significant number of downgrades to municipal debt which
by itself is an issue that I am interested in your thinking on, but
I think also represents a symptom of a much larger problem, and
that is municipal insolvency generally. We have seen Vallejo, California; Harrisburg, Pennsylvania; Camden, New Jersey; my own
hometown of Flint, Michigan, and now we see Detroit facing this
insolvency.
The solutions, the State-based solutions to these problems typically have been replacing existing management with different management that can presumably make different decisions that result
in outcomes that are more favorable. I think what we are facing,
in my opinion, in my work across the country, is something much
bigger than a failure of management but a structural failure in
what I think is potentially another institutional failure in the
urban setting, in municipal governments.
I am interested in your thoughts about the implications for that
trend, if you agree that it is taking place on our economy, what solutions the Federal Government might consider, if any, to deal with
that. And then a corollary to that, to the extent that the sequester
will disproportionately affect the most vulnerable of our citizens,
isn’t it also logical to assume that the sequester cuts might exacerbate what is already a growing problem in urban America and
make this insolvency even more difficult to manage?
Mr. BERNANKE. The last few years have been a very tough time
for State and local governments. Not only are income and sales
taxes down, but so are property taxes as property values have come
down as well. As a result, as I mentioned before, State and local
governments have cut workforces, have cut spending, have cut capital projects. Some have been able to steady the ship. Others are
still under a lot of stress.
Obviously, in the short term trying to promote job creation as the
Fed is trying to do and as I am asking the Congress to think about
in their decisions is going to help a lot of these areas by creating
more economic activity and more tax revenues.
There are obviously some parts of the country where there are
longer-term, more structural problems that are not just business
cycle problems, and some of those may be in your State. There I
don’t really have a solution. The Federal Government has not in
the past involved itself that much with those distressed municipalities.
Mr. KILDEE. I guess if I could just quickly follow up on that, the
Federal Government hadn’t involved themselves in a lot of things
until the necessity appeared. What I am concerned about the State
governments may not have the capacity and the cities failing will
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be a national problem one way or another. I suggest perhaps at a
different juncture we might pursue some thought about how the
Federal Government might intervene in that case.
I would yield the remainder of my time to Mr. Ellison.
Mr. ELLISON. Thank you, Mr. Kildee. I am very grateful.
Chairman Bernanke, I don’t have much time so I am going to
ask you straight, Sheila Bair had an article in today’s New York
Times focusing on income inequality. My question to you is, does
inequality matter in terms of the inefficiency and functioning and
growth of our economy?
Mr. BERNANKE. It is very important in its own right. We want
everybody to have opportunities, we want a fair society. I think it
does. If people don’t have—if talented people don’t have the ability
to move up and get a good education and to move into the middle
class, that that is a loss for everyone, not just for those individuals.
So I think a society in which there is greater equality of opportunity will be a more productive and efficient society as well.
Mr. ELLISON. Those points you made I think are absolutely right,
but 70 percent of our economy is consumer spending. If folks on the
bottom don’t have—
Mr. BERNANKE. But in the longer term, what matters is our productive capacity. And there, human talent and skills are really the
most important thing. In this country, we had a period where we
brought women into the labor force, and that brought a whole new
set of skills and talents into our economy.
Chairman HENSARLING. The time of the gentleman has expired
just under the wire. The last word will go to the gentleman from
Wisconsin. Mr. Duffy is recognized for 5 minutes.
Mr. DUFFY. Thank you, Mr. Chairman. And good afternoon,
Chairman Bernanke. Yesterday in the Senate hearing, you had a
conversation about some of your concerns about Dodd-Frank. You
didn’t have much time to answer that question. Would you mind
sending me in writing a little more detail on all of your concerns
with Dodd-Frank, maybe, say, in 2 weeks?
Mr. BERNANKE. Sure. But we don’t have a long list of specifics
at this point.
Mr. DUFFY. That is okay.
Mr. BERNANKE. I do think it would be a good thing for Congress
to review.
Mr. DUFFY. But if you wouldn’t mind sending the Fed’s concerns,
I would appreciate that. Is that okay?
Mr. BERNANKE. Certainly.
Mr. DUFFY. In 2 weeks?
Mr. BERNANKE. That would be fine.
Mr. DUFFY. 2 or 3 weeks?
Mr. BERNANKE. As soon as we can.
Mr. DUFFY. You have a big team. All right. Quickly, I want to
talk about the debt. Roughly, we spend about, what, $225 billion
a year to service our $16.5 trillion in debt. Is that right? Roughly?
Mr. BERNANKE. Sounds about right.
Mr. DUFFY. Okay. And for the CBO, for every additional point
that our interest rates go up, it costs us an additional $100 billion
a year to service the debt. Does that sound right?
Mr. BERNANKE. Yes.
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Mr. DUFFY. So if you stop with your accommodative monetary
policy, we could see interest rates rise 2 or 3 percent, right? So we
would have an additional $200 billion to $300 billion of additional
dollars going to service our current debt. Is that fair to say?
Mr. BERNANKE. That is right. CBO takes this into account in
their projections.
Mr. DUFFY. And so, for me, I look at that and say, listen, this
is a half a trillion dollars a year to service our current debt, $5 trillion over 10 years. I look at this and I see the lights going off, the
sirens are blaring, and I am almost setting a proverbial can on my
counter and you are kicking it saying, listen, don’t worry about $85
billion in cuts; do it a different day.
I listened to what you are saying, and I think you are giving
cover to a set of policies that aren’t responsible, and we are all
going to pay the price for the fiscal irresponsibility. And instead of
encouraging responsibility, you come in and say, listen, to cut 2
percent of our budget, you can’t do it. It is going to have a great
impact on our economy. Mr. Chairman, that doesn’t make sense to
me.
Mr. BERNANKE. I think most economists, including the CBO,
would say that this will cost a lot of jobs in the short run, and you
can address—you can achieve the same results with longer-term
programs.
Mr. DUFFY. And so on that point, how many jobs are lost if we
cut the $27 million that go to Moroccan pottery classes or the $2.2
billion in free cell phones? We pay $700 billion to see how long
shrimp can run on a treadmill. I believe we paid for the travel expenses for the Watermelon Queen in Alabama.
There is fat in the budget, and I think every American looks at
how we spend our money and they say, I can cut 2 percent out of
my family budget, small businesses can say, I can cut 2 percent out
of my budget, but you come in and tell us, listen, I agree with the
President. It is catastrophic, it is catastrophic if you cut 2 percent,
mass mayhem in our economy, I find that to be unbelievable.
Mr. BERNANKE. The sequester is not designed to cut wasteful
stuff. It is across-the-board.
Mr. DUFFY. So, then, are you here telling us that if we cut $85
billion in a more reflective way in the bad spending that I just referenced, you would support it? It is a good idea if we are not doing
it by way of the sequester, but we have a little more reflective analysis—
Mr. BERNANKE. It would be better.
Mr. DUFFY. —on the $85 billion?
Mr. BERNANKE. It would be better.
Mr. DUFFY. So is it better, or you would agree with us that we
should actually reduce spending?
Mr. BERNANKE. I am still concerned about the short-run impact
on jobs. And you don’t get as much benefit as you think, because
if you slow the economy, that hurts your revenues, and that means
your deficit reduction is not as big as you think it is.
Mr. DUFFY. So the revenues that we get from the Moroccan pottery classes, then, and the $2.2 billion in free cell phones, and the
list goes on, Mr. Chairman, that is a great driver of economic
growth in our country? Is that your position?
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Mr. BERNANKE. Most of the spending goes to the military and to
transfer programs like Social Security and Medicare.
Mr. DUFFY. And there is a lot of fat and you can find 2 percent
fat that doesn’t affect our military, doesn’t affect our—
Mr. BERNANKE. I also said in my testimony that not all spending
and taxes are the same. I very much advocate trying to make good
decisions about how you tax and how you spend.
Mr. DUFFY. So you agree there is fat and that you would encourage us to cut the fat, because if you weren’t interjecting your policy,
this would be a half a trillion dollar expense to the American Government, almost what we spend on our military?
Mr. BERNANKE. I think there is good—yes. It is obviously a good
idea to improve or fiscal budgeting and to make better decisions,
certainly.
Mr. DUFFY. I know you like to say you stick to monetary policy,
but you do come in here and you talk about fiscal policy all the
time. And if you don’t like our approach to try and reduce how
much we spend and you want to kick the can down the road, if—
and I don’t have much time, 15 seconds—if you wouldn’t mind supplying in writing your plan for a long-term fiscal approach, I would
appreciate that, because you keep—whenever we try to cut spending, you come at us and say, don’t cut spending today. No, no, no.
Cut it tomorrow. If you have a better plan on how we can have a
long-term approach to fix this problem, if you would submit that
in writing, too, I would appreciate it, Mr. Chairman. Thank you.
Mr. BERNANKE. You bet.
Chairman HENSARLING. The time of the gentleman has expired.
I would like to thank Chairman Bernanke for his testimony today.
The Chair notes that some Members may have additional questions for this witness, which they may wish to submit in writing.
Without objection, the hearing record will remain open for 5 legislative days for Members to submit written questions to this witness
and to place his responses in the record. We would ask you, Chairman Bernanke, to please respond as promptly as you are able.
Also, without objection, Members will have 5 legislative days to
submit extraneous materials to the Chair for inclusion in the
record.
Without objection, the hearing is adjourned.
[Whereupon, at 1:08 p.m., the hearing was adjourned.]
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APPENDIX
February 27, 2013
(57)
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THE HONORABLE DENNIS
Ross (Fl-1S)
229 Cannon House Office Building
Washington, DC 20515
Office: 202-225-1252
http://dennisross.house.gov
Committee on Financial Services
Hearing: Monetary Policy and the State of the Economy
February 27, 2013
Statement for the Record
Thank you Chairman Hensarling for holding this important hearing today, and thank you Chairman
Bernanke for testifying before this committee. I take your opinions and the actions of the Federal
Reserve Board (the Board) to heart. So again, thank you.
If you are here to speak on the state of the economy, you cannot speak on the economy of my state
without taking into consideration the deeply entangled role natural disasters and property/casualty
insurance plays in it. Florida has more than twice the national average for foreclosure filings; one of
every 706 housing units received some type of foreclosure filing in October 2012. Unfortunately though,
while home values might be slowly increasing, so are insurance costs. The average premium for a
homeowners' policy in 2002, prior to the four major hurricanes that crossed our state in 2004, was
$786. In 2010, it was almost double that amount, $1,544 - which was the third highest in the nation.
I have spent most of my life in Florida. I remember Hurricane Andrew, and how fearful my wife and I
were when the property and casualty insurance market dried up and we were left without insurance
coverage that was required by our mortgage lender. If you were to conSider that event today, it would
prove disastrous to our state. If another hurricane were to hit six Florida counties (Broward, Dade,
Hillsborough, Lee, Monroe and Palm Beach) and 5% of the businesses had to shut down, that would
translate into the closure of nearly 2,500 business, lost sales of $3.8 billion, $81.8 million in lost sales tax
receipts, $79.8 million in payroll losses and the loss of more than 30,000 jobs - and 5% was about only
half of what Hurricane Andrew was in 1992. Insurance helps to mitigate the negative economic effects
of natural disasters, and elected officials like myself must do everything in our power to ensure
insurance is available and reflects the true costs of the market.
I was also chair of the Insurance Committee in the Florida State Legislature after the disastrous
hurricane seasons of '04 and 'OS. And I can tell you after all of those years of personal experience that
with all due respect, you - as a federal regulator and Chair of the Federal Reserve Board, and the other
governors who look at things from a bank-centric point of view - do not have the experience, foreSight,
insight, or hindsight to make decisions affecting insurers in Florida. So to say I have grave concerns over
the Board's proposed rules coming out of Basel III regarding capital requirements for insurance
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companies is a drastic understatement.
59
Simply put: these bank-centric rules for minimum leverage and risked-based capital requirements are
wrong for companies whose primary business comes from selling insurance products, regardless of
whether they have a saving and loan holding company (SLHC) or not. Moreover, insurance companies
selling auto, health, life, property and casualty, even surplus lines policies are not even subjected to the
same capital requirements, much less the same across the country. The fact is, capital requirements
should be determined by the state in which the insurance company is domiciled should be the minimum
-period.
As Florida Insurance Commissioner and President of the National Association of Insurance Commissioner
Kevin McCarty stated when he testified at a field hearing last year:
"Insurance has shorter duration liabilities in many of the property/casualty and health
product lines, and the assets held are similarly short-term. Insurance has longer
duration liabilities in life and annuity product lines, and these liabilities are matched
against longer-term assets. This is a critical distinction from banking and other financial
products. The reason many other financial firms suffered during the financial crisis was
that the duration of their assets and liabilities were not matched in a way that enabled
them to fund their liabilities when they came due ... It is for this reason that insurance
regulators purposely avoid a 'one-size-fits-all' approach and, instead, opt for company
and product specific analysis and examination."
Another explanation comes from a representative of the American Council of Ufe Insurers:
"Banks rely on short term, on-demand funding that can put pressure on liquidity in
times of stress. Ufe insurers are much less likely to experience a 'run on the bank'
liquidity event because their products are long-term and do not have an immediate call
ability."
What troubles me most about the Board's proposed capital requirements is the claim by one insurance
company I spoke with that stated that under some scenarios, an insurance-based SLHC could be subject
to seizure levels under a state regulator but would look well-capitalized under a Basel "consolidated"
framework. Florida cannot take this gamble on the viability of the insurance providers the Board rules
are suggesting. Hundreds of years of natural disasters, an aging population, a housing boom, and a
fickle economy have taught us that.
My second concern regarding the Board's proposed rule is the new requirement that insurance
companies will be required to follow Generally Accepted Accounting Principles (GAAP) instead of
Statuary Accounting Procedures (SAP). Today, mutual insurance companies are required to file financial
statements based on SAP principles by their state regulators that were designed by them to assist them
in monitoring the solvency of an insurer. GAAP accounting principles were designed to provide key
information to investors of public companies to look at ongoing concerns. Therefore, the assets,
liabilities, and surplus reported in statutory financial statements under SAP are typically much more
conservative than under GAAP.
Honorable Dennis Ross (FL-lS)
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Additionally, one of the largest insurance companies in Florida stated they expect it will take four years
to implement the GAAP filing requirements that will be in addition to the SAP filings the state will still
require and cost $150 million a year to comply - and these costs will be placed squarely on the backs of
policyholders in my state. As I previously stated, Floridians are already paying some of the highest
premiums in the country that have doubled over the past five years. This is not the time to increase
costs for insurance premiums - especially when the Board will not learn any new, helpful financial
information from the GAAP filings.
Finally, I reiterate the claims and concerns of others that a rule of this nature is not only violating
McCarran-Ferguson, it is blatantly ignoring Congressional intent under the Dodd-Frank Act. Not even
amendment-writer and sponsor Senator Collins believes the Board is right. Under the Collins
Amendment, the Board is directed to set minimum capital requirements for depository institution
holding companies, but the amendment does not preclude the Board from taking into account the
existing and comprehensive requirements under state jurisdiction. Nor does Dodd-Frank suggest any
such limitation. She and other Members of Congress understood very clearly the simple reality that you
cannot regulate banks and insurance in the same way. I do not understand why the Board is having such
trouble understanding that as well.
Furthermore, the McCarran-Ferguson Act prohibits Congress from getting into the business of regulating
insurance. Without a clearly expressed Congressional directive, the Board's proposed rule runs the risk
of legal challenges under McCarran-Ferguson that could result in years of litigation battles and increased
costs for policyholders. Again, this is not the time to dump that kind of burden on families in Florida.
I recognize that the Board is attempting - at the direction of Congress - to ensure that a collapse of an
AIG-nature never happens again, and I truly applaud you for your efforts. However, as I continue to
watch this process unfold, my opinion is that the Board is searching the past for problems to their
solutions proposed under this rule. The Board is building a system to combat the last crisis, but I am not
confident that had any of these rules been in place a decade ago they would have caught or prevented
the AIG collapse
a collapse that is still partly to blame for the underwhelming economic outlook you
will be presenting today, Chairman Bernanke.
I firmly believe that instead of taking away the power of the state regulators and proven, effective state
requirements, requiring onerous and costly regulatory burdens, and even possibly violating current
federal law as the Board proposes, there is a better approach. The approach the Board could take
should work to actually reduce systemic risk instead of merely accepting it and forcing others who
played no part in the economic situation we are in today to mitigate for it.
Thank you Mr. Chairman, and Chairman Bernanke, for hearing my concerns, and I look forward to your
testimony.
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Honorable Dennis Ross (Fl-1S)
61
For release on delivery
10:00 a.m. EDT
February 27,2013
Statement by
Ben S. Bemankc
Chainnan
Board of Govemors of the Federal Reserve System
before the
Committee on Financial Services
u.s. House of Representatives
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February 27, 2013
62
Chairman Hensarling, Ranking Member Waters, and other members of the Committee, I
am pleased to present the Federal Reserve's semiannual MonetaJY Policy Report. I will begin
with a short summary of current economic conditions and then discuss aspects of monetary and
fiscal policy.
Curreut Ecouomic Conditions
Since I last reported to this Committee in mid-2012, economic activity in the United
States has continued to expand at a moderate if somewhat uneven pace. In particular, real gross
domestic product (GDP) is estimated to have risen at an annual rate of about 3 percent in the
third quarter but to have been essentially flat in the fourth quarter. 1 The pause in real GDP
growth last quarter does not appear to reflect a stalling-out of the recovery. Rather, economic
activity was temporarily restrained by weather-related disruptions and by transitory declines in a
few volatile categories of spending, even as demand by U.S. households and businesses
continued to expand. Available information suggests that economic growth has picked up again
this year.
Consistent with the moderate pace of economic growth, conditions in the labor market
have been improving gradually. Since July, nonfarm payroll employment has increased by
175,000 jobs per month on average, and the unemployment rate declined 0.3 percentage point to
7.9 percent over the same period. Cumulatively, private-sector payrolls have now grown by
about 6.1 million jobs since their low point in early 20 I 0, and the unemployment rate has fallen a
bit more than 2 percentage points since its cyclical peak in late 2009. Despite these gains,
however, the job market remains generally weak, with the unemployment rate well above its
longer-run normal level. About 4.7 million of the unemployed have been without ajob for six
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I Data for the fourth quarter of 20 12 from the national income and product accounts reflect the advance estimate
released on January 30, 20]3.
63
-2-
months or more, and millions more would like full-time employment but are able to find only
part-time work. High unemployment has substantial costs, including not only the hardship faced
by the unemployed and their families, but also the harm done to the vitality and productive
potential of our economy as a whole. Lengthy periods of unemployment and underemployment
can erode workers' skills and attachment to the labor force or prevent young people from gaining
skills and experience in the first place--developments that could significantly reduce their
productivity and earnings in the longer term. The loss of output and earnings associated with
high unemployment also reduces government revenues and increases spending, thereby leading
to larger deficits and higher levels of debt.
The recent increase in gasoline prices, which reflects both higher crude oil prices and
wider refining margins, is hitting family budgets. However, overall inflation remains low. Over
the second half of 20 12, the price index for personal consumption expenditures rose at an annual
rate of 1-112 percent, similar to the rate of increase in the first half of the year. Measures of
longer-term inflation expectations have remained in the narrow ranges seen over the past several
years. Against this backdrop, the Federal Open Market Committee (FOMC) anticipates that
inflation over the medium term likely will run at or below its 2 percent objective.
Monetary Policy
With unemployment well above normal levels and inflation subdued, progress toward the
Federal Reserve's mandated objectives of maximum employment and price stability has required
a highly accommodative monetary policy. Under normal circumstances, policy accommodation
would be provided through reductions in the FOMC's target for the federal funds rate--the
interest rate on overnight loans between banks. However, as this rate has been close to zero
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since December 2008, the Federal Reserve has had to use alternative policy tools.
64
-3These alternative tools have fallen into two categories. The first is "forward guidance"
regarding the FOMe's anticipated path for the federal funds rate. Since longer-term interest
rates reflect market expectations for shorter-term rates over time, our guidance influences longertenn rates and thus supports a stronger recovery. The formulation of this guidance has evolved
over time. Between August 2011 and December 2012, the Committee used calendar dates to
indicate how long it expected economic conditions to warrant exceptionally low levels for the
federal funds rate. At its December 2012 meeting, the FOMC agreed to shift to providing more
explicit guidance on how it expects the policy rate to respond to economic developments.
Specifically, the December postmeeting statement indicated that the current exceptionally low
range for the federal funds rate "will be appropriate at least as long as the unemployment rate
remains above 6-112 percent, inflation between one and two years ahead is projected to be no
more than a half percentage point above the Committee's 2 percent longer-run goaL and longerterm inflation expectations continue to be well anchored."z An advantage of the new
formulation, relative to the previous date-based guidance, is that it allows market participants
and the public to update their monetary policy expectations more accurately in response to new
information about the economic outlook. The new guidance also serves to underscore the
Committee's intention to maintain accommodation as long as needed to promote a stronger
economic recovery with stable prices. 3
See Board of Governors of the Federal Reserve System (2012), "Federal Reserve Issues FOMC Statement," press
release, December 12, www.federalreserve.gov/newsevents/press/monetary/20121212a.htm.
3 The numerical values for unemployment and inflation included in the guidance are thresholds, not triggers; that is,
depending on economic circumstances at the time, the Committee may judge that it is not appropriate to begin
raising its target for the federal funds rate as soon as one or both of the thresholds is reached. The 6-1/2 percent
threshold for the unemployment rate should not be interpreted as the Committee's longer-term objective for
unemployment; because monetary policy affects the economy with a lag, (he first increase in the target for the funds
rate will likely have to occur when the unemployment rate is still above its longer-run normalleve\. Likewise, the
Committee has not altered its longer-run goal for inflation of2 percent, and it neither seeks nor expects a persistent
increase in inflation above that target.
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2
65
-4-
The second type of nontraditional policy tool employed by the FOMC is large-scale
purchases of longer-term securities, which, like our forward guidance, are intended to support
economic growth by putting downward pressure on longer-term interest rates. The Federal
Reserve has engaged in several rounds of such purchases since late 2008. Last September the
FOMC announced that it would purchase agency mortgage-backed securities at a pace of
$40 billion per month, and in December the Committee stated that, in addition, beginning in
January it would purchase longer-term Treasury securities at an initial pace of $45 billion per
month. 4 These additional purchases oflonger-term Treasury securities replace the purchases we
were conducting under our now-completed maturity extension program, which lengthened the
maturity of our securities portfolio without increasing its size. The FOMC has indicated that it
will continue purchases until it observes a substantial improvement in the outlook for the labor
market in a context of price stability.
The Committee also stated that in determining the size, pace, and composition of its asset
purchases, it will take appropriate account of their likely efficacy and costs. In other words, as
with all of its policy decisions, the Committee continues to assess its program of asset purchases
within a cost-benefit framework. In the current economic environment, the benefits of asset
purchases, and of policy accommodation more generally, are clear: Monetary policy is
providing important support to the recovery while keeping inflation close to the FOMe's
2 percent objective. Notably, keeping longer-term interest rates low has helped spark recovery in
the housing market and led to increased sales and production of automobiles and other durable
goods. By raising employment and household wealth--for example, through higher home
prices--these developments have in turn supported consumer sentiment and spending.
See Board of Governors of the Federal Reserve System (2012), "Federal Reserve Issues FOMC Statement," press
reJease, September 13, www.federalreserve.gov/newsevents/press/monetary120120913a.htm; and Board of
Governors, "FOMC Statement," December 12, in note 2.
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4
66
-5Highly accommodative monetary policy also has several potential costs and risks, which
the Committee is monitoring closcly. For example, if further expansion of the Federal Reserve's
balance sheet were to undermine public confidence in our ability to exit smoothly from our
accommodative policies at the appropriate time, inflation expectations could rise, putting the
FOMe's price-stability objective at risk. However, the Committee remains confident that it has
thc tools necessary to tighten monetary policy when the time comes to do so. As I noted,
intlation is currently subdued, and inflation expectations appear well anchored; neither the
FOMC nor private forecasters are projecting the development of significant intlation pressures.
Another potential cost that the Committee takes very seriously is the possibility that very
low interest rates, if maintained for a considerable time, could impair financial stability. For
example, portfolio managers dissatisfied with low returns may "reach for yield" by taking on
more credit risk, duration risk, or leverage. On the other hand, some risk-taking--such as when
an entrepreneur takes out a loan to start a new business or an existing firm expands capacity--is a
necessary element of a healthy economic recovery. Moreover, although accommodative
monetary policies may increase certain types of risk-taking, in the present circumstances they
also serve in some ways to reduce risk in the system, most importantly by strengthening the
overall economy, but also by encouraging firms to rely more on longer-term funding, and by
reducing debt service costs for households and businesses. In any case, the Federal Reserve is
responding actively to financial stability concerns through substantially expanded monitoring of
emerging risks in the financial system, an approach to the supervision of financial firms that
takes a more systemic perspective, and the ongoing implementation of reforms to make the
financial system more transparent and resilient. Although a long period of low rates could
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encourage excessive risk-taking, and continued close attention to such developments is certainly
67
- 6warranted, to this point we do not see the potential costs ofthc increased risk-taking in some
financial markets as outweighing the benefits of promoting a stronger economic recovery and
more-rapid job creation. 5
Another aspect of the Federal Reserve's policies that has been discussed is their
implications for the federal budget. The Federal Reserve earns substantial interest on the assets
it holds in its portfolio, and, other than the amount needed to fund our cost of operations, all net
income is remitted to the Treasury. With the expansion ofthe Federal Reserve's balance sheet,
yearly remittances have roughly tripled in recent years, with payments to the Treasury totaling
approximately $290 billion between 2009 and 2012. 6 However, if the economy continues to
strengthen, as we anticipate, and policy accommodation is accordingly reduced, these
remittances would likely decline in coming years. Federal Reserve analysis shows that
remittances to the Treasury could be quite low for a time in some scenarios, particularly if
interest rates were to rise quickly.7 However, even in such scenarios, it is highly likely that
average annual remittances over the period affected by the Federal Reserve's purchases will
remain higher than the pre-crisis nonn, perhaps substantially so. Moreover, to the extent that
monetary policy promotes growth and job creation, the resulting reduction in the federal deficit
would dwarf any variation in the Federal Reserve's remittances to the Treasury.
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5 The Federal Reserve is also monitoring financial markets to ensure that asset purchases do not impair their
functioning.
6 See Board of Govemors oflhe Federal Reserve System (2013), "Reserve Bank Income and Expense Data and
Transfers to the Treasury for 2012," press release, January 10,
www.fedcralreserve.gov/newsevents/press/other/20130IIOa.htm.
7 See Carpenter, Seth B., Jane E. Ihrig, Elizabeth C. Klee, Daniel W. Quinn, and Alexander H. Boote (2013), "The
Federal Reserve's Balance Sheet and Earnings: A Primer and Projections," Finance and Economics Discussion
Series 2013-01 (Washington: Federal Reserve Board, January), available at
ht!p:llwww.federalreserve.gov/pubs/feds/2013/201301120 130 I pap.pdf.
68
7
Thoughts on Fiscal Policy
Although monetary policy is working to promote a more robust recovery, it cannot carry
the entire burden of ensuring a speedier return to economic health. The economy's performance
both over the near term and in the longer run will depend importantly on the course of fiscal
policy. The challenge for the Congress and the Administration is to put the federal budget on a
sustainable long-run path that promotes economic growth and stability without unnecessarily
impeding the current recovery.
Significant progress has been made recently toward reducing the federal budget deficit
over the next few years. The projections released earlier this month by the Congressional Budget
Office (CBO) indicate that, under current law, the federal deficit will narrow from 7 percent of
GOP last year to 2-1/2 percent in fiscal year 2015. 8 As a result, the federal debt held by the
public (including that held by the Federal Reserve) is projected to remain roughly 75 percent of
GOP through much of the current decade.
However, a substantial portion of the recent progress in lowering the deficit has been
concentrated in near-term budget changes, which, taken together, could create a significant
headwind for the economic recovery. The CBO estimates that deficit-reduction policies in
current law will slow the pace ofreal GOP growth by about 1-112 percentage points this year,
relative to what it would have been otherwise. A significant portion of this effect is related to the
automatic spending sequestration that is scheduled to begin on March 1, which, according to the
CBO's estimates, will contribute about 0.6 percentage point to the fiscal drag on economic
growth this year. Given the still-moderate underlying pace of economic growth, this additional
near-term burden on the recovery is significant. Moreover, besides having adverse effects on
See Congressional Budget Office (2013), The Budget and Economic Outlook: Fiscal Years 2013 to 2023
(Washington: CBO. February), available at www.cbo.gov/publicationl43907.
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8
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-8jobs and incomes, a slower recovery would lead to less actual deficit reduction in the short run
for any given set of fiscal actions.
At the same time, and despite progress in reducing near-term budget deficits, the difficult
process of addressing longer-term fiscal imbalances has only begun. Indeed, the CBO projects
thaI the federal deficit and debt as a percentage of GOP will begin rising again in the latter part
of this decade, reflecting in large part the aging of the population and fast-rising health-care
costs. To promote economic growth in the longer tenn, and to preserve economic and financial
stability, fiscal policymakers will have to put the federal budget on a sustainable long-run path
that first stabilizes the ratio of federal debt to GOP and, given the current elevated level of debt,
eventually places that ratio on a downward trajectory. Between 1960 and the onset of the
financial crisis, federal debt averaged less than 40 percent of GOP. This relatively low level of
debt provided the nation much-needed flexibility to meet the economic challenges of the past
few years. Replenishing this fiscal capacity will give future Congresses and Administrations
greater scope to deal with unforeseen events.
To address both the ncar- and longer-term issues, the Congress and the Administration
should consider replacing the sharp, frontloaded spending cuts required by the sequestration with
policies that reduce the federal deficit more gradually in the near term but more substantially in
the longer run. Such an approach could lessen the near-term fiscal headwinds facing the
recovery while more effectively addressing the longer-term imbalances in the federal budget.
The sizes of deficits and debt matter, of course, but not all tax and spending programs are
created equal with respect to their effects on the economy. To the greatest extent possible, in
their efforts to achieve sound public finances, fiscal policymakers should not lose sight of the
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need for federal tax and spending policies that increase incentives to work and save, encourage
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- 9investments in workforce skills, advance private capital formation, promote research and
development, and provide necessary and productive public infrastructure. Although economic
growth alone cannot eliminate federal budget imbalances, in either the short or longer term, a
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more rapidly expanding economic pie will ease the difficult choices we face.
71
LETTER OF TRANSMITTAL
BOARD OF GOVERNORS OF THE
FEDERAL RESERVE SYSTEM
Washington, D.C., February 26, 2013
THE PRESlDENT OF THE SENATE
THE SPEAKER OF THE HOGSE OF REPRESENTATIVES
The Board of Governors is pleased to submit its Monetary Policy Report pursuant to
section 2 B of the Federal Reserve Act.
Sincerely,
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~"e::-
72
CONTENTS
Summary .......................................................... .
1
Part 1
Recent Economic and Financial Developments .. . . . . . . . . . . . . . . . . . . . . . . . .. 5
Domestic Developments. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. 5
Financial Developments. . . . . . . . .. . ...................................... 22
International Developments ............................................... 29
Part 2
Monetary Policy ......................................................... 37
Part 3
Summary of Economic Projections ....................................... 43
The Outlook for Economic Activity. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . ..
The Outlook for Inflation ..................................................
Appropriate Monetary Policy ..............................................
Uncertainty and Risks ....................................................
45
47
52
53
Abbreviations ........................................................... 59
List of Boxes
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Statement on Longer-Run Goals and Monetary Policy Strategy. . . . . . . . . . . . . . . .. 3
Assessing Conditions in the Labor Market. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. 8
The Federal Reserve's Actions to Foster Financial Stability ..................... 30
An Update on the European Fiscal and Banking Crisis ....................... 32
Efficacy and Costs of Large-Scale Asset Purchases ........................... 39
Forecast Uncertainty ................................................. 57
73
SUMMARY
Conditions in the labor market gradually
improved. Employment increased at an
average monthly pace of 175,000 in the
second half of the year, about the same as in
the first half. The unemployment rate moved
down from 8\4 percent last summer to a
little below 8 percent in January. Even so,
the unemployment rate was still well above
levels observed prior to the recent recession.
Moreover, it remained the case that a large
share of the unemployed had been out of
work for more than six months, and that a
significant portion of the employed had parttime jobs because they were unable to find fulltime employment. Meanwhile, consumer price
inflation remained subdued amid stable longterm inflation expectations and persistent slack
in labor markets. Over the second half of the
year, the price index for personal consumption
expenditures increased at an annual rate of
1~ percent.
During the summer and fall, the Federal Open
Market Committee (FOMC) judged that the
economic recovery would strengthen only
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gradually over time, as some of the factors
restraining activity-including restrictive credit
for some borrowers, continuing concerns about
the domestic and international economic
environments, and the ongoing shift toward
tighter federal fiscal policy-were thought
likely to recede only slowly. Moreover, the
Committee judged that the possibility of an
escalation of the financial crisis in Europe and
uncertainty about the course of fiscal policy in
the United States posed significant downside
risks to the outlook for economic activity.
However, the Committee expected that,
with appropriate monetary accommodation,
economic growth would proceed at a moderate
pace, with the unemployment rate gradually
declining toward levels consistent with
the FOMe's dual mandate of maximum
employment and price stability. Against
this backdrop, and with long-run inflation
expectations well anchored, the FOMC
projected that inflation would remain at or
below the rate consistent with the Committee's
dual mandate.
Accordingly, to promote its objectives,
the FOMC provided additional monetary
accommodation during the second half
of 2012 by both strengthening its forward
guidance regarding the federal funds rate
and initiating additional asset purchases. In
September, the Committee announced that
it would continue its program to extend the
average maturity of its Treasury holdings and
would begin purchasing additional agencyguaranteed mortgage-backed securities (MBS)
at a pace of $40 billion per month. The
Committee also stated its intention to continue
its purchases of agency MBS, undertake
additional asset purchases, and employ
its other policy tools as appropriate until
the outlook for the labor market improves
substantially in a context of price stability. The
Committee agreed that in determining the size,
pace, and composition of its asset purchases,
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The US. economy continued to expand at a
moderate rate, on average, over the second half
of 2012. The housing recovery appeared to
gain additional traction, consumer spending
rose moderately, and business investment
advanced further. Financial conditions eased
over the period but credit remained tight for
many households and businesses, and concerns
about the course of federal fiscal policy
and the ongoing European situation likely
restrained private-sector demand. In addition,
total government purchases continued to
move lower in an environment of budget
restraint, while export growth was held back
by slow foreign economic growth. All told, real
gross domestic product (GDP) is estimated
to have increased at an average annual rate
of I y, percent in the second half of the year,
similar to the pace in the first half.
74
SUMMARY
it would, as always, take account of the likely
efficacy and costs of such purchases. The
Committee also modified its forward guidance
regarding the federal funds rate at the
September meeting, noting that exceptionally
low levels for the federal funds rate were
likely to be warranted at least through mid2015, longer than had been indicated in
previous FOMC statements. Moreover, the
Committee stated its expectation that a highly
accommodative stance of monetary policy
would remain appropriate for a considerable
time after the economic recovery strengthens.
In December, the Committee announced
that in addition to continuing its purchases
of agency MBS, it would purchase longerterm Treasury securities, initially at a pace
of S45 billion per month, starting after the
completion at the end of the year of its
program to extend the maturity of its Treasury
holdings. It also further modified its forward
rate guidance, replacing the earlier date-based
guidance with numerical thresholds for the
unemployment rate and projected inflation.
In particular, the Committee indicated that it
expected the exceptionally low range for the
federal funds rate would remain appropriate
at least as long as the unemployment rate
remains above 6;;' percent, inflation between
one and two years ahead is projected to be
no more than :12 percentage point above the
Committee's 2 percent longer-run goal, and
longer-term inflation expectations continue to
be well anchored.
Partly in response to this additional monetary
accommodation, as well as to improved
sentiment regarding the situation in Europe,
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broad financial conditions eased over the
second half of 2012. Although yields on
nominal Treasury securities rose, on net, yields
on inflation-protected Treasury securities
declined, and longer-term interest rates
paid by households and firms generally fell.
Yields on agency MBS and investment- and
speculative-grade corporate bonds touched
record lows, and broad eq nity price indexes
rose. Conditions in short-term dollar funding
markets eased over the summer and remained
stable thereafter, and market sentiment toward
the banking industry improved. Nonetheless,
credit remained tight for borrowers with lower
credit scores, and borrowing conditions for
small businesses continued to improve more
gradually than for large firms.
At the time of the most recent FOMe
meeting in January, Committee participants
saw the economic outlook as little changed
or modestly improved from the time of their
December meeting, when the most recent
Summary of Economic Projections (SEP) was
compiled. (The December SEP is included as
Part 3 of this report.) Participants generally
judged that strains in global financial markets
had eased somewhat, and that the downside
risks to the economic outlook had lessened.
Under the assumption of appropriate
monetary policy-that is, policy consistent
with the Committee's Statement on LongerRun Goals and Monetary Policy Strategy
(see box)-FOMC participants expected the
economy to expand at a moderate pace, with
the unemployment rate gradually declining
and inflation remaining at or below the
Committee's 2 percent longer-run goal.
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2
75
MONETARY POLICY REPORT, fEBRUARY 2013
3
Statement on longer-Run Goals and Monetary Policy Strategy
As amended effective on January 29, 2013
reduces economic and financial uncertainty, increases
the effectiveness of monetary policy, and enhances
transparency and accountability, which are essential in
a democratic society.
inflation, employment, and long-term interest
rates fluctuate over time in response to economic and
financial disturbances. Moreover, monetary policy
actions tend to influence economic activity and prices
with a lag. Therefore, the Committee's policy decisions
reflect its longer-run goals, its medium-term outlook,
and its assessments of the balance of risks, including
risks to the financial system that could impede the
attainment of the Committee's goals.
The inflation rate over the longer run is primarily
determined by monetary policy, and hence the
Committee has the ability to specify a longer-run
goal for inflation. The Committee judges that inflation
at the rate of 2 percent, as measured by the annual
change in the price index for personal consumption
expenditures, is most consistent Over the longer
run with the Federal Reserve's statutory mandate.
Communicating this inflation goal clearly to the
public helps keep longer-term inflation expectations
firmly anchored, thereby fostering price stability
and moderate long-term interest rates and enhancing
the Committee's ability to promote maximum
employment in the face of significant economic
disturbances.
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The maximum level of employment is largely
determined by nonmonetary factors that affect the
structure and dynamics of the labor market. These
factors may change over time and may not be
directly measurable. Consequently, it would not be
appropriate to specify a fixed goal for employment;
rather, the Committee's policy decisions must be
informed by assessments of the maximum level of
employment, recognizing that such assessments are
necessarily uncertain and subject to revision, The
Committee considers a wide range of indicators
in making these assessments. Information about
Committee participants' estimates of the longer-run
normal rates of output growth <lnd unemployment is
published four times per year in the FaMe's Summary
of Economic Projections. For example, in the most
recent projections, FOMC participants' estimates of the
longer-run normal rate of unemployment had a central
tendency of 5.2 percent to 6.0 percent, unchanged
from one year ago but substantially higher than the
corresponding interval several years earlier.
In setting monetary poliCY, the Committee seeks
to mitigate deviations of inflation from its longerrun goa I and deviations of employment from the
Committee's assessments of its maximum level. These
objectives are generally complementary. However,
under circumstances in which the Committee judges
that the objectives are not complementary, it follows
a balanced approach in promoting them, taking
into account the magnitude of the deviations and
the potentially different time horizons over which
employment and inflation are projected to return to
levels judged consistent with its mandate.
The Committee intends to reaffirm these principles
and to make adjustments as appropriate at its annual
organizational meeting each January.
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The Federal Open Market Committee (FOMC)
is firmly committed to fulfilling its statutory
mandate from the Congress of promoting maximum
employment, stable prices, and moderate long-term
interest rates. The Committee seeks to explain its
monetary policy decisions to the public as clearly
as possible. Such darity faei litates well-informed
decisionmaking by households and businesses,
76
5
PART
1
RECENT ECONOMIC AND FINANCIAL DEVELOPMENTS
Real gross domestic product (GOP) increased at a moderate annual rate of 1V2 percent, on average,
in the second half of 20l2-similar to the rate of increase in the first half-as various headwinds
continued to restrain growth. Financial conditions eased over the second half in response to the
additional monetary accommodation provided by the Federal Open Market Committee (FOMC)
and to improved sentiment regarding the crisis in Europe. However, credit availability remained tight
for many households and businesses. In addition, declines in real government purchases continued
to weigh on economic activity, as did household and business concerns about the economic
outlook, while weak foreign demand restrained exports. In this environment, conditions in the labor
market continued to improve gradually but remained weak. At a little under 8 percent in January,
the unemployment rate was still well above levels prevailing prior to the recent recession. Inflation
remained subdued at the end of last year, with consumer prices rising at about a 1V2 percent annual
rate in the second half, and measures of longer-run inflation expectations remained in the narrow
ranges seen over the past several years.
Domestic Developments
GOP increased moderately but continued
to be restrained by various headwinds
Real GDP is estimated to have increased
at an annual rate of 3 percent in the third
quarter but to have been essentially fiat in the
fourth, as economic activity was temporarily
restrained by weather-related disruptions and
declines in some erratic categories of spending,
including inventory investment and federal
defense spending.' On average, real GDP
expanded at an annual rate of I';' percent in
the second half of 2012, similar to the pace of
increase in the first half of the year (figure 1).
The housing recovery gained additional
traction, consumer spending continued to
increase moderately, and business investment
rose further. However, a severe drought
in much of the country held down farm
production, and disruptions from Hurricane
Sandy also likely held back economic activity
somewhat in the fourth quarter. More
fundamentally, some of the same factors
that restrained growth in the first half of last
year likely continued to weigh on activity.
Although financial conditions continued to
1.
Change in real gross domestic product, 2006--12
- - - - -l'ercent,annualrJle
H2
II
I I
2006
2007
I
2008
I ilil
-2
2009
2010
2011
2012
Non" Here and 10 subsequent figures, except as noted, change for a given
penod is measured to its final quarter from the final quaner of the preceding
period
SotJRCE: Department of Commerce, Bureau of Economic Analysis.
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80869.019
I. Data for the fourth quarter of 2012 from the
national income and product accounts reflect the advance
estimate released on January 30, 2013.
77
6
PART
2.
Net change in payroll employment, 2006-13
RECENT ECONOMIC AND fiNANCIAL DEVElOPMENTS
-~
400
200
200
400
800
LL____ J __ ""~_L
2006
2007
2008
The data arc
2009
2010
thrce~month
I
2011
-LJ
I
2012
2013
moving averages and cxtend through
Department of Labor, Bureau of Labor Statistics.
3. Civilian unemployment rate, 1979-2013
Percent
12
LLLLLLLU.l.lJ..l.l.lJ.Jl..LU.1 I!
19RJ
1989
1997
! j
2013
l'on:: The data arc monthly and extend through January 2013,
SO\!RCE: Department of Labor, Bureau of Labor Statistics
4.
Long~term
unemployed, 1979-2013
than it was prior to the recent recession,
Percent
50
40
30
20
10
L.1...LuLLJ.' I I I ! I I 1 I I I 1 I UJJ_I I ! r I ! I I I I I I
1981
1989
1997
2005
2013
I
The data afC monthly and extend through January 2013. The series
shown
the percentage of total unemployed persons who have been
unemployed for 27 weeks or more
SOURCE: Department of Labor, Bureau of Labor StatIstics.
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The labor market improved somewhat,
but the unemployment rate remained
high
In this economic environment, firms increased
their workforces moderately. Over the second
half of last year, nonfarm payroll employment
rose an average of about 175,000 per month,
similar to the average increase in the first
half (figure 2)_ These job gains helped lower
the unemployment rate from 82 percent in
the second quarter of last year to 7.9 percent
in January (figure 3). Nevertheless, the
unemployment rate remained much higher
I I I I I LUJ-LLJ
2005
improve overall, the financial system has not
fully recovered from the financial crisis, and
banks remained cautious in their lending to
many households and businesses. In particular,
restricted financing for home mortgages
and new-home construction projects, along
with the depressing effects on housing
demand of an uncertain outlook for house
prices and jobs, kept the level of activity in
the housing sector well below longer-run
norms. Budgetary pressures at all levels of
government also continued to weigh on GDP
growth. Moreover, businesses and households
remained concerned about many aspects of
the economic environment, including the
uncertain course of U.S. fiscal policy at the
turn of the year as well as the still-worrisome
European situation and the slow recovery
more generally_
Fmt 6601
and long-term unemployment continued to
be widespread. In the fourth quarter, about
40 percent of the unemployed had been out
of work for more than six months (figure 4).
Moreover, the proportion of workers
employed part time because they were unable
to find full-time work remained elevated_ Some
of the increase in the unemployment rate since
the begiuning of the recent recession could
reflect structural changes in the labor markelsuch as a greater mismatch between the types
of jobs that are open and the skills of workers
available to fill them-that would reduce the
maximum sustainable level of employment.
However, most of the economic analysis
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80869.020
1;
78
MONETARY POliCY REPORT: FEBRUARY 2013
7
on this subject suggests that the bulk of the
increase in unemployment probably reflects a
deficiency in labor demand.' As a result, the
unemployment rate likely remains well above
levels consistent with maximum sustainable
employment.
As described in the box "Assessing Conditions
in the Labor Market," the unemployment
rate appears to be a very good indicator of
labor market conditions. That said, other
indicators also provide important perspectives
on the health of the labor market, and the
most accnrate assessment of labor market
conditions can be obtained by combining the
signals from many such indicators. Aside from
the decline in the unemployment rate, probably
the most important other pieces of evidence
corroborating the gradnal improvement in
labor market conditions over the second half
of last year were the gains in nonfarm payrolls
noted earlier and the slight net reduction in
initial claims for unemployment insnranee.
5.
Measures of change in hourly compensation,
2002-12
Percent
2. See, for example, Mary C. Daly, Bart Hobijn,
Ay,egiiI $ahin, and Robert G. Valletta (2012), "A
Search and Matching Approach to Labor Markets:
Did the Natural Rate of Unemployment Rise?" Journal
of Economic Perspectives, vol. 26 (Summer), pp. 3-26;
Michael W. L. Elsby, Bart Hobijn, Ay,egul $ahin, and
Robert G. Valletta (20 II), "The Labor Market in the
Great Recession-An Update to September 2011,'"
Brookings Papers on Economic Activity, Fall, pp. 353--71~
and Jesse Rothstein (2012), "The Labor Market Four
Years into the Crisis: Assessing Structural Explanations,"
ILRRevielV, vol. 65 (July), pp. 467-500.
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2012
NOTE: The data are quarterly and extcnd through 2012.Q4. For nonfarm
busine~s compensation, change is over four qmlflers; for the employment cost
mdex (Eel), change is over the 12 months endmg in the last month of each
quarter. The nonfann business sector excludes fanns, government, nonprofit
institutions, and households. The sector covered by the EO used here IS the
nonfaml busmcss scctor plus nonprofit institutions.
SOGRCC Department of Labor, Bureau of Labor Statistics.
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Restrained by the ongoing weak conditions
in the labor market, labor compensation
has increased slowly. The employment cost
index for private industry workers, which
encompasses both wages and the cost to
employers of providing benefits, increased
only 2 percent over the 12 months of 2012,
similar to the rate of gain since 2010 (figure 5).
Similarly, nominal compensation per honr
in the nonfarm business sector-a measure
derived from the labor compensation data in
the national income and prod net accounts
(NIPA)-increased 2V, percent over the four
quarters of 2012, well below average increases
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79
80
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80869.023
()
81
10
PART 1: RECENT ECONOMIC AND FINANCIAL DEVELOPMENTS
of close to 4 percent in the years prior to the
recent recession. As a result of these modest
gains, nominal compensation has increased
only about as fast as consumer prices over the
recovery.
Inflation remained low ...
Change in the chain-type price index for personal
consumption expenditures, 2006-12
Perce;'!!
L
II
2006
2007
2008
2009
II
2010
2011
2012
NOl 10: The data arc monthly and extend through December 2012; changes
are from one year earlier.
SOURO.: Department ofConuncrcc, Bureau of Economic Analysis
7.
Change in output per hour, 1948-2012
Per~cnj,
annual ratc
NoT!': Nonfarm business sector Change for each multiyear period is
measured to the fourth quarter of the final year of the period from the fourth
quarter of the year immediulcJy preceding the period.
SOURCr: Department of Labor, Bureau of Labor Statistics.
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As noted, gains in labor compensation have
been subdued given the weak conditions in
labor markets, and unit labor costs-which
measure the extent to which compensation
rises in excess of productivity-have increased
very little over the recovery. That said,
compensation per hour rose more rapidly
last year, and productivity growth, which
has averaged I '/, percent per year over the
recovery, was relatively low (figure 7). As a
result, unit labor costs rose 2 percent in 2012,
well above average increases earlier in the
recovery.
Global oil prices rose in early 2012 but
subsequently gave up those gains and remained
about flat through the later part of the year
(figure 8). Developments related to Iran,
including a tightening embargo on Iranian oil
exports, likely put upward pressure on prices,
but these pressures were apparently offset
by continued concerns about weak global
demand. However, in recent weeks, global oil
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80869.024
6.
Consumer price inflation was low over the
second half of 2012. With considerable slack
in labor markets and limited increases in labor
costs, relatively stable prices for commodities
and imports, and well-anchored longer-term
inflation expectations, prices for personal
consumption expenditures (PCE) increased
at an annual rate of I \I, percent in the second
half of the year, similar to the rate of increase
in the first half (figure 6). Excluding food and
energy prices, consumer prices increased only
1 percent in the second half of the year, down
from 2 percent in the first half. A deceleration
in prices of imported goods likely contributed
to the low rate of inflation seen in the second
half, though price increases for non-energy
services were also low.
82
11
MONETARY POLICY REPORT: FEBRUARY 2013
prices have increased in response to generally
positive demand indicators from China and
some reductions in Saudi production. Partly
in response to this rise, retail gasoline prices,
which changed little, on net, over 2012, have
moved up appreciably.
8.
Prices of oil and nonfucl commodities, 2008-13
Ooli3rsperbarrci
DeC<,'lTlbcr20(l6"'"100
140
160
120
140
100
Nonfuel commodity prices have remained
relatively flat over the past year despite
significant movements in the prices of a few
specific commodities. Of particular interest,
prices for corn and soybeans eased some over
the fall after having risen sharply during the
summer as the scale of the drought affecting
much of the United States became apparent.
Given this easing and the small share of grain
costs in the retail price of food, the effect of
the drought on U.S. consumer food prices is
likely to be modest: Consumer food prices
rose at an annual rate of 2 percent in the
fourth quarter following increases of less than
I percent in the middle of last year.
120
80
100
60
80
40
L __ ---L.l
I I
2008
2009
2010
2011
2012
2013
NOTE: The data are monthly. The 011 price is the spot pnce of Brent crude
011, and the last observation is the average for fehruary 1-21, ~013. The price
of lIonfuel commodities IS an mdex of 45 primary ..mmmodity prices and
extends Ihrougll January 2013
SOVR(T: For oil, the Commodity
Research Bureau;
commodities, lntemational Monetary Fund.
for
nonfucl
In line with these flat overall commodity
prices, as well as earlier dollar appreciation,
prices for imported goods excluding oil were
about unchanged on average over the last five
months of 2012 and the early part of 2013 .
Survey measures of longer-term inflation
expectations have changed little, on net, since
last summer. Median expected inflation over
the next 5 to 10 years, as reported in the
Thomson Reuters/University of Michigan
Surveys of Consumers, was 3 percent in
early February, within the narrow range of
the past 10 years (figure 9). In the Survey of
Professional Forecasters, conducted by the
Federal Reserve Bank of Philadelphia, the
median expectation for the increase in the
price index for PCE over the next 10 years
was 2 percent in the first quarter of this
year, similar to its level in recent years. A
measure of 5-year inflation compensation
derived from nominal and inflation-protected
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9. Median inflation expectations, 2001-13
-~
6
!vlldllgan c;urv,;y C'.>.r('ct;!l!~lll~
f\): H¢'{t 5 \0 iO
~
for next 10 yean,
200 1
2003
1005
2007
2009
NOTE: The Michigan survey data are monthly
200 I through a preliminary estimate for February
quarterly and extend from 2007:Ql through 2013:QJ,
SOURCE: Thomson Reuters/University of Michigan Surveys of Consumers
and Survey of Professional Forecasters (SPF),
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80869.025
. . . and longer-term inflation
expectations stayed in their historical
range
83
12
10.
PART 1: RECENT ECONOMIC AND FINANCIAL DEVELOPMENTS
Inflation compensation, 2004-13
------
Percent
-4
Non.: The data are weekly averages of daily data and extend through
Fehruary 15, 2013. lnflation compensation is the dlfferellce between yields
on nominal Treasury securities and Treasury inOation-protected securities
(TIPS) of comparable maturitIes, based on yield curves fitted to off-thc-run
nomina! Treasury sccurillcs and on- and off-tnc-run TIPS. The 5-year
measure is adjusted for the eflect of indexation lags.
SOURCE: Federal Reserve Bank of New York; Barclay;;; Federal Reserve
Board staff estimates.
11.
Change in real personal consumption expenditures and
disposable personal income, 2006-12
Pco;;ent,3ntlualratc
•
Change in real peE
o Change in real DPI
Treasury securities has increased 55 basis
points since the end of June, while a similar
measure of inflation compensation for the
period 5 to 10 years ahead has increased about
30 basis points; both measures are within their
respective ranges observed in the several years
before the recent financial crisis (figure 10).
While the increases in these measures could
reflect changes in market participants'
expectations of future inflation, they may
also have been affected by improved investor
risk sentiment and an associated reduction in
demand for the relatively greater liquidity of
nominal Treasury securities.
Consumer spending continued to
increase moderately
Turning to some important components
of final demand, real peE increased at a
moderate annual rate of 2 percent over the
second half of 2012, similar to the rate of
increase in the first half (figure 11). Household
wealth-buoyed by increases in house prices
and equity values·-moved up over the second
half of the year and provided some support
for consumer spending (figure 12). In addition,
for those households with access to credit,
low interest rates spurred spending on motor
vehicles and other consumer durables, which
increased at an annual rate of 11 percent over
the second half of last year. But increases in
real wages and salaries were modest over the
second half of the year, and overall growth in
consumer spending continued to be held back
by concerns about the economic outlook and
limited access to credit for some households.
After rising earlier in the year, consnmer
sentiment·-which reflects household views
on their own financial sitnations as well as
broader economic conditions-fell back at the
end of the year and stood well below longerrun norms (figure 13).
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80869.026
Real disposable personal income (DPI) rose at
an annual rate of 3Jh percent over the second
half of 2012. However, much of this increase
was a result of unusually large increases in
dividends and employee bonuses, as many
firms apparently shifted income disbursements
84
MONETARY POLICY REPORT: FEBRUARY 2013
into 2012 in anticipation of an increase in
marginal tax rates for high-income households
at the beginning of this year. Excluding these
special payments, real DPI is estimated to
have increased at a modest annual rate of
1\!4 percent over the second half of the year,
similar to the average pace of increase over
the recovery. The surge in dividend and bonus
payments also led the personal saving rate to
jump from 3.8 percent in the second quarter
to 4.7 percent in the fourth quarter (figure 14).
In their absence, the saving rate would have
likely been little changed over the second half
of the year.
Households continue to pay down debt
and gain access to credit
Household debt---the sum of mortgage
and consumer debt---edged down further
in the third quarter of 2012 as a continued
contraction in mortgage debt more than offset
a solid expansion in consumer credit. With
the reduction in household debt, low levels
of most interest rates, and modest income
growth, the household debt service ratiothe ratio of required principal and interest
payments on outstanding household debt to
DPI-decreased further and, at the end of the
third quarter, stood at a level last seen in 1983
(figure 15).
Consumer credit expanded at an annual
rate of about 5\!4 percent in the second half
of 2012. Nonrevolving credit (mostly auto
loans and student loans), which accounts for
about two-thirds of total consumer credit
outstanding, drove the increase. Revolving
consumer credit (primarily credit card
lending) was about flat on net. Overall, the
increase in nonrevolving consumer credit is
consistent with banks' recent responses to the
Senior Loan Officer Opinion Survey on Bank
Lending Practices (SLOOS), which indicated
that demand had strengthened and standards
eased, on net, for aulo loans (figure 16)3
12.
13
Wealth-to-incomc ratio, 1989-2012
_ _ _ _ _ _ _...:..Rauo
-4
NorE: The data are quarterly and extend through 2012:Q3. The series is
the raho of household net worth to disposable persona! income
SouRn.: For nct worth, Federal Rcscrve Board, flow of funds data; for
income, Department ofComm<.'fce, Bureau of Economic Analysis.
13.
Consumer sentiment indexes, 1999-2013
14"
120
100
80
40
20
200l
2004
NOTE: The Conference Board data, indexed to 100 in 1985, arc monthly
and extend through Jan. 2013. The Mich. survey data, indexed to 100 in
1966, are monthly and extend through a preliminary Feb 2013 estimate.
SOURCE: The Conference Board and Thomson RcutcrsiUnivcrsity of
Michigan Surveys of Consumers
14.
Personal saving rate, 1989-2012
_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ Pcrccnt
-3
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80869.027
3. The SLOOS is available on the Federal Reserve
Board's website at www.fcderalreservc.gov/boarddocs/
SnLoanSurvcy.
85
14
Household debt service, 1980-20 l2
_ _ _l'_C!L_,"_tof<l!sposal::lJe Hlcomc
14
13
12
11
LLLuLLL I lJJ,J_LLLLLLLU~LLLlJ.ll.LJ
1980
1984
1988
1992
1996
2000
2004
2008
2012
NOTE: The data arc quarterly and extend through 2012:Q3. Debt service
payments consist of estimated required payments on olltstanding mortgage
and consumer debt
SOURCE: Federal Reserve Board. "Household Debt Service and Financial
Obligations Ratios," statistical release.
16.
Change in standards and demand for auto loans,
2011-12
NClperccIlt
40
Demand
30
20
10
------"~~~-
10
20
30
~
Q3
Q2
Q4 i·"CQ"'t,-L-;Q"'2-L-;'Q~3...lL'Q4-LJ
2011
2012
NOlL: The data arc from a survey generally conducted 4 tim,"s per year:
the last observation is from the Jan. 1013 survey, which covers 2012:Q4.
Each senes
the net percent of surveyed banks that reported a
of
or stronger demand for auto loans over the past
Federal RCllerve Board, Senior Loan Officer Opinion Survey on
Bank Lending Practices.
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Changes in interest rates on consumer loans
were mixed over the second half of 2012.
Interest rates on auto loans declined a bit, as
did most measures of the spreads of rates on
these loans over yields on Treasury securities
of comparable maturity. Interest rates on
credit card debt quoted by banks generally
declined slightly, while rates observed in credit
card offer mailings continued to increase,
The housing market recovery gained
traction ...
The housing market has continued to recover.
Housing starts, sales of new and existing
hQmes, and builder and realtor sentiment all
increased Qver the second half of last year,
and residential investment rose at an annual
rate of nearly 15 percent. Combined, singlefamily and multifamily housing starts rose
from an average annual rate of 740,000 in the
second quarter of last year to 900,000 in the
fourth quarter (figure 17), Activity increased
most noticeably in the smaller multifamily
sector-where starts have nearly reached prerecession levels-as demand for new housing
has apparently shifted toward smaller rental
units and away from larger, typically owneroccupied single-family units.
... as mortgage interest rates reached
record lows and house prices rose ...
Mortgage interest rates declined to
historically low levels toward the end of
20l2-importantly reflecting Federal Reserve
policy actions-making housing quite
affordable for households with good credit
ratings (figure 18). However, the spread
between mortgage rates and yields on agencyguaranteed mortgage-backed securities (MBS)
remained elevated by historical standards.
This unusually wide spread probably reflects
still-elevated risk aversion and some capacity
constraints among mortgage originators.
Overall, refinance activity increased briskly
over the second half of 20l2-though it was
still less than might have been expected, given
the level of interest rates-while the pace of
mortgage applications for home purchases
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80869.028
15.
PART 1; RECENT ECONOMIC AND FINANCIAL DEVELOPMENTS
86
15
MONETARY POLICY REPORT; FEBRUARY 2013
remained sluggish (figure 19). Recent responses
to the SLOOS indicate that banks' lending
standards for residential mortgage loans were
little changed over the second half of 2012.
17.
Private housing starts, 1999--2013
MilhonsQfUll\!s,annualrale
-------~
18
... but the level of new construction
remained low, and mortgage
delinquencies remained elevated
Despite the improvements seen over the second
half of 2012, housing starts remained well
below the 1960-2000 average of 1.5 million
per year, as concerns about the job market
and tight mortgage credit for less-creditworthy households continued to restrain
demand for housing. In addition, although the
number of vacant homes for sale has declined
significantly, the stock of vacant homes held
off the market remained quite elevated. Once
put on the market, this "shadow" inventory,
which likely includes many bank-owned
properties, may redirect some demand away
from new homes and toward attractively priced
existing homes. With home values depressed
and unemployment still high, measures of
late-stage mortgage delinq uency, such as
the inventory of properties in foreclosure,
remained elevated, keeping high the risk of
homes transitioning to vacant bank-owned
properties (figure 21).
Growth of business investment has
slowed since earlier in the recovery
After increasing at double-digit rates in 2010
and 20 II, business expenditures on eqnipment
and software (E&S) decelerated in 2012
(figure 22). Pent-np demand for capital goods,
an important contributor to earlier increases
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14
10
.Mllhif,Unlly
1999
2001
2003
200S
2011
2013
Non:: The data are monthly and extend through January 2013.
SOURCE: Department of Commerce, Bureau of the Census,
18. Mortgage interest rates,
1995~2013
-7
L L l..L L l l
1995
J998
I I
I I I I I I I LLLLLJ
2001
2004
2007
20 I0
20!3
NO:t: The data, which are weekly and extend through February 20, 2013,
are contract rates on 30-year mortgages
SOURCE: Federal Home Loan Mortgage Corporation
19.
Mortgage Bankers Association purchase and refinance
indexes, 1990··-2013
March 16, 1990= 100
M;uchI6,199D--IOO
500
10,000
40()
8,000
6,000
200
4,000
100
2,000
Non: The dala, which are seasonally adjusted, are a
average and extend through February 15,1013.
four~week
moving
SOURCE: Mortgage Bankers Association
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80869.029
House prices, as measured by several national
indexes, continued to increase in the second
half of 2012. For example, the CoreLogic
repeat-sales index rose 312 percent (not an
annual rate) over the last six months of
the year to reach its highest level since late
2008 (figure 20). This recent improvement
notwithstanding, this measure of house prices
remained 27 percent below its peak in early
2006.
87
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80869.030
Ih
88
I!
H111(1
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80869.031
I'll
89
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80869.032
II~r\""{
90
MONFTARY POLICY REPORT: FEBRUARY 2013
19
high, as some borrowers with five-year loans
issued in 2007 were unable to refinance upon
the maturity of those loans because of high
loan-to-value ratios. While delinquency
rates for eRE loans at commercial banks
continued to decline, they remained somewhat
elevated, especially for construction and land
development loans.
Budget strains for state and local
governments eased, but federal purchases
continued to decline
Strains on state and local government
budgets appear to have lessened some since
earlier in the recovery. Although federal
grants provided to state governments in the
American Recovery and Reinvestment Act
have essentially phased out, state and local
tax receipts, which have been increasing since
2010, rose moderately further over the second
half of last year. Accordingly, after declining
at an annual rate of I Y, percent in the first
half of last year, real government purchases
at the state and local level changed little in the
second half (figure 27). Similarly, employment
levels at states and municipalities, which had
been declining since 2009, changed little, on
balance, over the second half of last year.
Federal purchases continued to decline over
the second half of 2012, reflecting ongoing
efforts to reduce the budget deficit and the
scaling back of overseas military activities.
As measured in the NIPA, real federal
expenditures on consumption and gross
investment-the part of federal spending
included in the calculation of GDP-fell at
an annual rate of 3Y, percent over the second
half of 2012. Real defense spending fell at an
annual rate of a little over 6 percent, while
nondefense purchases increased at an annual
rate of 2 percen t.
27.
Change in real government expenditures
on consumption and investment, 2006-12
_ _ _ _ f'ercenl,annaalrate
o Federal
•
State and
~
10001
[I,
[l. l
IL
L-ll-lJ LI
u_ ..__l_--'_--'~
2006
2007
2008
2009
HI Hl
-1~--'-~--'-~--...LU.
2010
2011
2012
SOCRCf.: Department of Commerce, Bureau of Econonllc Analysis
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80869.033
The deficit in the federal unified budget
remains high. The budget deficit for fiscal
year 2012 was $1.1 trillion, or 7 percent of
nominal GDP, down from the deficit recorded
in 2011 but still sharply higher than the
91
20
28,
PART 1, RECENT ECONOMIC AND rlNANCIAL DEVELOPMENTS
Federal receipts and expenditures, 1992-2012
Percent (Jfrwmmal GDP
24
22
Receipts
20
18
16
14
LLLl
I !
I ! I
1992
1996
I
LLLL.L.LLLLLL-L_l.J-.J
2000
2004
2008
2012
:;\IOTE: The receipts and expenditures dala afC on a unified-budget basis and
are for fiscal years (October through Septembo:r); gross domestic product
(GDP) is for the four quarters cnding in 03.
SOVRCf:.:
29.
Offi~
of Management and Budget
Federal government debt held by Ihe public, 1960-2012
PcrcentofnomiualGDP
70
60
50
40
30
,- 20
Ll!!!! 1111111 II Ill! III!!! 11111 II! I! III II! III! 1111LillJJ-J
1962
1972
1982
1992
2002
2012
NOTE: The data for debt through 2012 are as of year-end. and the
corrcspondmg values for gross domestic product (GDP) are for Q4 at an
annual rate. Excludes securities held as investments of federal government
ac,ounls.
SOURCE: Bureau of Economic Analysis; Department of the Treasury,
Fmancial Management Service
30.
deficits recorded prior to the onset of the last
recession. The narrowing of the budget deficit
relative to fiscal 20 I I reflected an increase in
tax revenues that largely stemmed from the
gradual increase in economic activity as well
as a decline in spending. Despite the rise in
tax revenues, the ratio of federal receipts to
national income, at 16 percent in fiscal 2012,
remained near the low end of the range for
this ratio over the past 60 years (figure 28).
The ratio of federal outlays to GDP declined
but was still high by historical standards, at
23 percent. With deficits still large, federal
debt held by the public rose to 73 percent of
nominal GDP in the fourth quarter of 2012,
5 percentage points higher than at the end of
2011 (figure 29).
Change in real imports and exports of goods
and services, 2007-12
Pcn:ea!. amlU;ll tate
o lmpnrts
II Exports
2007
Real imports of goods and services contracted
at an annual rate of nearly 2 percent over the
second half of 2012, held back by the sluggish
pace of U.S. demand (figure 30). The decline
in imports was fairly broad based across major
trading partners and categories of trade.
Real exports of goods and services also fell at
an annual rate of about 2 percent in the second
half despite continued expansion in demand
from EMEs. Exports were dragged down by
a steep falloff in demand from the euro area
and declining export sales to Japan, consistent
with weak economic conditions in those areas.
In contrast, exports to Canada remained
essentially flat. Across the major categories
of exports, industrial supplies, automotive
products, and agricultural goods contributed
to the overall decrease.
15
10
LL-
Net exports added modestly to real GDP
growth
I
Overall, real net exports added an estimated
0.1 percentage point to real GDP growth in
the second half of 2012, according to the
advance estimate of GDP from the Burean
of Economic Analysis, but data received
since then suggest a somewhat larger positive
contribution.
-L_-L-_l----Ll
2008
2009
2010
2011
2012
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80869.034
SOURCE: Department of Commerce, Bureau ofEcormmic Analysis
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80869.035
92
93
22
33.
PART 1, RECENT ECONOMIC AND FINANCiAL DEVElOPMEN IS
Financial Developments
Net saving, 1992-2012
Percent of nom mal GDP
Nonfederal saving
L_LLL.!
I ! I
! 996
1992
I
!
I
2000
I
I
I
I LLLLLu...J
I
2004
2008
20 J 2
NOTE: The data are quarterly and extend through 2012:Q3. Nonfederal
saving is the sllm of personal and net business saving and the net ~avmg of
state and local governments. GDP is gross domestic produce
SOURCl-: Department of Commerce, Bureau of Economic Analysis.
34.
lnterest rates on Treasury securities at selected
maturities, 2004-13
-----.------
\
I
'f,.'v-, __
.
---'--- ¥V.;;----;
LL-L
"LI_~=_'_-~I=J
2005
2007
2009
1"'\"1
I
I
I
~1
20 II
!
I
20 J3
NOTE: The data are daily and extend through febnmry 2i, 2013
inflation-protected securities (TIPS) are bast-d on yield curves
federal Reserve staff to 00- and off-the-run T1PS.
Department of the TreaslUY; Barclays; Federal Reserve Board
Expectations regarding the future
stance of monetary policy reflected the
additional accommodation provided by
the Federal Open Market Committee ...
In response to the steps taken by the FOMe
to provide additional monetary policy
accommodation over the second half of
2012, market participants pushed out the
date when they expect the federal funds rate
to first rise above its current target range of
oto Y. percent In particular, interest rates on
overnight index swaps indicate that investors
currently anticipate that the effective federal
funds rate will rise above its current target
range around the fourth quarter of 2014,
roughly four quarters later than they expected
at the end of June 2012. Meanwhile, the modal
target rate path--·-the most likely values for
future federal funds rates derived from interest
rate options-suggests that investors think
the rate is most likely to remain in its current
range through the first quarter of 2016. In
addition, recent readings from the Survey
of Primary Dealers conducted by the Open
Market Desk at the Federal Reserve Bank of
New York suggest that market participants
expect the Federal Reserve to hold about
$3.75 trillion of Treasury and agency securities
at the end of 2014, roughly $1 trillion more
than was expected in the middle of 2012.'
... and held yields on longer-term
Treasury securities and agency mortgagebacked securities near historic lows
Yields on nominal and inflation-protected
Treasury securities remained near historic
lows over the second half of 2012 and
into 2013. Yields on longer-term nominal
Treasury securities rose, on balance, over this
period, while yields on inflation-protected
securities fell (figure 34). These changes likely
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80869.036
5. The Survey of Primary Dealers is available on
the Federal Reserve Bank of New York's website at
www.newyorkfed.org/markets/primarydealecsurvey_
questions.htmL
94
MONETARY POLICY REPORT: FEBRUARY 2013
23
reflect the effects of additional monetary
accommodation, a substantial improvement
in sentiment regarding the crisis in Europe
that reduced demand for the relative safety
and liq uidity of nominal Treasury securities,
and increases in the prices of key commodities
since the end of June 2012. On balance,
yields on 5-, 10-, and 30-year nominal
Treasury securities increased roughly 15 basis
points, 30 basis points, and 40 basis points,
respectively, from their levels at the end of
June 2012, while yields on 5- and 10-year
inflation-protected securities decreased
roughly 55 basis points and 15 basis points,
respectively. Treasury auctions generally
continued to be well received by investors, and
the Desk's outright purchases and sales of
Treasury securities did not appear to have a
material adverse effect on liquidity or market
functioning.
Yields on agency MBS were little changed,
on net, over the second half of 2012 and
into 2013. They fell sharply following the
FOMe's announcement of additional agency
MBS purchases in September but retraced
over subsequent months. Spreads of yields
on agency MBS over yields on nominal
Treasury securities narrowed, largely reflecting
the effects of the additional monetary
accommodation (figure 35). The Desk's
outright purchases of agency MBS did not
appear to have a material adverse effect on
35.
Current-coupon yield and spread for agencyguaranteed mortgage-backed securities, 2009-13
Percen1~_ _ _ _ __
_
_ _ _ _B::M::ispOll1lS
175
150
125
100
liquidity or market functioning, although
implied financing rates for some securities in
the MBS dollar roll market declined in the
second half of 2012, and the Desk responded
by postponing settlement of some purchases
using dollar roll transactions6
I
!
Jan,
!
!
July
2009
!
j
Jan.
!
!
July
2010
!
I!
Jan.
!
!
July
2011
!
Jan.
!
,I
!
July
2012
!
Jan.
2013
The data are daily and extend through febma.I)' 21, 2013. Yield
shown
for the Fannie Mae 30.year cument coupon, the coupon rale at
""hleh new mortgage-backed s(X;uritles would be priced at par, or face, value.
Spread shown is to the average of the 5- and lO.year nominal Treasury yields
Sm;R("£: Department of the Treasury; Barclays
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80869.037
6. Dollar roll transactions consist of a purchase or sale
of agency MBS with the simultaneous agreement to sell
or purchase substantially similar securities on a specified
fulure date. The Committee directs the Desk to engage in
these transactions as necessary to facilitate settlement of
the Federal Reserve's agency MBS purchases.
95
24
36.
PART 1: RECENT ECONOMIC AND FINANCIAL DEVELOPMENTS
Yields on corporate bonds reached record
lows, and equity prices increased
Spreads of corporate bond yields over comparable
off-the-run Treasury yields, by securities rating,
1997-2013
Percentagepomls
-------------
SOURCE: Derived from smoothed corporate YIeld curves using Merrill
Lynch bond data.
37.
S&P 500 index, 1995-2013
_ _ _ _ _ ..•• _ _ _ _ _ _.___ .. _
Jan!lary2.201}9~ 100
180
~II-:~
V
80
60
Yields on investment- and speculative-grade
bonds reached record lows in the second
half of 2012 and early 2013, respectively,
partly reflecting the effects of the FOMC's
additional monetary policy accommodation
and increased investor appetite for bearing
risk. Spreads to comparable-maturity Treasury
securities also narrowed substantially but
remained above the narrowest levels that they
reached prior to the financial crisis (figure 36).
Prices in the secondary market for syndicated
leveraged loans have increased, on balance,
since the middle of 2012.
Broad equity price indexes have increased
about 10 percent since the end of June 2012,
boosted by the same factors that contributed
to the narrowing in bond spreads (figure 37).
Nevertheless, the spread between the 12-month
forward earnings-price ratio for the S&P 500
and a long-run real Treasury yield-a rough
gauge of the equity risk premium-remained
at the high end of its historical range
(figure 38). Implied volatility for the S&P 500
index, as calculated from option prices, spiked
at times but is currently near the bottom end
of the range it has occupied since the onset of
the financial crisis (figure 39).
40
Conditions in short-term dollar funding
markets improved some in the third
quarter and remained stable thereafter
Measures of stress in unsecured dollar funding
markets eased somewhat in the third quarter
of 2012 and remained stable at relatively low
levels thereafter, reflecting improved sentiment
regarding the crisis in Europe. For example,
the average maturity of unsecured financial CP
issued by institutions with European parents
increased, on net, to around the same length
as such CP issued by institutions with U.S.
parents.
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80869.038
Signs of stress were largely absent in secured
short-term dollar funding markets. In the
market for repurchase agreements (repos),
96
25
MONETARY POLICY REPORT: FEBRUARY 2013
bid-asked spreads and haircuts for most
collateral types have changed little since the
middle of 2012. However, repo rates continued
to edge up over the second half of 2012, likely
reflecting in part the financing of the increase
in dealers' inventories of shorter-term Treasury
securities that resulted from the maturity
extension program (MEP). Following yearend, repo rates fell back as the MEP came
to an end and the level of reserve balances
began to increase. In asset-backed commercial
paper (ABCP) markets, volumes outstanding
declined a bit for programs with European and
U.S. sponsors, while spreads on ABCP with
European bank sponsors remained slightly
above those on ABCP with U.S. bank sponsors.
Year-end pressures in short-term funding
markets were generally modest and roughly
in line with the experiences during other years
since the financial crisis.
Real long-run Treasury yield and 12~month forward
earnings-price ratio for the S&P 500, 1995-2013
38.
_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _Pc:e~1l1
10
NOTE: The data are monthly and extend through January 2013 The
expe<:ted rcal yield on IO-year Treasury is defined as the off-thc-mn IO-year
Treasury yield less the Federal Reserve Bank of Philadelphia's lO-ycar
expected inflanon
SOURCE: Standard & Poor's; Thomson Reuters Financial; Federal Reserve
Board; Federa! Re,~erve Bank ofPhilade!phia
39_
Implied S&P 500 volatility. 1995-2013
PCf(:Cnl, llilno"l rate
Market sentiment toward the banking
industry improved as the profitability of
banks increased
The profitability of BHCs increased in the
second half of 2012 but continued to run
well below the levels that prevailed before
the financial crisis (figure 41). Measures of
asset quality generally improved further, as
delinquency and charge-off rates decreased for
almost all major loan categories, although the
recent improvement in delinquency rates for
consumer credit in part reflects a compositional
shift of credit supply toward higher-creditquality borrowers. Loan loss provisions were
flat at around the slightly elevated levels seen
prior to the crisis, though they continued
to be outpaced by charge-offs. Regulatory
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70
60
50
40
30
20
10
I
'
!
1995
I
!
1.1
1998
!
!
2001
I
t
I
2004
I
I 1_.1 I I I I I !
2007
2010
2013
Non,' 11u; data aJ'"C weekly and extend through the week endmg
February 15, 2013. The senes shown···-the VIX-is the implied 30-d3Y
volatility of the S&P 500 stock price index as calculated from a weIghted
average of option!> prices
SOURCE: Chicago Board Options Exchange
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80869.039
Market sentiment toward the banking
industry improved in the second half of 2012,
reportedly driven in large part by perceptions
of reduced downside risks stemming from the
European crisis. Equity prices for bank holding
companies (BHCs) increased, outpacing
the increases in broad equity price indexes,
and BHC credit default swap (CDS) spreads
declined (figure 40).
80
97
26
PART 1, RECENT ECONOMIC AND FINANCiAL DEVELOPMENTS
40.
Spreads on credit default swaps for selected
U.S. banking organizations, 2007-13
Baslspo]ll!S
400
:;50
300
250
200
150
100
50
--'_---' _ _-L. ___
2009
2010
_LJ
I
2011
2012
2013
1\on:: The data are daily and extend through February 2l, 2013. Median
for six large bank holding companies and nine other banks
spread~
SOI]RCf" MaTh,
41.
Profitability of bank holding companies, 1997-2012
Percent, annuai nlle
_____
Pcrccnt, annual rate
RctHm
'lli a~~cl~
L5
20
LO
10
.5
.5
10
10
20
1.5
I
I
I
1997
I
I
L.-.L!
:WOO
I
2003
!
!
!
2006
!
I
!...LL...LJ
2009
2012
NOTE' The data, which arc seasonally adjusted, arc quarterly and extend
through 2012:Q4.
SOUR.CE: Federal Reserve Board, FR Y-9C, Consolidated Financial
Statements for Bank Holdmg Companies.
capital ratios remained at high levels based
on current standards, but the implementation
of generally more stringent Basel III capital
requirements will likely lead to some decline in
reported regulatory capital ratios at the largest
banks. Overall, banks remain well funded
with deposits, and their reliance on short-term
wholesale funding stayed near its low levels
seen in recent quarters. The expiration of
the Federal Deposit Insurance Corporation's
Transaction Account Guarantee program
on December 31, 2012, does not appear to
have caused any significant change in the
availability of deposit funding for banks.
Credit provided by commercial banking
organizations in the United States increased
in the second half of 2012 at about the same
moderate pace as in the first half of the year.
Core loans-the sum of C&I loans, real
estate loans, and consumer loans--expanded
modestly, with strong growth in C&lloans
offsetting weakness in real estate and credit
card loans (figure 42). Banks' holdings of
securities continued to rise moderately overall,
as strong growth in holdings of Treasury and
municipal securities more than offset modest
declines in holdings of agency MBS.
Despite continued improvements in
market conditions, risks to the stability of
financial markets remain
While conditions in short-term dollar funding
markets have improved, these markets remain
vulnerable to potential stresses. Money market
funds (MMFs) have sharply reduced their
overall exposures to Europe since the middle
of 2011, but prime fund exposures to Europe
continue to be substantial. MMFs also remain
susceptible to the risk of investor runs due
to structural vulnerabilities posed by the
rounding of net asset values and the absence
of loss-absorbing capitaL'
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80869.040
7. ]n November 2012, the Financial Stability Oversight
Council proposed recommendations for structural
reforms of U.S. MMFs to reduce their vulnerability to
runs and mitigate associated risks to the financial system.
98
MONETARY POLICY REPORT: FEBRUARY 2013
Dealer firms have reduced their wholesale
short-term funding ratios and have increased
their liquidity buffers in recent years, but
they still heavily rely on wholesale short-term
funding, As a result, they remain susceptible
to swings in market confidence and a possible
resurgence of anxiety regarding counterparty
credit risk. Respondents to the Senior Credit
Officer Opinion Snrvey on Dealer Financing
Terms indicated that credit terms applicable to
important classes of counterparties were little
changed over the second half of 2012 8 Dealers
reported increased demand for funding of
securitized products and indicated that the use
of financial leverage among trading real estate
investment trusts, or REITs, had increased
somewhat. However, respondents continued
to note an increase in the amount of resources
and attention devoted to the management
of concentrated exposures to central
counterparties and other financial utilities as
well as, to a smaller extent, dealers and other
financial intermediaries.
42.
27
Change in commercial and industrial loans and core
loans, J 990-20 I 2
I'cr<:CIlI,allnuairatc
30
20
10
10
20
30
LLLLLLI I j ! I I ! I ! I
199!
1994 1997 2000 2003
Ll_! I
2006
j
i I I I I
2009
2012
NOTE: The data, which are seasonally adjusted, arc quarterly and extend
through 2012:Q4. Core loans consist of commercia! and industrial loans, real
estate loans. and consumer loans. Data have been adjusted for banks'
implementation of Gertain accounting rule changes (bleluding the Financial
Accounting Standards Board's Statements of Financial Accounting Standards
Nos. 166 and 167) and for the cffects of large nonbank institutions converting
to commercial banks or mcrging with a commercial bank
SOUf!,CE; Federal Reserve Board, Statistical Release H.8, "Assets and
Liabtlities of Commercia! Banks in the United States."'
With prospective returns on safe assets
remaining low, some financial market
participants appeared willing to take on more
duration and credit risk to boost returns. The
pace of speculative-grade corporate bond
issuance has been rapid in recent months, and
while most of this issuance appears to have
been earmarked for the refinancing of existing
debt, there has also been an increase in debt
to facilitate transactions involving significant
risks. In particular, in bonds issued to finance
private equity transactions, there has been a
reemergence of payment-in-kind options that
permit the issuer to increase the face value of
debt in lieu of a cash interest payment, and
anecdotal reports indicate that bond covenants
arc becoming less restrictive. Similarly,
issuance of bank loans to finance dividend
recapitalization deals as well as covenant-lite
loans was robnst over the second half of the
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8. The Senior Credit Officer Opinion Survey on Dealer
Financing Terms is available on the Federal Reserve
Board's website at www.federalrcserve.gov/econresdata/
releases/secos.htm.
99
28
PART 10 RECENT ECONOMIC AND FINANCIAL DEVELOPMENTS
Table 1. Selected components of the Federal Reserve balance sheet, 2012--13
Millions of dollars
Balance sheet item
Total assets ...
Feb,22,
Feb. 20.
2012
2013
2,935.149
2,865,698
3,0%,802
107,959
27,059
5.192
4,773
845
439
30.822
15,031
1,4151
1,656,581
100,817
853.045
1,666,530
91,484
854,979
1,032,712
2,880,556
2,811,629
3,04J.820
0
36,033
0
1I7,923
0
40,703
54.594
54,669
54,982
18
Pnmarycredit...
Central hank liquidity swaps.
Lane LLC, Maiden Lane II LLC. and Maiden Lane III LLCI ,.
TotlllliabHities, .....
507
Sek'Cted liabilities
1.048,004
89.824
1,622,800
Federal Reserve assets increased, and the
average maturity of its Treasury holdings
lengthened ...
Total assets of the Federal Reserve increased
to S3,097 billion as of February 20,2013,
$231 billion more than at the end of
June 2012 (table J). The increase primarily
relleets growth in Federal Reserve holdings
of Treasury secnrities and agency MBS as a
result of the purchase programs initiated at the
September 2012 and December 2012 FOMC
meetings. As of February 20,2013, the par
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valne of Treasury securities and agency MBS
held by the Federal Reserve had increased
$70 billion and $178 billion, respectively,
since the end of June 2012. The composition
of Treasury securities holdings also changed
over the second half of 2012 as a result
of the continuation of the MEP, which was
announced at the June 2012 FOMC meeting.
Under this program, between July and
December, the Desk purchased $267 billion in
Treasury securities with remaining maturities
of 6 to 30 years and sold or redeemed an
equal par value of Treasury securities with
maturities of 3 years or less. As a result. the
average maturity of the Federal Reserve's
Treasury holdings increased 1.7 years over the
second half of 2012 and into 2013 and, as of
February 2013, stood at 10.5 years.
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80869.042
year. (leor a discussion of regulatory steps
taken related to financial stability, see the
box "The Federal Reserve's Actions to Foster
Financial Stability.")
0
100
MONETARY POLICY REPORT; FEBRUARY 2013
In the second half of 2012, the Federal
Reserve continued to reduce its exposure to
facilities established during the financial crisis
to support specific institutions, The portfolio
holdings of Maiden Lane LLC and Maiden
Lane III LLC--entities that were created
during the crisis to acquire certain assets
from The Bear Stearns Companies, Inc., and
American International Group, Inc" to avoid
the disorderly failures of those institutions-declined $14 billion to approximately
$1 billion, primarily reflectiug the sale of the
remaining securities in Maiden Lane III LLC
that was announced in August 2012, These
sales resulted in a net gain of $6,6 billion for
the benefit of the U.S, public, The Federal
Reserve's loans to Maiden Lane LLC
and Maiden Lane III LLC had been fully
repaid, with interest, as of June 2012, Loans
outstanding under the Term Asset-Backed
Securities Loan Facility (TALF) decreased
$4 billion to under $1 billion because of
prepayments and maturities of TALF loans,
With accumulated fees collected through
TALF exceeding the amount of TALF
loans outstanding, the Federal Reserve and
the Treasury agreed in January to end the
backstop for TALF provided by the Troubled
Asset Relief Program,
The improvement in offshore U.S, dollar
funding markets over the second half of 2012
led to a decline in the outstanding amount
of dollars provided through the temporary
U.S, dollar liquidity swap arrangements
with other central banks, As of February 20,
2013, draws on the liquidity swap lines were
$5 billion, down from $27 billion at the end of
June 2012, On December 13, 2012, the Federal
Reserve announced the extension of these
arrangements through February 1,2014,
On the liability side of the Federal Reserve's
balance sheet, deposits held by depository
institutions increased $176 billion since
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June 2012, while Federal Reserve notes in
circulation rose $60 billion, reflecting solid
demand both at home and abroad, M2
has increased at an annual rate of about
8 percent since June 2012, Holdings of M2
assets, including its largest component, liquid
deposits, remain elevated relative to what
would have been expected based on historical
relationships with nominal income and
interest rates, likely due to investors' continued
preference to hold safe and liquid assets,
As part of its ongoing program to ensure the
readiness of tools to manage reserves, the
federal Reserve conducted a series of smallvalue reverse repurchase transactions using
all eligible collateral types with its expanded
list of counterparties, as well as a few smallvalue repurchase agreements with primary
dealers, In the same vein, the Federal Reserve
continued to offer small-value term deposits
through the Term Deposit Facility to provide
eligible institutions with an opportunity
to become familiar with term deposit
operations,
International Developments
Foreign financial market stresses
abated ...
Since mid-July, global financial market
conditions have improved, on balance, in
part reflecting reduced fears of a significant
worsening of the European fiscal and financial
crisis, Market sentiment was bolstered
by a new European Central Bank (ECB)
framework for purchases of sovereign debt
known as Outright Monetary Transactions
(OMT), agreements on continued officialsector support for Greece, progress by Spain
in recapitalizing its troubled banks, and some
steps toward fiscal and financial integration
in Europe, Nevertheless, financial market
stresses in Europe remained elevated, and
policymakers still face significant challenges
(see the box "An Update on the European
Fiscal and Banking Crisis"),
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· .. while exposure to facilities
established during the crisis continued to
wind down
29
101
30
PART 1: RECENT ECONOMIC AND fiNANCIAL DEVELOPMENTS
The Federal Reserve's Actions to Foster Financial Stability
The Federal Reserve continued to take actions
in the second half of 2012 and early 2013 to meet
its financial stability responsibilities. Although
much remains to be done, the Federal Reserve
has implemented regulatory reforms to strengthen
the U.s. financial system, and it has taken further
steps to gather information from the supervision of
large banks, market reports, and other economic
and financial sources to assess threats to financial
stability. The Federal Reserve also has continued
to work closely with its domestic regulatory
counterparts and has taken actions to increase the
resilience of the international financial regulatory
architecture.
has been the development of the Basel III capital
reforms. In June 2012, the Federal Reserve Board and
the other u.s. banking agencies issued a proposal
to amend the u.s. bank capital rules to implement
these reforms. The Basel III reforms will raise the
quantity of capital that must be held by u.s. banking
firms, improve the quality of regulatory capital of
those firms, and strengthen the risk-weight framework
of u.S. bank capital rules.
Consistent with the requirements of the Dodd-
Frank Wall Street Reform and Consumer Protection
Act of 201 0 (Dodd-Frank Act), the Board has
also proposed rules to strengthen the oversight of
the u.S. operations of foreign banks. Under the
Board's December 2012 proposal. foreign banking
u.s. presence
would be required to create an intermediate holding
company (tHe) Over their U.s. subsidiaries, which
would help facilitate consistent and enhanced
supervision and regulation of the U.S. operations of
these foreign banks. An IHC of a foreign bank would
be required to meet the same u.s. risk-based capital
and leverage rules as a U.s. bank holding company
(BHC). In addition, IHCs and the u.s. branches and
agencies of foreign banks with a large U.S. presence
would need to meet liquidity requirements similar to
those imposed on U.S. BHCs.
Progress in regulatory reform outside of the
traditional banking sector has been notable as well.
16:58 Aug 02, 2013
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important and thus subject to enhanced risk-
management standards. On July 30, the Federal
Reserve Board approved a final rule establishing
enhanced risk-management standards for designated
FMUs supervised by the Federal Reserve. The rule
also establishes processes to review and consult with
the Securities and Exchange Commission (SEC) and
Fmt 6601
materially affect the nature or level of their risk.
The FSOC has also continued to make progress in
its work to designate systemically important nonbank
financial companies for consolidated supervision by
the Federal Reserve. Relying primarily on data from
publicly available reports, the FSOC is evaluating
the potential systemic importance of a number of
nonbank firms that meet the quantitative criteria
for a first-stage review; to date, it has concluded
that some finns warranted further consideration
and has advanced them to the third and final stage
of the determination process. Meanwhile, the
International Association of Insurance Supervisors,
under the oversight of the Financial Stability
Board, has continued to move forward on crafting
a methodology to identify global systemically
important insurers and developing policy measures
that would be applicable to those institutions.
In addition, efforts to increase the resilience
of "shadow banking," which refers to credit
intermediation that occurs at least partly outside
of the traditional banking system, are continuing.
In November 2012, the FSOC proposed
recommendations for structural reforms of U.S.
money market funds to reduce their vulnerability to
runs and mitigate associated risks to the financial
system. Another set of reforms has been aimed
at the triparty repurchase agreement markets,
including efforts by the Federal Reserve to reduce
the vulnerabilities created by the large amollnts of
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A core element of the global regulatory
community's efforts to improve banking regulation
VerDate Nov 24 2008
July 2012, the f-inancial Stability Oversight Council
(FSOC) designated eight FMUs as systemically
the Commodity Futures Trading Commission (CFTC)
on any proposed changes to the rules, procedures,
or operations of certain designated FMUs that could
Regulation
organizations (FBOs) with a large
For example, as mandated by the Dodd-Frank Act,
the new supervisory framework for systemically
important financial market utilities (FMUs)-that
is, those entities that provide the infrastructure
to make payments and clear and settle financial
transactions-has continued to take shape. In
102
MONETARY POLICY REPORT FEBRUARY 2013
Supervision
The Federal Reserve has continued to work to
embed its supervisory practices within a broader
macroprudential framework. Annual stress tests,
which assess the internal capital planning processes
and capital adequacy of the largest BHes, continue
to be an important element in its strengthened,
cfOss-firm supervisory approach. The latest
Comprehensive Capital Analysis and Review (CCAR
2013), which covers the 18 largest BHCs (and is
being conducted in a modified form for 11 other
large SHCs), is now under way. In October 2012,
the Board published final stress-testing rules under
the Dodd-Frank Act, and it released the economic
and financial market stress scenarios for CCAR
2013 in November.' CCAR 2013 results will be
released in March of this year.
The Federal Reserve has also been working
to improve the resolvability of the largest, most
complex banking firms. The Dodd~-Frank Act
created the Orderly Liquidation Authority (OLA) to
improve the prospects for an orderly liquidation of
a systemic financial firm and requires that all large
BHes submit resolution plans to their supervisors.
The Federal Deposit Insurance Corporation (FDIC)
has been developing a single-point-of-entry strategy
for resolving systemic financial firms under OlA,
and the Federal Reserve, working closely with the
FDIC, has been carefully reviewing the resolution
plans (the so-called living wills) submitted in th('
summer and fall of 2012 by the largest and most
complex 8HCs and FBOs.
In Hne with a joint agency report to the Congress
in July 2011, the Federal Reserve has continued
1. Information on the Dodd-Frank Act stress tests
and CCAR are available on the Federal Reserve Board's
website at www.federalreseflle.gov/bankinfOfegistresstests-capital-p!anning.htm.
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to work with the SEC and the CFTC to develop
and implement effective superviSOry practices
and techniques for deSignated FMUs, including
appropriate information-sharing arrangements and
Federal Reserve participation in SEC and erTC
examinations of designated FMUs.
Monitoring
The Federal Reserve has continued to pursue
an active program of research and data collection,
often in conjunction with other U.s. and foreign
regulators and supervisors, and to work on
developing a framework and infrastructure for
monitoring risks to financial stability. It continues
to regularly monitor a variety of items that measure
key financial vulnerabilities, such as leverage,
maturity mismatch, interconnectedness, and
complexity of financial institutions, markets, and
products. In a context of adverse shocks, such
vulnerabilities could lead to fire sales and an
adverse feedback loop with credit availability,
which could, in turn, inflict harm on the rea!
economy.
The Federa! Reserve pays special attention
to developments at the largest, most complex
financial firms, using both information gathered
through supervision and indicators of financial
conditions and systemic risk from financial markets.
It has been analyzing the consequences for firms
and markets resulting from the ongoing strains
in European financial markets as we!! as those
associated with the fiscal situation in the United
States. Another issue that the Federal Reserve is
monitoring closely is the potential incentive for
some investors and institutions to take on excessive
risk-for example, by increasing leverage, credit
risk, and duration risk-in an attempt to reach for
yield in a sustained low interest rate environment.
Moreover, efforts are ongoing, both at the Federal
Reserve and elsewhere, to evaluate and develop
new macroprudential tools that could help limit
buildups of systemic risk or increase the resilience
of financial institutions and markets to potential
adverse shocks.
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intraday credit provided by clearing banks in these
markets. International regulatory groups have also
been addressing the financial stability risks of
shadow banking.
31
103
32
PART 1: RECENT ECONOMIC AND FINANCIAL DEVEl OPMENTS
An Update on the European Fiscal and Banking Crisis
vulnerable euro-area economies, strengthen
domestic public finances and banking systems,
and reinforce the monetary union. As a result,
Furopean financial stresses have moderated over
the past several months. Nevertheless, they remain
elevated, and European policymakers still face
_significant challenges as they seek to improve fiscal
positions, implement growth-augmenting structural
reforms, and bolster regional integration in a difficult
economic environment.
A key turning point in the euro-area crisis
occurred in late July, when Mario Draghi, the
European Central Bank (EeB) preSident, stated,
"Within our mandate, the ECB is ready to do
whatever it takes to preserve the eUrD."l The feB
subsequently unveiled a framework for Outright
Monetary Transactions (OMT) to address distortions
in euro-area government bond markets that
undermine the transmission of monetary policy.
Under certain conditions, the ECB can purchase
potentially unlimited amounts of government
bonds.' To date, the ECB has not purchased any
bonds under the GMT framework. Nevertheless,
the announcement of the framework has mitigated
investors' concerns about the adequacy of financial
backstops for the Italian and Spanish governments
and, more generally, about the integrity of the euro
area,
Vulnerable euro-area countries have made
progress in strengthening their banking systems
and public finances in recent months. The
governments of Ireland and Portugal have been
1. See Mario Draghi (2012), "Verbatim of the Remarks
Made
by Mario Draghi," speech delivered at the Global
lnvestment ConferencE', london, July 26, www,ecb,intJ
press/key/date/2012Ihtm!lsp 12072 6,en.html.
2, The EeB's purchases will focus on government
bonds with maturities of one to three years. The ECB will
have full discretion over these purchases. A necessary
condition for ECB purchases is that a government request
a full or precautionary financial assistance program from
the European Financial Stability Facility or the European
Stability Mechanism. A government that already has
such a program must regain market access, In addition,
governments must fulfill their policy commitments under
their programs and the euro-area governance framework
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generally fulfilling their policy commitmenls under
their official financial assistance programs. In
Spain, the government secured euro-area official
approval and financing for its bank restructuring and
recapitalization plans. In Greece, the government
reinvigorated its long-stalled austerity and reform
initiatives, In response, European authorities resumed
fmancial assistance to the Greek government and
took steps to address Greece's public debt burden,
including easing the terms of euro-area official
financing and funding a discounted buyback
of roughly £30 billion in privately held Greek
government debt. More generally, official financial
assistance is continuing to provide vulnerable
countries with breathing room to make the difficult
adjustments needed to resolve their crises.
European governments have also made some
progress toward a European bJnking union. After
protracted negotiations, European leaders agreed
in December on key details of a Single supervisory
mechanism (SSM) for European banks with the
EeB at its center. The SSM is expected to be
established sometime this spring and should enter
into force in early 2014. The ECB will directly
supervise large eura-area banks and will be able
to assume (from national authorities) supervision
of any euro-area bank when necessary to ensure
consistent application of high supervisory standards.
Establishment of the SSM is viewed as a necessary
precondition for euro-area governments to share
more directfy the fiscal burden of resotving
national banking crises. In addition, European
governments recently set objectives to accelerate
the harmonization of national policy frameworks for
bank resolution and deposit insurance and, further
down the road, to create a single mechanism for
bank resolution and recovery.
In part because of the positive developments
highlighted previously, financial stresses facing
vulnerable European governments and banksthough still elevated-moderated substantially in the
second half of 2012 and early 2013. Sovereign yields
declined significantly even as the Italian and Spanish
governments issued substantia! amounts of debt.
In addition, the Irish and Portuguese governments
began returning to bond markets; each conducted a
limited, yet successful, sale of bonds in January.
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In the second half of 2012, European
policymakers stepped up efforts to support
104
33
MONETARY POLICY REPORT, FEBRUARY 2013
43.
Equity indexes for selected foreign economies,
2009-13
June 30.
2009·~
130
120
llO
100
90
80
70
60
50
t:.l'rl'-mC,l
As risk sentiment improved, foreign equity
indexes rose significantly: Over the second half
of 2012 and into early 2013, equity indexes
increased abont 10 percent for the United
Kingdom and Canada, about 15 percent in
the euro area, and about 25 percent in Japan;
equity indexes in EMEs also moved up across
the board, as shown in figure 43. Likewise,
yields on 10-year government bonds in many
countries increased moderately, though
Japanese yields remained below 1 percent.
Spreads of peripheral European sovereign
yields over German bond yields of comparable
maturity declined significantly as overall
euro-area financial strains abated (figure 44).
Corporate credit spreads also declined, and
bond issuance picked up.
The U.S. dollar depreciated nearly 1 percent
against a broad set of currencies over the
second half of 2012 and into early 2013
(figure 45). Some of this depreciation reflected
a reversal of flight-to-safety flows, in part
stemming from the reduction in European
financial stress. Indeed, the dollar depreciated
4 percent against the euro. In contrast, the
dollar appreciated 17 percent against the
Japanese yen. Most of this rise came in recent
months, as Shinzo Abe, the newly elected
prime minister of Japan, called for the Bank
of Japan to employ "unlimited easing" of
monetary policy to overcome deflation.
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100
160
150
140
L~ul~'-~~J->..L,~J
2009
2010
20ll
2012
40
2013
NOTE: The data arc daily. The last observatlOll for each series is
February 20, 2013. Emerging markets are Brazil, Chile, China. Colombia,
Czech Republic, Egypt, Hungary, India, Ind;)IlCsia, Malaysia, Mexico,
Morocco, Peru, the Phitippmes, Poland. Russia, South Africa, South Korea,
Taiwan, Thailand, and Turkey.
SOURCE: For emerging markets, Morgan Stanky Emerging Markets MXEF
Capital Index; for the curo area, Dow Jones Eum STOXX Index; for
eUTo-area banks, Dow Jones Euro STOXX Bank Index; for Japan. Tokyo
Stock Exchange (TOPIX); all via Bloomberg
44,
Government debt spreads for peripheral
European economies, 2009-13
32
28
24
20
16
12
U...w.J!!!
2009
I
),-1.1 .... !
2010
!.!
!
2011
1...1-!
!
2012
!
I
__
J
2013
Non.: The data arc weekly. The last observation for each
February 15,2013, The spreads shown are the yields on
the 1O-year German bond yield
SouRn: For Greece, Italy, P0I1ugal. and Spam, Bloomberg; for Ireland.
staff estimates usmg traded bond prices from Thomson Reuters and
Bloomberg.
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Reduced concerns about the European crisis
contributed to an easing of funding conditions
for European banks. Euro-area banks have
relied somewhat less on ECB funding in
recent months, and use of central bank dollar
liquidity swap lines declined significantly.
Reflecting market views of the decreased
risk of defanlt, CDS premiums on the debt
of many large banks in Europe dropped
significantly, on net, especially for Italy and
Spain, and euro-area bank stocks increased
about 30 percent since mid-20 I 2 (figure 43).
105
45.
PART L
RECENT ECONOMIC AND FINANCiAL DEVELOPMENTS
U.S. dollar exchange rate against broad index
and selected major currencies, 2010-13
De<;cml>"r~I,21W<)
100
120
ll5
llO
105
100
95
90
80
..J1c.w..Lw2clOI~0"""-'-'-'~~20~'~.L-cL~20.L'2~1 .L.Ll~
LI
NOTE: The data, which are in foreign currency unie; per dollar. arc daily.
The Jast observation for each series is FebOiary 21, 2013.
SOURCE: Fedeml Reserve Board. Statistical Release H.IO, "ForeIgn
Exchange Rates,"
46.
Real gross domestic product growth in selected
advanced foreign economies, 2010-12
?crcent,annualratc
12
12
KOT(" The data are quarterly and extend through 20J2:Q3 for Canada and
2012:Q4 for the curo area, Japan, and the United Kingdom.
SOCRCE: For Canada, StatistIcs Canada: for the curo arca, Euwstat: for
Japan. Cabinet Office of Japan; and for the United Kingdom, Office for
National Statistics.
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... but economic activity in the advanced
foreign economies continued to
weaken ...
Despite the easing of financial stresses in the
euro area and some improvement in global
financial markets, activity in the advanced
foreign economies (AFEs) continued to lose
steam in the second half of 2012 (figure 46).
The euro area fell further into recession, as
fiscal austerity, rising unemployment, and
depressed confidence restrained spending,
especially in the countries at the center of the
crisis. Real GDP also contracted in Japan.
reflecting plummeting exports. In the United
Kingdom, real GDP growth resumed in the
third quarter, partly thanks to a temporary
boost to demand from the London Olympics,
but contracted again in the fourth quarter.
Canadian real GDP growth remained positive
but also weakened, largely owing to lower
external demand. Survey indicators suggest
that conditions in the AFEs improved only
marginally around the turn of the year. Amid
this weakness in economic activity and limited
pressures from commodity prices, inflation
readings for most AFEs remained contained.
Several foreign central banks expanded their
balance sheets further and took other actions
to support their economies (figure 47). Tn
addition to its introduction of the OMT, the
ECB lowered its main policy rate. The Bank
of England completed its latest round of asset
purchases, bringing its holdings to £375 billion,
and began the implementation of its Funding
for Lending Scheme, designed to boost lending
to households and firms. The Bank of Japan
took a number of steps. It introduced a new
Stimulating Bank Lending Facility in October
and raised its inflation target from 1 percent to
2 percent in January. In addition, it increased
the size of its Asset Purchase Program by
¥30 trillion, to ¥I 0 I trillion, by the end of 2013
and announced that purchases would be open
ended beginning in 2014.
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34
106
35
MONETARY POLICY REPORT, FEBRUARY 2013
· .. even as economic growth stabilized in
emerging market economics
47.
Central bank assets in selected advanced
economies, 2008-12
Percenlofnol1li""IGUP
After slowing earlier in the year, in part
because of headwinds associated with Europe's
troubles, economic growth in EMEs stabilized
in the third quarter and appeared to pick up
in the fourth. This modest pickup in economic
activity in the face of continued weakness in
exports to advanced economies was supported
by monetary and fiscal policy stimulus.
35
30
25
20
15
10
In China, following slower growth in the
first half of 2012, stimulus measures helped
boost the pace of real GOP growth in the
second half of the year. Improved economic
conditions in China also provided a lift
to other emerging Asian economies. GOP
accelerated in Hong Kong and Taiwan in the
third quarter; in the fourth quarter, exports
and purchasing managers indexes moved
higher in most of the region, and GOP growth
rebounded in a number of economies.
1 t!
!
2008
!
I
!
!
2009
!
I
!
f
2010
!
I
I
I
!
2011
I
!
!
I
!
2012
NOTE: The data are quarterly and extc-nd through 2012:Q3 for the curo area
and the United Kingdom and 20 12;Q4 for Japan_
SOURCE; For the curo area, European Central Bank and Eurostat; for Japan,
Bank of Japan and Cabinet Office of Japan; and for the United Kingdom,
Bank of England and Office for National Statistics.
After stagnating for about a year, economic
activity in Brazil picked up in the third quarter
to a still-lackluster pace of 2V, percent.
Indicators for the fourth quarter suggest
a further modest pickup, supported by
accommodative policies. In contrast, GOP
growth in Mexico continued to fall in the third
quarter as the growth of U.S. manufacturing
production slowed; however, Mexican
growth picked up to 3 percent in the fourth
quarter, boosted by services and the volatile
agricultural sector.
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Despite occasional spikes in food prices,
inflation in most emerging Asian economies
remained well contained as moderate output
growth limited broader price pressures. India
was a notable exception, with 12-month
inflation around 10 percent in recent months.
In some Latin American economies, increases
in food prices had a greater effect on inflation
than in Asia, leading to 12-month price
increases of around 5V, percent in Brazil and
around 4'4 percent in Mexico over the second
half of last year.
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107
108
PART 2: MONETARY POLICY
of Treasury securities that was announced
in June 2012 and continued its policy of
reinvesting principal payments from its holdings
of agency debt and agency-guaranteed
mortgage-backed securities (MBS) into agency
MBS.
At the September 12-13 meeting, the
Committee agreed that the outlook called for
additional monetary accommodation, and
that such accommodation should be provided
by both strengthening its forward guidance
regarding the federal funds rate and initiating
additional purchases of agency MBS at a
pace of $40 billion per month. Along with the
ongoing purchases of $45 billion per month
of longer-term Treasury securities under the
maturity extension program announced in June,
these purchases increased the Committee's
holdings of longer-term securities by about
$85 billion each month through the end of the
year. These actions were taken to put downward
pressure on longer-term interest rates, support
mortgage markets, and help make broader
financial conditions more accommodative (see
the box "EtIicacy and Costs of Large-Scale
Asset Purchases"). The Committee agreed that
it would closely monitor incoming information
on economic and financial developments in
coming months, and that if the outlook for the
labor market did not improve substantially, it
would continue its purchases of agency MBS,
undertake additional asset purchases, and
employ its other policy tools as appropriate
until such improvement is achieved in a
context of price stability. The Committee also
agreed that in determining the size, pace, and
composition of its asset purchases, it would,
as always, take appropriate account of the
likely etIicacy and costs of such purchases.
This flexible approach was seen as allowing
the Committee to tailor its policy over time
in response to incoming information while
clarifying its intention to improve labor market
conditions, thereby enhancing the effectiveness
of the action by helping to bolster business and
consumer confidence.
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The Committee also modified its forward
guidance regarding the federal funds rate at the
September meeting, noting that exceptionally
low levels for the federal funds rate were
likely to be warranted at least through mid2015, longer than had been indicated in
previous FOMC statements. Moreover, the
Committee stated its expectation that a highly
accommodative stance of monetary policy
would remain appropriate for a considerable
time after the economic recovery strengthens.
The new language was meant to clarify that
the Committee's anticipation that exceptionally
low levels for the federal funds rate were likely
to be warranted at least through mid-20lS did
not reflect an expectation that the economy
would remain weak, but rather reflected the
Committee's determination to support a
stronger economic recovery.
At the December 11-12 meeting, members
judged that continued provision of monetary
accommodation was warranted in order
to support further progress toward the
Committee's goals of maximum employment
and price stability. The Committee judged
that, following the completion of the maturity
extension program at the end of the year,
such accommodation should be provided in
part by continuing to purchase agency MBS
at a pace of $40 billion per month and by
purchasing longer-term Treasury securities at
a pace initially set at $45 billion per month.
The Committee also decided that, starting in
January, it would resume rolling over maturing
Treasury securities at auction.
With regard to its forward rate guidance, the
Committee decided to indicate in the statement
that it expects the highly accommodative stance
of monetary policy to remain appropriate for
a considerable time after the asset purchase
program ends and the economic recovery
strengthens. In addition, it replaced the
date-based guidance for the federal funds
rate with numerical thresholds linked to the
unemployment rate and projected inflation.
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38
109
MONETARY POLICY REPORT: fEBRLlARY 2013
39
Efficacy and Costs of Large-Scale Asset Purchases
Federal Reserve has undertaken a series of largescale asset purchase (LSAP) programs. Between late
2008 and early 2010, the Federal Reserve purchased
approximately $1.7 trillion in longer-term Treasury
securities, agency debt, and agency mortgage-backed
securities (MBS). From late 201 () to mid-20l1, a
second round of LSAPs was implemented, consisting
of purchases of $600 biltion in longer-term Treasury
securities. Between September 2011 and the end of
2012, the Federal Reserve implemented the maturity
extension program and its continuation, under which
it purchased approximately $700 billion in longerterm Treasury securities and sold or allowed to run off
an equal amount of shorter-term Treasury securities.
And in September and December 2012, the Federal
Reserve announced flow-based purchases of agency
MBS and longer~term Treasury securities at initial paces
of $40 billion and $45 billion per month, respectively.
These purchases were undertaken in order to put
downward pressure on longer-term interest rates,
support mortgage markets, and help to make broader
financial conditions more accommodative, thereby
supporting the economic recovery. One mechanism
through which asset purchases can affect financial
conditions is the "portfolio balance channel," which
is based on the premise that different financial assets
may be reasonably close but imperfect substitutes
in investors' portfolios. This assumption implies that
changes in the supplies of various assets available
to private investors may affect the prices or yields
of those assets and the prices of assets that may be
reasonably close substitutes. As a result, the Federal
Reserve's asset purchases can push up the prices
and lower the yields on the securities purchased
and influence other asset prices as well. As investors
further rebalance their portfolios, overall financial
conditions should ease more generally, stimulating
economic activity through channels similar to those
for conventional monetary policy. In addition, asset
purchases could also signal that the central bank
intends to pursue a more accommodative policy
stance than previously thought, thereby lowering
investor expectations about the future path of the
federal funds rate and putting additional downward
pressure on longer-term yields.
A substantial body of empirical research finds that
the Federal Reserve's asset purchase programs have
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significantly lowered longer-term Treasury yields.'
More important, the effects of LSAPs do not seem to be
restricted to Treasury yields. In particular, LSAPs have
been found to be associated with significant declines
in MBS yields and corporate bond yields as well as
with increases in eqUity prices.
Continued on next page
1. For a ~electjve list of references regarding the effect of
the first lSAP, see the box "The I::ffects of Federa! Reserve
Asset Purchases" in Board of Governors of the Federa!
Reserve System (2011), Monetary Policy Report to the
Congress (Washington: Board of Governors, March), www.
federalreserve.gov/monetarypo! icy/mpr _2011 0301_part2 .htm.
For additional references, including those that analyze the
effect of the second lSAP as well as the maturity extension
program, see, for example, Stefania D'Amico, William
English, David l6pez-Salido, and Edward Nelson (2012), "The
Federal Reserve's large-Scale Asset Purchase Programmes:
Rationale and Effects," Economic Journal, vol. 122
(November), pro F415--45; Arvind Krishnamurthy and Annette
Vissing-Jorgensen (2011), "The Effects of Quantitative fasing
on Interest Rates: Channels and Implications for PoliCY,"
Brookings Papers on Economic Activity, Fall, pp. 215-65;
Canlin li and Min Wei (2012), "Term Structure Modelltng
with Supply Factors and the Federal Reserve's Large
Scale Asset Purchase Programs," Finance and Economics
Discussion Series 2012~37 (Washington: Board of Governors
of the Federal Reserve System, May), www.federalreserve.
gov/pubslfeds/2012/20123 71201237pap.pdf; and references
in those studies. For work that specifically emphasizes the
signaling channel of lSAPs, scc, for example, Michael D.
Bauer and Glenn D. Rudebusch (2012), "The Signaling
Channel for Federal Reserve Bond Purchases," Working Paper
Serje~ 2011-21 (San Francisco: Federal Reserve Bank of San
Francisco, August), www.frbsf.orglpublications/economics/
papersl2011/wp11~21 bk.pdf. For work that focuses on
the effects on credit default risk, see, for example, Simon
Gilchrist and Egon Zakrajsek (2012), "The Impact of the
Federal Reserve's large-Scale Asset Purchase Programs on
Default Risk" paper presented at "Macroeconomics and
Financial Intermediation: Directions since the Crisis," a
conference held at the National Bank of Belgium, Brussels,
Decenlber 9~1 0,2011. Although the majority of research
on the effects of LSAPs appears to support a significant
influence on asset price'>, the overall result of such programs
is generally difficult to estimate precisely: Event studies can
make onty sharp predictions on the effects within a relatively
short time horizon, whereas approaches based on timeseries models tend to face challenges in isolating the effects
of the programs from other economic developments. For a
more skeptical view on the effect of lSAPs, see, for example,
Daniell. Thornton (2012), "Evidence on the Portfolio Balance
Channel of Quantitative Easing," Working Paper Series 2012~
OlSA (S1. louis: Federal Reserve Bank of S1. louis, October),
http://research.stlouisfed.orglwp/2012/2 0 12 -015.pdf.
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In order to provide additional monetary stimulus
when short-term interest rates are near zero, the
110
40
PART 2, MONETARY POLICY
Efficacy and Costs of large-Scale Asset Purchases, continued
broader financial conditions, obtaining accurate
estimates of the effects of LSAPs on the macroeconomy
is inherently difficult, as the counterfactual case-how
the economy would have performed without LSAPs-cannot be directly observed. However, econometric
models can be used to estimate the effects of LSAPs
on the economy under the assumption that the
economic effects of the easier financial conditions
that are induced by lSAPs are similar to those that
are induced by conventional monetary policy easing.
Model simulations conducted at the Federal Reserve
have generally found that asset purchases provide
a significant boost to the economy. For example,
J study based on the Federal Reserve Board's
FRB/US model estimated that, as of 2012, the first
two rounds of LSAPs had raised real gross domestic
product almost 3 percent and increased private payroll
employment by about 3 million jobs, while lowering
the unemployment rate about 1.5 percentage points,
relative to what would have been expected otherwise.
These simulations also suggest that the program
materially reduced the risk of deflation.'
Of course, all model-based estimates ofthe
macroeconomic effects of LSAPs are subject to
considerable statistical and modeling uncertainty
and thus should be treated with caution. Indeed,
while some other studies atso report signiflcant
macroeconomic effects from asset purchases,
other research finds smaller effects. 3 Nonetheless,
2. These results are discussed further in Hess Chung,
Jean-Philippe laforte, David Reifschneider, and John C.
Williams (2012), "Have We Underestimated the likelihood
and Severity of Zero Lower Bound Events?" Journal of Money,
Credit and Banking, voL 44 (February supplement),
pp.47-82.
3. For studies reporting significant macroeconomic effects
from asset purchases, see, for example, jeffrey C. Fuhrer and
Giovanni P. Olivei (2011), "The Estimated Macroeconomic
fffecfs of the Federal Reserve's large-Scate Treasury Purchase
Program," Public Policy Briefs 11-02 (Boston: Federa! Reserve
Bank of Boston, Apri!), www.bosJrb.orgieconomic/ppb/20111
ppb112.pdf; and Christiane Baumeister and Luca Benat;
(2012), "Unconventional Monetary Policy and the Great
Recession: Estimating the Macroeconomic Effects of a Spread
Compression at the Zero lower Bound," Working Papers
2012-21 (Ottawa: Bank of Canada, July), wW\v.bankofcanada.
calwp-contentJuploadsl2012/07/wp2012-21.pdf. Also, the
Bank of England has implemented tSArs similar to those
undertaken by the Federal Reserve, and its staff research finds
that the effects appear to be quantitatively similar to those in
the United States.
For studies reporting smaller effects from asset
purchases, see, for example, Michael T. Kiley (2012),
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a balanced reading of the evidence supports the
conclusion that LSAPs have provided meaningful
support to the economic recovery while mitigating
deflationary risks.
The potential benefits of LSAPs must be considered
alongside their possible costs. One potential cost of
conducting additional LSAPs is that the operations
could lead to a deterioration in market functioning
or liquidity in markets where the Federal Reserve
is engaged in purchasing. More specifically, if the
Federal Reserve becomes too dominant a buyer in
a certain market, trading among private participants
could decrease enough that market liquidity and
price discovery become impaired. As the global
financial system relies on deep and liquid markets
for U.S, Treasury securities, significant impairment of
this market would be especially costly; impairment
of this market could also impede the transmission of
monetary policy. Although the large volume of the
Federal Reserve's purchases relative to the size of
the markets for Treasury or agency securities could
ultimately become an issue, few if any problems have
been observed in those markets thus far,
A second potential cost of LSAPs is that they may
undermine public confidence in the Federal Reserve's
ability to exit smoothly from its accommodative
policies at the appropriate time. Such a reduction
in confidence might increase the risk that long-term
inflation expectations become unanchored. The
Federal Reserve is certainly aware of these concerns
and accordingly has placed great emphasis on
developing the necessary tools to ensure that polley
accommodation can be removed when appropriate.
For example, the Federal Reserve will be able to
put upward pressure on short-term interest rates at
the appropriate time by raising the interest rate it
pays on reserves, using draining tools !ike reverse
repurchase agreements or term deposits with
depository institutions, or selling securities from the
Federal Reserve's portfolio. To date, the expansion of
the balance sheet does not appear to have materially
affected long-term inflation expectations.
A third cost to be weighed is that of risks to
financia! stability. For example, some observers have
"The Aggregate Demand Effects of Short- and long-Term
Interest Rates," Finance and Economics Discussion Series
2012-54 (Washington: Board of Governors of the Federal
Reserve System, August), www.federa!reserve.gov/pubsl
feds/2012/2012541201254pap.pdf; and Han Chen, Vasco
Curdia, and Andrea Ferrero (2012), "The Macroeconomic
Effects of large-Scale Asset Purchase Programmes," Economic
Journal, voL 122 (November), pp. F289-315.
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While there seems to be substantial evidence that
LSAPs have lowered longeHerm yields and eased
111
MONETARY POLICY REPORT: FEBRUARY 2013
taking is a necessary element of a healthy economic
recovery, and accommodative monetary policies
could even serve to reduce the risk in the system
by strengthening the overall economy_ Nonetheless,
the Federal Reserve has substantially expanded its
monitoring of the financial system and modified
its supervisory approach to take a more systemic
perspective.
There has been limited evidence so far of excessive
buildups of duration, credit risk, or leverage, but the
Federal Reserve will continue both its careful oversight
and its implementation of financial regulatory reforms
designed to reduce systemic risk,4
The Federal Reserve has remitted substantial
income to the Treasury from its earnings on securities,
totaling some $290 billion since 2009. However,
if the economy continues to strengthen and policy
accommodation is withdrawn, remittances will likely
4. For additional details, see the box "The Federal Reserve's
Actions to Fo~ter Financial Stability" in Part 1.
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decline in coming years, Indeed, in some scenarios,
particularly if interest rates were to rise quickly,
remittances to the Treasury could be quite low for
a time,S Even in such scenarios, however, average
annual remittances over the period affected by the
Federal Reserve's purchases are highly likely to be
greater than the pre~crisis norm, perhaps substantially
so, Moreover, if monetary policy promotes a stronger
recovery, the associated reduction in the federal
deficit would far exceed any variation in the Federal
Reserve's remittances to the Treasury, That said, the
Federal Reserve conducts monetary policy to meet
its congressionally mandated objectives of maximum
employment and price stability and not primarily for
the purpose of turning a profit for the u.s. Department
of the Treasury
5. For additional details, see Seth Bo Carpenter, Jane L
Ihrig, Elizabeth C. Klee, Daniel W. Quinn, and Alexander
I~. Boote (2013), "The Federal Reserve's Balance Sheet and
farnings: A Primer and Projections," Finance and Economics
Discussion Series 2013-01 (Washington: Board of Governors
of the Federa! Reserve System, January), www.federalreserve.
gov/pubsifeds12013/201301/201301 abs.html.
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raised concerns that, by driving longer-term yields
lower, nontraditional policies could induce imprudent
risk-taking by some investors. Of course, some risk-
41
112
PART 2, MONETARY POLICY
In particular, the Committee indicated that it
expected that the exceptionally low range for
the federal funds rate would be appropriate
at least as long as the unemployment rate
remains above 6\-1 percent, inflation between
one and two years ahead is projected to be
no more than Ii, percentage point above the
Committee's 2 percent longer-run goal, and
longer-term inflation expectations continue to
be well anchored. These thresholds were seen as
helping the pnblic to more readily understand
how the likely timing of an eventual increase in
the federal funds rate would shift in response to
nnanticipated changes in economic conditions
and the ontlook. Accordingly, thresholds could
increase the probability that market reactions
to economic developments would move longerterm interest rates in a manner consistent
with the Committee's assessment of thc likely
future path of short-term interest rates. The
Committee indicated in its December statement
that it viewed the economic thresholds, at
least initially, as consistent with its earlier,
date-based guidance. The new langnage noted
that the Committee would also consider other
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information when determining how long to
maintain the highly accommodative stance of
monetary policy, including additional measures
of labor market conditions, indicators of
inflation pressures and inflation expectations,
and readings on financial developmcnts.
At the conclusion of its January 29-30 meeting,
the Committee made no changes to its target
range for the federal funds rate, its asset
purchase program, or its forward guidance for
the federal funds ratc. The Committee stated
that, with appropriate policy accommodation, it
expected that economic growth wonld proceed
at a moderate pace and the unemployment
rate wonld gradually decline toward levels
the Committee judges consistent with its
dual mandate. It noted that strains in global
financial markets had eased somewhat, but
that it continued to sec downside risks to the
economic outlook. The Committee continued
to anticipate that inflation over the medium
term likely would run at or below its 2 percent
objective.
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42
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43
PART
3
SUMMARY OF ECONOMIC PROJECTIONS
The following material appeared as an addendum to the minutes of the December 77-72,2072,
meeting of the Federal Open Market Committee.
In conjunction with the December 11-12,
2012, Federal Open Market Committee
(FOMC) meeting, meeting participants--the
7 members of the Board of Governors and the
12 presidents of the Federal Reserve Banks,
all of whom participate in the deliberations of
the FOMC-submitted their assessments of
real output growth, the nnemployment rate,
inflation, and the target federal funds rate for
each year from 2012 through 2015 and over
the longer run. Each participant's assessment
was based on information available at the time
of the meeting plus his or her judgment of
appropriate monetary policy and assumptions
about the factors likely to affect economic
outcomes. The longer-run projections
represent each participant's judgment of the
value to which each variable would be expected
to converge, over time, under appropriate
monetary policy and in the absence of
further shocks to the economy. "Appropriate
monetary policy" is defined as the future
path of policy that each participant deems
most likely to foster outcomes for economic
activity and inflation that best satisfy his or
her individual interpretation of the Federal
Reserve's objectives of maximum employment
and stable prices.
Overall, the assessments submitted in
December indicated that FOMC participants
projected that, under appropriate monetary
policy, the pace of economic recovery would
gradually pick up over the 2012--15 period
and inflation would remain subdued (table 1
and figure I). Participants anticipated that the
growth rate of real gross domestic product
(GDP) wonld increase somewhat in 20]3 and
again in 2014, and that economic growth in
2014 and 2015 wonld exceed their estimates
of the longer-run sustainable rate of growth,
while the unemployment rate would decline
gradually through 2015. Participants projected
that each year's inflation, as measured by the
annual change in the price index for personal
consnmption expenditures (PCE), would run
Table 1. Economic projections of Federal Reserve Board members and Federal Reserve Bank presidents, December 2012
Variable
VerDate Nov 24 2008
Longer
2012
2015
2015
Longer run
Change in rea! GDP ....
September projecti{)n ..
1.7 to 1.8
2.0103.2
2.3103.5
2.2t03.0
3.0 to 3.8
1,6 to 2.0
1.6102.0
2.5 to 4.2
2.5 to 3.0
2.3 t02.5
2.3 ta2.S
2.8 to 4.0
1.7 to 2.0
3.0 to 3.7
3.0to 3.8
2.7104.1
2.5 t04.2
2.2 to 3.0
Unemployment rate ..
September projection, ...
7.8 t07.9
8..0108,2
7.4 to 7.7
7.6 to 7,9
6.8 to 7.3
6.7 to 7.3
6.0 to 6.6
6.0 to 6.8
5.2 106.0
5.2 to 6.0
7.7 t08.0
8.0 to 8.3
6.9to 7.8
7.0108.0
6.1 to 7.4
6.3 to 7,5
5.7 to 6.8
5.010 6.0
5.7t06.9
50to 6.3
peE inflation ..
September projection ...
1.6 to 1.7
1.7 to 1.8
1.3 102,0
L7 to 2.0
2.0
2.0
1.6 to 1.8
Uto 1.9
1.3 to 2.0
1.6 to 2.0
1.5102.0
1.6 to 2,0
1.5 to 2,1
IAto 2.2
1.6to 22
1.5 to 2.2
1.8 to 2.3
2.0
2.0
Core peE inflation 1 ....
L6toU
1,6101.9
1.6to 2.0
1.6 to 1.8
1.5 ta2.0
1.5 t02.0
1.7 to 2,2
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2012
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Percent
114
11
;\\1'
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\ <1;
115
MONETARY POLICY REPORT: FEBRUARY 2013
As shown in figure 2, most participants judged
that highly accommodative monetary policy
was likely to be warranted over the next few
years. In particular, 14 participants thought
that it would be appropriate for the first
increase in the target federal funds rate to
occur during 2015 or later. Most participants
judged that appropriate monetary policy
would include purchasing agency mortgagebacked securities (MBS) and longer-term
Treasury securities after the completion of the
maturity extension program at the end of 2012.
As in September, participants jndged the
uncertainty associated with the outlook
for real activity and the unemployment
rate to be unusually high compared with
historical norms, with the risks weighted
mainly toward slower economic growth
and a higher unemployment rate. While a
number of participants viewed the uncertainty
surrounding their projections for inflation
to be unusually high, more saw the level of
uncertainty to be broadly similar to historical
norms; most considered the risks to inflation
to be roughly balanced.
The Outlook for Economic Activity
Participants judged that the economy grew
at a moderate pace over the second half of
2012 and projected that, conditional on their
individual assumptions about appropriate
monetary policy, the economy would grow
at a somewhat faster pace in 2013 before
expanding in 2014 and 2015 at a rate above
what participants saw as the longer-run rate
of output growth. The central tendency of
their projections for the change in real GOP
in 2012 was 1. 7 to 1.8 percent, slightly lower
than in September. A number of participants
mentioned that last summer's drought and
the effects of Hurricane Sandy likely had held
down economic activity in the second half of
this year. Many participants also noted that,
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while conditions in the housing and labor
markets appeared to have improved recently,
uncertainty about fiscal policy appeared to
be holding back business and household
spending. Participants' projections for 2013
through 2015 were generally little changed
relative to their September projections. The
central tendency of participants' projections
for real GOP growth in 2013 was 2.3 to
3.0 percent, followed hy a central tendency of
3.0 to 3.5 percent for 2014 and one of 3.0 to
3.7 percent for 2015. The central tendency
for the longer-run rate of increase of real
GOP remained 2.3 to 2.5 percent, unchanged
from September. Most participants noted
that the high degree of monetary policy
accommodation assumed in their projections
would help promote the economic recovery
over the forecast period; however, they also
judged that several factors would likely
hold back the pace of economic expansion,
including slower growth abroad, a stillweak housing market, the difficult fiscal
and financial situation in Europe, and fiscal
restraint in the United States.
Participants projected the unemployment
rate for the final quarter of 2012 to be close
to its average level in October and November,
implying a rate somewhat below that projected
in September. Participants anticipated a
gradual decline in the unemployment rate over
the forecast period; even so, they generally
thought that the unemployment rate at the
end of 2015 would still be well above their
individual estimates of its longer-run normal
level. The central tendencies of participants'
forecasts for the unemployment rate were
7.4 to 7.7 percent at the end of 2013, 6.8 to
7.3 percent at the end of 2014, and 6.0 to
6.6 percent at the end of 2015. The central
tendency of participants' estimates of the
longer-run normal rate of unemployment that
would prevail under appropriate monetary
policy and in the absence of further shocks to
the economy was 5.2 to 6.0 percent, unchanged
from September. Most participants projected
that the unemployment rate would converge
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close to or below the FOMe's longer-run
inflation objective of 2 percent.
45
116
f(
"
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H'
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MONETARY POLICY REPORT: FEBRUARY 2013
Figures 3.A and 3.B provide details on the
diversity of participants' views regarding the
likely outcomes for real GDP growth and
the unemployment rate over the next three
years and over the longer run. The dispersion
in these projections reflects differences in
participants' assessments of many factors,
including appropriate monetary policy
and its effects on the economy, the rate
of improvement in the housing sector, the
spillover effects of the fiscal and financial
situation in Europe, the prospective path for
U.S. fiscal policy, the extent of structural
dislocations in the labor market, the likely
evolution of credit and financial market
conditions, and longer-term trends in
productivity and the labor force. With the data
for much of 2012 now in hand, the dispersion
of participants' projections of real GDP
growth and the unemployment rate this year
narrowed compared with their September
submissions. Meanwhile, the distribution
of participants' forecasts for the change in
real GDP in 2013 shifted down a bit, and
that for 2014 narrowed slightly. However, the
range of projections for real GDP growth
in 2015 was little changed from September.
The distributions of the unemployment rate
projections at the end of 2012, 2013, and 2014
all shifted lower, while the range of projections
for the unemployment rate for 2015, at 5.7 to
6.8 percent, remained close to its September
level. The dispersion of estimates for the
longer-run rate of output growth stayed fairly
narrow, with all but one between 2.2 and
2.5 percent. The range of participants'
estimates of the longer-run rate of
unemployment, at 5.0 to 6.0 percent, narrowed
relative to September. This range reflected
different judgments among participants about
several factors, including the outlook for labor
force participation and the structure of the
labor market.
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The Outlook for Inflation
Participants' views on the broad outlook for
inflation under appropriate monetary policy
were little changed from September. Most
anticipated that inflation for 2012 as a whole
would be close to 1.6 percent, somewhat lower
than projected in September. A number of
participants remarked that recent inflation
readings had come in below their expectations.
Almost all of the participants judged that
both headline and core inflation would remain
subdued over the 2013-15 period, running at
rates equal to or below the FOMC's longerrun objective of 2 percent. Specifically, the
central tendency of participants' projections
for inflation, as measured by the PCE price
index, moved down to 1.3 to 2.0 percent for
2013 and was little changed for 2014 and 2015
at 1.5 to 2.0 percent and 1.7 to 2.0 percent,
respectively. The central tendencies of the
forecasts for core inflation were broadly similar
to those for the headline measure for 2013
through 2015. In discussing factors likely to
sustain low inflation, several participants cited
stable inflation expectations and expectations
for continued sizable resource slack.
Figures 3.C and 3.D provide information
about the diversity of participants' views
about the outlook for inflation. The range of
participants' projections for headline inflation
for 2012 narrowed from 1.5 to 1.9 percent
in September to 1.6 to 1.8 percent in
December; nearly all participants' projections
in December were at 1.6 percent or 1.7 percent,
broadly in line with recent inflation readings.
The distributions of participants' projections
for headline inflation in 2013 and 2014 shifted
lower compared with the corresponding
distributions for September, while the range of
projections for core inflation narrowed slightly
for both years. The distributions for core and
overall inflation in 2015 were concentrated
near the Committee's longer-run inflation
objective of 2 percent, although somewhat less
so than in Septem ber.
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to their estimates of its longer-run normal rate
in five or six years, while a few judged that less
time would be needed.
47
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119
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f'C)!ICl
120
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I'\Rl
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,I
11
!h
11
~lt)
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--- S
122
PART 3: SUMMARY OF ECONOMIC PROJECTIONS
Appropriate Monetary Policy
As indicated in figure 2, most participants
judged that exceptionally low levels of the
federal funds rate would remain appropriate
for sevcral more years. In particular,
13 participants thought that the first increase
in the target federal funds rate would not be
warranted until 2015, and 1 judged that policy
firming would likely not be appropriate until
2016 (upper panel). The 13 participants who
expected that the target federal funds rate
would not move above its effective lower
bound until 20 IS thought the federal funds
rate would be I V. percent or lower at the
end of that year, while the 1 participant who
expected that policy firming would commence
in 2016 saw the federal funds rate target at
50 basis points at the end of that year. Five
participants judged that an earlier increase in
the federal funds rate, in 2013 or 2014, would
be most consistent with the Committee's
statutory mandate. Those participants judged
that the appropriate value for the federal funds
rate would range from Y2 to 2% percent at the
end of 2014 and from 2 to 4 1/ , percent at the
end of 2015.
Among the participants who saw a later
tightening of policy, a majority indicated that
they believed it was appropriate to maintain
the current level of the federal funds rate
until the unemployment rate is less than or
equal to 6V, percent. In contrast, a majority
of those who favored an earlier tightening of
policy pointed to concerns about inflation as
a primary reason for expecting that it would
be appropriate to tighten policy sooner.
Participants were about evenly split between
those who judged the appropriate path for the
federal funds rate to be unchanged relative to
September and those who saw the appropriate
path as lower.
Nearly all participants saw the appropriate
target for the federal funds rate at the end of
2015 as still well below its expected longerrun value. Estimates of the longer-run target
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federal funds rate ranged from 3 to 4Y:2 percent,
reflecting the Committee's inflation objective
of 2 percent and participants' judgments about
the longer-run equilibrium level of the real
federal funds rate.
Participants also provided information on
their views regarding the appropriate path
of the Federal Reserve's balance sheet. Most
participants thought it was appropriate for
the Committee to continue purchasing MBS
and longer-term Treasury securities after
completing the maturity extension program
at the end of this year. In their projections,
taking into account the likely benefits and
costs of purchases as well as the expected
evolution of the outlook, these participants
were approximately evenly divided between
those who judged that it would likely be
appropriate for the Committee to complete its
asset purchases sometime around the middle
of 2013 and those who judged that it would
likely be appropriate for the asset purchases
to continue beyond that date. In contrast,
several participants believed the Committee
would best foster its dual objectives by ending
its purchases of Treasnry securities or all of
its asset purchases at the end of this year
when the maturity extension program was
completed.
Key factors informing participants'
views of the economic outlook and the
appropriate setting for monetary policy
include their judgments regarding labor
market conditions that would be consistent
with maximum employment, the extent to
which employment currently deviated from
maximum employment, the extent to which
projected inflation over the medium term
deviated from the Committee's longer-term
objective of 2 percent, and participants'
projections of the likely time horizon necessary
to return employment and inflation to
mandate-consistent levels. Many participants
mentioned economic thresholds based on the
unemployment rate and the inflation outlook
that were consistent with their judgments
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52
123
53
MONfTARY POLICY REPORT: FEBRUARY 20]3
Figure 3.E details the distribution of
participants' judgments regarding the
appropriate level of the target federal funds
rate at the end of each calendar year from
2012 to 2015 and over the longer run. As
previously noted, most participants judged
that economic conditions would warrant
maintaining the current low level of the
federal funds rate until 2015. Views on the
appropriate level of the federal funds rate by
the end of 2015 varied, with 12 participants
seeing the appropriate level of the federal
funds rate as 1 percent or lower and 4 of them
seeing the appropriate level as 2V, percent or
higher. Generally, the participants who judged
that a longer period of very accommodative
monetary policy would be appropriate were
those who projected that a sizable gap between
the unemployment rate and the longer-run
normal level of the unemployment rate would
persist until 2015 or later. In contrast, the
majority of the 5 participants who judged that
policy firming should begin in 2013 or 2014
indicated that the Committee would need to
act relatively soon in order to keep inflation
near the FOMe's longer-run objective of
2 percent and to prevent a rise in inflation
expectations.
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Table 2. Average historical projection error ranges
Percentage points
Variable
2012
2015
±1.7
Change in real GDPl.
±O.6
Unemployment rate l
iO.2
±O.9
±1.5
±1.9
Tolal consumer prices) ..
±O.S
±O.9
±1.1
1-1.0
Error ranges shown arc measured as plus or minus tbe root
mean squared error of projections for 1992 through 201! that were
released in the fall by various private and government forecasters. As
described in tbe box "Forecast Uncertainty," under certain assumptions.
there is about a 70 percent probability that actual outcomes fllf real GDI>,
unemployment, and consumer prices will be in ranges implied by the
average size of projection errors made in the past. Further information
may be found in David Reifschneider and Peter Tulip (2007), "Gauging
the Uncertainty of the Economic Outlook from Historical Forecasting
Errors," Finance and Economics Discussion Series 2007-60 (Washington:
Board of Govemors of the Federal Reserve System, November).
L Definitions of wriablcs are in the general note to table L
2. Measure is the overall consumer price index, the price measure that
has been most widely used in government and private economic forecasts
Projection is percent change. fourth quarter of the previous year to the
fourth quarter of the year indicated.
:--JOTE:
Uncertainty and Risks
Nearly all of the participants judged their
current levels of uncertainty about real GDP
growth and unemployment to be higher than
was the norm during the previous 20 years
(figure 4).' Seven participants judged that the
levels of uncertainty associated with their
forecasts of total PCE inflation were higher
as well, while another 10 participants viewed
uncertainty about inflation as broadly similar
to historical norms. The main factors cited
as contributing to the elevated uncertainty
ahout economic outcomes were the difficulties
involved in predicting fiscal policy in the
United States, the continuing potential for
European developments to threaten financial
stability, and the possibility of a general
slowdown in global economic growth. As in
September, participants noted the challenges
associated with forecasting the path of the
1. Table 2 provides estimates of the forecast
uncertainty for the change in real GDP, the
unemployment rate, and total consumer price inflation
over the period from 1992 through 2011. At the end
of this summary, the box "Forecast Uncertainty"
discusses the sources and interpretation of uncertainty
in the economic forecasts and explains the approach
used to assess the uncertainty and risks attending the
participants' projections,
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of when it would be appropriate to consider
beginning to raise the federal funds rate.
A couple of participants noted that their
assessments of the appropriate path for the
federal funds rate took into account the
likelihood that the neutral level of the federal
funds rate was somewhat below its historical
norm. There was some concern expressed that
a protracted period of very accommodative
monetary policy could lead to imbalances in
the financial system. It was also noted that
because the appropriate stance of monetary
policy is conditional on the evolution of real
activity and inflation over time, assessments
of the appropriate future path of the federal
funds rate and the balance sheet could change
if economic conditions were to evolve in an
unexpected manner.
124
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125
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12
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-
126
PART 3: SUMMARY OF ECONOMIC PROJECTIONS
u.s. economic recovery following a financial
crisis and recession that differed markedly
from recent historical experience. A number
of participants also commented that in the
aftermath of the financial crisis, they were
more uncertain about the level of potential
output and its rate of growth. It was noted
that some of the uncertainty about potential
output arose from the risk that a continuation
of elevated levels of long-term unemployment
might impair the skills of the affected
individuals or cause some of them to drop out
of the labor force, thereby reducing potential
output iu the medium term.
A majority of participants reported that they
saw the risks to their forecasts of real GDP
growth as weighted toward the downside and,
accordingly, the risks to their projections
of the unemployment rate as tilted to the
upside. The most frequently identified sources
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of risk were US. fiscal policy, which many
participants thought had the potential to slow
economic activity significantly over the near
term, and the situation in Europe.
Most participants continued to judge the risks
to their projections for inflation as broadly
balanced, with several highlighting the recent
stability of longer-term inflation expectations.
However, three participants saw the risks to
inflation as tilted to the downside, reflecting,
for example, risks of disinflation that could
arise from adverse shocks to the economy that
policy would have limited scope to offset. A
couple of participants saw the risks to inflation
as weighted to the upside in light of concerns
about US. fiscal imbalances, the current highly
accommodative stance of monetary policy,
and uncertainty about the Committee's ability
to shift to a less accommodative policy stance
when it becomes appropriate to do so.
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56
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MONETARY POliCY REPORT: FEBRUARY 2013
57
Forecast Uncertainty
presidents of the Federal Reserve Banks inform
discussions of monetary policy among policymakers
and can aid public understanding of the basis for
policy actions. Considerable uncertainty attends
these projections, however. The economic and
statistical models and relationships used to help
produce economic forecasts are necessarily
imperfect descriptions of the real world, and the
future path of the economy can be affected by
myriad unforeseen developments and events. Thus,
in setting the stance of monetary policy, participants
consider not only what appears to be the most likely
economic outcome as embodied in their projections,
but also the range of alternative possibilities, the
likelihood of their occurring, and the potential costs
to the economy should they occur,
Table 2 summarizes the average historical
accuracy of a range of forecasts, including those
reported in past Monetary Policy Reports and those
prepared by the Federal Reserve Board's staff in
advance of meetings of the Federal Open Market
Committee, The projection error ranges shown in
the table illustrate the considerable uncertainty
associated with economic forecasts, For example,
suppose a participant projects that rea! gross
domestic product (CDP) and total consumer prices
will rise steadily at annual rates of, respectively,
3 percent and 2 percent. If the uncertainty attending
those projections is similar to that experienced in
the past and the risks around the projections are
broadly balanced, the numbers reported in table 2
would imply a probability of about 70 percent that
actual CDP would expand within a range of 2.4 to
3,6 percent in the current year, 1,6 to 4.4 percent in
the second year, and 1.3 to 4.7 percent in the third
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and fourth years, 'Ihe corresponding 70 percent
confidence intervals for overall inflation would
be 1.5 to 2,5 percent in the current year, 1,1 to
2.9 percent in the second year, 0,9 to 3.1 percent in
the third year, and 1,0 to 3,0 percent in the fourth
year.
Because current conditions may differ from
those that prevailed, on average, over history,
participants provide judgments as 10 whether the
uncertainty attached to their projections of each
variable is greater than, smaller than, or broadly
similar to typical levels of forecast uncertainty
in the past, as shown in table 2, Participants also
provide judgments as to whether the risks to their
projections are weighted to the upside, are weighted
to the downside, or are broadly balanced. That is,
participants judge whether each variable is more
likely to be above or below their projections of the
most likely outcome, These judgments about the
uncertainty and the risks attending each participant's
projections are distinct from the diversity of
participants' views about the most likely outcomes.
Forecast uncertainty is concerned with the risks
associated with a particular projection rather than
with divergences across a number of different
projections.
As with real activity and inflation, the outlook
for the future path of the federal funds rate is subject
to considerable uncertainty. This uncertainty arises
primarily because each participant's assessment of
the appropriate stance of monetary policy depends
importantly on the evolution of real activity and
inflation over time, If economic conditions evolve
in an unexpected manner, then assessments of the
appropriate setting of the federal funds rate would
change from that point forward.
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The economic projections provided by the
members of the Board of Governors and the
128
59
VerDate Nov 24 2008
ABCP
asset -backed commercial paper
AFE
advanced foreign economy
BHC
bank holding company
CDS
credit default swaps
C&I
commercial and industrial
CMBS
commercial mortgage-backed securities
CP
commercial paper
CRE
commercial real estate
DPI
disposable personal income
ECB
European Central Bank
EME
emerging market economy
E&S
equipment and software
FOMC
Federal Open Market Committee; also, the Committee
GDP
gross domestic product
MBS
mortgage-backed securities
MEP
maturity extension program
MMF
money market fund
NIPA
national income and product accounts
OMT
Outright Monetary Transactions
PCE
personal consumption expenditures
REIT
real estate investment trust
repo
repurchase agreement
SEP
Summary of Economic Projections
SLOOS
Senior Loan Officer Opinion Survey on Bank Lending Practices
S&P
Standard and Poor's
TALF
Term Asset-Backed Securities Loan Facility
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ABBREVIATIONS
129
Questions for The Honorable Ben S. Bernanke, Chairman, Board of Governors of the
Federal Reserve System, from Representative Bachus:
1. During consideration of Dodd-Frank, one of the few bi-partisan amendments adopted
states that in the case of foreign financial companies nnder section 165, that the Federal
Reserve Board was required to "take into account the extent to which the foreign financial
company is subject on a consolidated basis in the US." In proposing your recent section
165 rule for foreign banks, press reports indicate that there are over 100 foreign banks
covered. With that in mind -a. How many countries are covered by these 100+ foreign banking organizations?
The standards in section 165 generally apply to foreign banking organizations that have a U.S.
banking presence and total consolidated assets of $50 billion or more. There are foreign banking
organizations operating in the United States from 33 countries in this category.
The standards in section 165 related to stress tests apply to foreign banking organizations with a
U.S. banking presence and total consolidated assets of more than $10 billion. Including the
foreign banking organizations described above, there are foreign banking organizations operating
in the United States from 46 countries that have total consolidated assets of more than
$10 billion.
b. Did you perform the required Dodd-Frank comparability analysis of the home country
standards for each of these countries as they are heing applied to firms on a consolidated
basis?
The Board has not yet taken final action on its proposal regarding the US operations of foreign
banking Qrganizations and continues to evaluate the issues and comments raised by that proposal.
The Board's proposal recognizes that home country supervisors impose standards on foreign
banks. For example, the proposal does not impose capital requirements on branches or agencies
of a foreign bank; rather, it looks to whether the foreign bank meets capital adequacy standards
at the consolidated level that are consistent with Basel capital adequacy standards. In addition,
the proposed risk management standards would provide flexibility for foreign banking
organizations to rely on home country governance structures, and would allow foreign banking
organizations to meet proposed stress testing requirements for branches and agencies at the
consolidated level (provided the home country maintains stress testing requirements that are
broadly consistent with U.S. requirements).
With respect to most other enhanced prudential standards that the Board is required by statute to
impose (e.g., liquidity requirements, single-counterparty credit limits, overall risk management,
stress testing, and early remediation), international standards have either not yet been adopted in
national jurisdictions or are not yet fully developed. As a result, international requirements vary
widely.
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Finally, it is important to note that section 165 requires the Board to consider risks to financial
stability and the principle of national treatment, in balance with the comparability of home
130
-2-
country standards. The proposal is designed to mitigate risks to financial stability posed by large
foreign banks by adjusting the Board's current regulatory approach to address the increased
complexity and risk profile of the U.S. operations of these foreign banks. The proposal gives
due regard to the principle of national treatment by proposing standards for large foreign banks
that are broadly consistent with those proposed for U.S. banking organizations under 165, such
that U.S. banking organizations are not put at a competitive disadvantage.
The Board is carefully weighing the comments that it has received on this proposal as well as the
effects of the proposal on financial stability and the principles of competitive equality and
national treatment in the United States.
c. If so, can you provide the Committee your country by country analysis including an
identification of gaps where individual home country regulations fell short of US or global
standards? If such an analysis was not done, can you explain why it was not given the
express direction in Dodd-Frank?
The Dodd-Frank Act requires the Board to take into account the extent to which a foreign
financial company is subject on a consolidated basis to home country standards that are
comparable to those applied to financial companies in the United States. Please see the answer
for question 1 part b.
2. Many of the foreign banking organizations covered by your 165 rule do not own an
insured bank and only operate in the US via a broker-dealer.
a. In establishing capital and other standards for these firms, did the Fed staff consult with
the SEC technical staff on a bilateral basis?
Yes. Federal Reserve staff consulted with SEC staff, as well as staff of the other FSOC member
agencies, prior to issuing the proposal.
b. Did the SEC indicate to the Fed that they believe that current broker-dealer capital or
other standards are inadequate?
SEC and Fed staff did not discuss the adequacy of current broker-dealer capital regulations or
other standards.
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c. Section 165(b)(3) of Dodd-Frank says that in prescribiug these standards, the Fed
should also take into account whether a foreign bank owns an insured bank as well as
whether it has another primary regulator. Did you take either ofthese factors in to
account when evaluating the situation of foreign bank not owning an insured bank &
engaged in primarily broker-dealer operations that are regulated by the SEC? If not, why
not?
131
-3In proposing the standards, the Board considered the extent to which foreign banking
organizations own U.S. insured depository institutions and adjusted the proposal to take into
account the different types of banking operations a foreign banking organization might have in
the United States. In order to be subject to the proposal, a foreign bank must have a banking
presence in the United States--either through ownership of an insured depository institution or
through operation ofU.8. branches or agencies. A foreign bank that has a banking presence
through a U.S. branch or agency (in lieu of or in addition to operating an insured depository
institution) would be permitted to continue to operate the branch or agency outside of the
intermediate holding company, and the branch or agency would generally be permitted to
continue to meet capital levels at the consolidated level as set by the foreign supervisor of the
foreign bank.
The Board also considered the extent to which the U.S. operations of a foreign banking
organization are regulated by the SEC. As noted above, the proposal would not apply
requirements to individual broker-dealer subsidiaries. The proposal would apply requirements to
the consolidated U.S. intermediate holding company of a foreign banking organization, in line
with the Federal Reserve's responsibility to supervise and regulate the overall U.S. operations of
foreign banking organizations.
3. In recent discussions with EU representatives, it has been stated that the EU was
completely blindsided by the 165 proposal.
a. Can you identify which international regulators the Fed consulted with in formulating
this proposal?
Board members and staff have met with numerous foreign regulators to discuss the details of and
concems about the proposaL The Board has also received a number of written comments from
foreign regulators. Consistent with past practice, the Board has provided a long comment period
on this proposal, which has allowed all members of the public, including foreign bank regulators,
an opportunity to provide detailed feedback on the proposaL The Board will carefully consider
all comments received during the public comment period, including those received from foreign
regulators, prior to fmalizing all rules.
b. Do these foreign regulators believe that their home country standards are not
comparable to US standards or are otherwise inadequate?
We have received comments from a number of foreign regulators. These regulators have
encouraged the Federal Reserve to place greater emphasis on the comparability of their standards
in the U.S. rules.
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c. Do you believe that implementation of the Fed's regime will lead to enhanced or
diminished cooperation between intcrnational regulators?
132
-4-
The Federal Reserve works hard to foster cooperation between international regulators, and
actively participates in international efforts to improve cooperation among supervisors around
the world. As a general matter, supervisors around the world have responded to the lessons
learned in the latest financial crisis by improving the supervisory and regulatory standards that
apply to their banking organizations. We have been working with our international counterparts
to develop common approaches to increasing the financial strength of our respective financial
organizations and the financial stability of our respective economies. While these efforts often
lead to unified approaches, such as the Basel III capital framework, it is also true that countries
move at different paces and develop supplemental solutions that are tailored to the unique legal
framework, regulatory system, and industry structure in each country. For example, the United
States has long been one of the only countries that applies a leverage ratio to its banking
organizations, and the United States has long had different activity restrictions for banking firms
than exist in other countries.
Further, Basel agreements allow host jurisdictions to apply their prudential requirements to
locally incorporated subsidiaries offoreign banking organizations. As a result, U.S. banking
organizations already operate in a number of overseas markets that apply Basel risk-based capital
requirements to their local commercial banking and investment banking activities. In addition,
the U.K., which is host to substantial operations of U.S. banking organizations, applies local
liquidity standards to commercial banking and investment banking subsidiaries of non-U.K.
banks operating in their market.
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As regulatory and supervisory standards are implemented throughout the world, we and our
international supervisory colleagues will gain further insight into which approaches are most
effective in improving the resilience of banking organizations and in protecting financial
stability, and we will take further action as appropriate.
133
Questions for The Honorable Ben S. Bernanke, Chairman, Board of Governors of the
Federal Reserve System, from Representative Fitzpatrick:
1. Since the Fed has embarked on, and has continued, a bond-buying program to maintain
economic stimulus, what is a prospective sale strategy for the acquired positions? The
sheer magnitude of the "Q-finity" purchases in the multi-billions of dollars leaves open
possibility of market destabilization on the un-winding of these positions. Is there a
strategy of holding positions until maturities? Or have target prices been set to assure that
global bond markets are minimally affected upon any future Fed sales prior to maturity?
How will the Fed maintain fixed-income market confidence so that access consumer credit
at reasonable prices is assured?
In the minutes to the June 2011 FOMC meeting, the Committee elaborated a strategy for the
eventual nonnalization of the stance of monetary policy when tinning the stance of monetary
policy once such a change is judged to be appropriate. In that strategy, the FOMC noted that it
will primarily rely on changes to the FOMC's target for the federal funds rate as the tool for
managing monetary policy.
The Committee also noted that it intended to use the payment of interest on reserves as the key
instrument to ensure that the federal funds rate and other money market rates remain close to the
target. The FOMC noted that it would likely use reserve draining tools to support the payment
interest on reserves as a tool, as necessary.
The minutes from that meeting also noted that the FOMC has considered selling its holdings of
mortgage-backed securities (MBS) after the target for the federal funds rate has been increased.
Any such sales would be gradual and arrnounced well in advance so as to minimize their effects
on financial market conditions.
The Committee noted, however, that it might change its strategy for the nonnalization of
monetary policy if there were changes in economic or fmancial market conditions. At the press
conference following the June 2013 FOMC meeting, I reported that there was general agreement
among FOMC participants that sales ofMBS would not be necessary for the finning of the
stance of monetary policy and the sales could possibly cause some deterioration in market
functioning. As a result the sales of MBS during the nonnalization of policy would be unlikely,
although once monetary policy has been nonnalized, some sales to eliminate residual holdings of
MBS might be possible.
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2. As credit has been eased to provide stimulus in this and other Fed actions, there are
inherent resulting inflationary pressures which may force a Fed response of higher shortterm interest rates. Inflationary signals also trigger bond price changes farther out on the
duration and maturity curves. Has the Fed boxed itself in by buying longer bonds whose
prices would decline due to anticipated inflation prospects (leading to higher interest rates),
leaving a less valuable asset portfolio providing less collateral value for Fed strategic
purposes in coming years?
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Price stability is one of the FOMe's two statutory mandates; maximum employment is the other.
The FOMC has interpreted price stability by setting a longer-mn objective for inflation of2
percent, based on the price index for personal consumption expenditures.
Currently, inflation is below the FOMe's target of2 percent, and the FOMC anticipates that
inflation will run at or slightly below its target over the medium term. The FOMC anticipates
that longer-term interest rates will rise over time as the economy recovers and it eventually
moves to normalize the stance of monetary policy. A consequence of those higher longer-term
interest rates will be a reduction in the market value of the fixed income securities in the
FOMC's portfolio. As of the end of May, the portfolio was in an unrealized gain position of just
under $200 billion.
Federal Reserve accounting only realizes gains or losses when securities are sold, and those
gains or losses would directly affect Federal Reserve income. Umealized gains or losses do not
have a direct effect on Federal Reserve income. In neither case would losses affect Federal
Reserve actions or the conduct of monetary policy.
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In particular, the FOMC has stated that it intends to use increases in the target for the federal
funds rate as its primary means of firming the stance of policy when it judges that such a change
in policy is appropriate. The FOMC has also noted that it intends to rely on the interest rate on
excess reserves as well as temporary reserve draining tools to ensure that the federal funds rate
and other money market rates remain near the target We are confident that we have the tools we
need to tighten policy when it becomes appropriate to do so. The market value of the FOMC's
portfolio will not have a direct effect on the conduct of monetary policy.
135
Questions for The Honorable Ben S. Bernanke, Chairman, Board of Governors of the
Federal Reserve System, from Representative Garrett:
1. Many countries peg their currencies to the U.S. dollar and therefore have to follow the
direction of U.S. monetary policy. Have Fed actions created global imbalances that we are
not fully appreciating when we examine the costs of our current loose monetary policy?
One of the effects of this policy is that world has been flooded with dollars, and some
foreign central banks have responded by depreciating their currencies relative to the
dollar. What has been the practical effect of the QE regime on the exchange rate of the
dollar? To what extent is the Fed concerned that exporting its easy money policy to the
rest of the world could lead to a potentially destabilizing effect on world currencies?
There are actually only a few countries that literally "peg their currencies to the dollar."
Exchange rates of most advanced economies are largely market-determined, and even among
emerging market economies, exchange rates have become more flexible over the last several
decades. Of course, some countries, including China, still maintain highly managed exchange
rates relative to the dollar.
The Federal Reserve's accommodative monetary policy is focused on easing domestic financial
conditions with the goal of stimulating spending by U.S. households and firms. Any effects of
this policy on the foreign exchange value of the dollar are ancillary and probably relatively
modest, as monetary policy in many of our trading partners has also been eased in response to
weak recoveries and high unemployment. All told, the average value of the dollar against the
currencies of our trading partners, in price-adj usted terms, is at about the same level as it was in
mid-2008, before the global financial crisis intensified. To be sure, the dollar has fluctuated over
this period, but its swings likely owe more to factors such as shifts in investor risk aversion than
to shifts in monetary policies here or abroad.
2. In addition, are you concerned that the Fed's easy money stance could be resulting in
"hot flows" of capital to emerging markets, ultimately creating greater financial instability
both domestically and abroad? What are the choices faced by emerging market economies
when faced with "hot flows" of U.S. dollars?
While many economies have challenges in a world of volatile international capital flows, it is not
clear that accommodative policies in advanced economies impose net costs on emerging market
economies ("EMEs").
To be sure, accommodative monetary policies in advanced economies such as the United States
tend to reduce their interest rates relative to those of EMEs and thus encourage private capital
flows to EMEs. But the evidence does not support the view that advanced-economy monetary
policies are the dominant factor behind emerging market capital flows. In recent years, the
relatively favorable economic growth prospects of the EMEs likely have been a major factor
behind these flows. And, over the past few years, swings in international investor sentiment
have also led to corresponding swings in EME capital flows.
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In addition, the effects of capital flows, whatever their cause, are not predetermined but depend
on the choices made by policymakers in the recipient countries. Allowing more flexible
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exchange rates can both diminish these inflows, by damping expectations of future currency
appreciation, and help to mitigate the effects of capital inflows on domestic financial conditions.
In contrast, systematically resisting pressures for exchange rate appreciation through exchange
market intervention can result in more unwanted capital flows, possibly fueling domestic
inflation in economies already near over-heating.
Finally, the Federal Reserve's accommodative policies confer real benefits on other countries.
Economic growth in emerging market economies slowed last year, in part reflecting a
deterioration of their exports to the United States and other advanced economies. Monetary
easing that supports the U.S. and other advanced economies should stimulate trade and growth in
the emerging economies as well.
3. I am growing increasingly concerned about the very real effects of the Fed's loose
monetary policy. Since December 2008, the FOMe has held the Fed Funds rate at the zero
bound, and these low rates have been chased with three rounds of quantitative easing and
as well as "Operation Twist." As we look broadly at the financial markets, these low rates
are forcing financial institutions to chase higher yields. For example, companies are
issuing records amount of junk bonds as well as riskier covenant-lite corporate loans. Last
year, we saw some $274 billion worth of junk bonds issued, representing a 55 percent
increase from the prior year, and seven-fold increase in covenant-lite corporate loan
volume since 2010. We have seen some financial market participants, such as Pimeo, warn
that valuations on some of these asset classes are extreme. Fed Reserve Governor Jeremy
Stein has stated, "we should be humble about our ability to see the whole picture, and
should interpret those cIues that we do see accordingly." How do you interpret these clues?
How has the Fed's easy money policy driven these asset bubbles? At what point will the
Fed know to put on the brakes and raise interest rates?
The staff at the Federal Reserve Board carefully monitors financial markets for signs of valuation
and other pressures. In addition, as noted in my speech on financial monitoring on May 10, staff
also consider whether assets that appear to be subject to pressures are being funded with
dangerously high degrees of financial leverage or through structures resulting in potentially
destabilizing levels of maturity transformations, as well as whether such assets are significantly
illiquid or sensitive to changes in financial conditions. The presence of these financial-system
vulnerabilities are essential for making a determination that adjustments in asset prices could be
amplified by asset fire sales and other coordination problems with consequent adverse effects on
the financial system. For example, the absence of high levels ofleverage helps to explain why
the sizeable losses in the stock market in 2000 and 2001 had a far smaller impact on broader
financial markets than the collapse of housing prices and prices of mortgage-related assets in
2008, which spurred a systemic crisis.
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With respect to the high-yield and leveraged loan markets, we are aware of the pressures
highlighted in your letter and will continue to monitor very carefully these and other financial
market developments. If an assessment is made that financial system vulnerabilities are
significant, the first line of defense, as noted in my May speech, will be the development of
137
-3macroprudential policy tools. Monetary policy, as you know, continues to be governed by the
dual mandate of maximum employment and price stability.
4. You have said that the Fed's mouetary policy actious earlier this decade (i.e. 2003-2005)
did not contribute to the housiug bubble iu the U.S. But as I uuderstand it, you are now
using monetary policy actions, particnlarly your QE program, to boost U.S. asset prices
(for example, equities and real estate prices). How can both of these things be true?
During 2003, the FOMe lowered the target federal funds rate to 1 percent, in the context of
persistently elevated unemployment and undesirably low readings on core inflation. Over the
next several years, monetary policy gradually tightened as the labor market strengthened and
inflation moved up. These policy responses were consistent with the Federal Reserve's mandate
to pursue maximum sustainable employment in the context of price stability. Over the same
period, unfortunately, house prices in the United States became unmoored from their long-run
fundamentals, primarily as a result of poor mortgage underwriting standards that allowed too
many unqualified borrowers to obtain credit on terms that, ultimately, they could not sustain. In
hindsight, better prudential supervision of mortgage lending and fmancial institutions more
broadly might have been able to check the housing bubble, and thus the severe fallout from its
collapse starting in 2008. Such a supervisory action would have been targeted on the source of
the housing bubble (excessive mortgage lending) without having an unduly adverse effect on the
rest of the economy. In contrast, if the FOMe had tried to prevent the housing bubble tluough
tighter monetary policy, the Federal Reserve would likely have caused a marked weakening in
overall economic activity and employment and pushed inflation down to an undesirable level
during the 2003 to 2007 period, especially as it probably would have taken a large increase in
interest rates to materially check the rise in house prices.
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Today, we are in a situation in which the real economy is persistently weak, the unemployment
rate remains well above its normal level, and inflation is running below the FOMC's long-run
goal of2 percent. Under such circumstances, it is appropriate that the FOMe pursue a highly
accommodative monetary policy intended to lower borrowing costs and improve financial
conditions more generally, including higher corporate equity prices; these improvements in
financial market conditions should in tum help to support the economic recovery and bring
inflation closer to its desired level. This general strategy is the same as that followed during
previous economic downturns, and asset purchases simply represent an additional tool to put
further downward pressure on long-term interest rates. As you note, the FOMe's current policy
does indeed appear to be strengthening the housing market and helping to boost house prices.
This development is not undesirable, however, because mortgage underwriting standards are
tight, access to mortgage credit is limited, and house prices are, if anything, lower than
fundamentals might suggest. Similarly, corporate equities do not appear overvalued despite their
significant rise over the past few years because firms are enjoying a high level of profitability.
That said, the Federal Reserve is diligently monitoring financial market developments for any
signs of emerging imbalances, and will use all its tools as necessary to preserve the stability of
the financial system while carrying out its dual-mandate responsibilities.
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S. You're undoubtedly familiar with Milton Friedman's work, indicating that people
consume off of what they view as their "permanent income," not just on changes in the
value of volatile financial assets like stock prices. Economists are well aware that even a
1 % change in the value of the stock market has historically affected Gnp growth by only a
few hundreds of 1%. Given how much you and other Fed governors point to elevated stock
prices as an indicator of the effectiveness of quantitative easing, why do you think that the
benefits to the economy outweigh the risk of creating excessive speculation-particularly
because the Fed has repeatedly contributed to speculation that has ended very badly over
the past decade?
The Federal Reserve's purchases oflonger-term assets boost equity prices by reducing the
interest rates investors use to discount future dividends and increasing expected future dividends
as a result of stronger economic activity. Such gains in equity prices reflect shifts in
fundamentals, not speculation. While, as you note, the resulting increase in household
consumption owing directly to higher stock market wealth is likely modest, the asset purchases
increase economic activity through a variety of channels and the combined effect on economic
activity is considerable.
At the same time, one of the potential costs of assets purchases is that they will contribute to
financial instability, perhaps by encouraging investors to take on risks that they do not fully
understand or by engendering increases in asset prices that are not supported by fundaments and
could be quickly reversed in a destabilizing manner. We are closely monitoring these risks but
currently do not judge there to be any widespread undesirable increase in risk taking or
misalignment of asset prices with fundamentals.
6. As oflast week, the U.S. monetary base has grown to more than 18 cents per dollar of
nominal Gnp. The only other time the monetary base got even to 17 cents per dollar of
Gnp was in the 1940's during World War II. The Federal Reserve didn't reserve that.
Instead, consumer prices shot up 80% by 1952. Given that restoring even 2% Treasury
bill rates would require cutting the Fed's balance sheet in half, why are you convinced that
continuing to expand the monetary base has less risk to the economy that the historic
monetary tightening that would be required if the Federal Reserve ever - ever - has to go
in the opposite direction?
The growth in the monetary base in recent years reflects the Federal Reserve's large-scale asset
purchase programs. As the portfolio of assets held by the Federal Reserve increases, reserve
balances, which are included in the monetary base and are a liability of the Federal Reserve, have
risen by roughly the same amount. The growth in reserve balances is a byproduct, not the
objective, of the asset purchases. The Federal Reserve's asset purchases are designed to lower
longer-term interest rates by reducing the supply ofionger-term assets in private hands. The
lower longer-term interest rates stimulate economic activity, improving the employment situation
and reducing disinflationary pressures.
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When the Federal Reserve concludes that it is appropriate to tighten monetary policy to maintain
full employment and stable prices, it will do so primarily by raising the interest rate paid on
139
-5reserve balances, which will put upward pressure on other short term interest rates, reducing the
amount of monetary stimulus. The Federal Reserve could also engage in temporary reserve
draining operations if needed to tighten the relationship between money market interest rates and
the interest rate on reserve balances.
Because the Federal Reserve has the tools necessary to tighten policy when appropriate, the risk
that the Federal Reserve would be unable in the future to prevent an unwanted rise in inflation is
low. By contrast, if the Federal Reserve were to refrain from taking necessary steps now to
stimulate the economy at a time when the unemployment rate is elevated and inflation is below
the FOMC's target, the risks of a pernicious disinflation would be significant.
7. As oflast week, the Federal Reserve's consolidated balance sheet indicated that the
Federal Reserve has capital of less than $55 billion, but assets of more than $3 trillion,
mostly in long-term bonds. This puts the Fed at a leverage ratio of nearly 55-to-1. Now,
assuming that the average maturity of those bonds is more than a few years, it only takes
an increase in interest rates of about one-quarter of one percent to wipe out $55 billion in
capital. What would be the effect of an increase in interest rates on the Fed's balance sheet
and how would that affect Fed remittances back to the Treasury?
Reserve Bank capital is not analogous to the capital of private-sector financial firms. Under the
Federal Reserve Act, member banks are statutorily required to subscribe to Reserve Bank capital
in direct proportion to the member banks' capital. The Reserve Banks retain earnings to create a
surplus capital account that is equal to the capital paid in by the member banks. Reserve Bank
capital does not confer control in the way that private-sector capital does.
Reserve Bank capital also differs from private-sector capital in the event of a loss. In the event
that Reserve Bank income is insufficient to cover interest expense, operating costs, and any loss
that may occur, remittances to the Treasury cease. Remittances do not resume until such a time
that Reserve Bank earnings are sufficient cover interest expense, operating costs, and any losses
that have been incurred. The value of those suspended outlays is booked as a deferred asset.
Because the Reserve Banks are able to take account of future earnings, Reserve Bank capital
does not fall in the event of a loss.
Because Reserve Bank capital differs fundamentally from private-sector capital, conventional
measures ofleverage are not applicable.
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8. As you are aware, the Financial Stability Oversight Council (FSOC) will convene its
next regularly scheduled meeting on Thursday, February 28, 2013. Along with many
others, I am very concerned about the transparency of FSOC. I know that you aware that
the Government Accountability Office (GAO) issued a report last September that clarified
concerns that many of us on the Committee have with respect to FSOC transparency.
Specifically, the GAO noted that FSOC needs to create a better system of coordination
between disparate agencies, keep records of closed-door meetings, share more information
with the public, as well as engage outside stakeholders. The GAO also expressed concerns
of the Office of Financial Research, the organization dedicated to producing financial data
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that can be used to gauge risk. As Chairman of an organization that has faced similar
criticisms in the past regarding transparency, what do you believe that FSOC can do to
improve its transparency, especially given FSOC's authority to designate financial
institutions as "too-big-to-fail"?
The Financial Stability Oversight Council ("Council") is firmly committed to promoting
transparency and accountability in connection with its activities. In November 2012, the Council
and the Office of Financial Research jointly provided a response to Congress and the GAO with
a description of the actions planned and taken in response to each of the recommendations in the
report. The report made a number of constructive recommendations on ways in which the
Council could further enhance its transparency, including improving the Council's website.
Subsequently, the Council's website was reintroduced, in December 2012, to improve
transparency and usability, to improve access to Council documents, and to allow users to
receive e-mail updates when new content is added. The Council is firmly committed to holding
open meetings and closes its meetings only when necessary. However, the Council must
continue to find the appropriate balance between its responsibility to be transparent and its
central mission to monitor emerging threats to the financial system. Council members frequently
discuss supervisory and other market-sensitive data during Council meetings, including
information about individual firms, transactions, and markets that require confidentiality. In
many instances, regulators or firms themselves provide nonpublic information that is discussed
by the Council. Continued protection of this information, even after a period oftime, is often
necessary to prevent destabilizing market speculation or other adverse consequences that could
occur if that information were to be disclosed.
9. On a recent member delegation trip, I visited Germany's central bank-the Budesbank.
As you are aware, historically, the Budesbank has been regarded for its model
independence. Under its charter, the Budesbank does not undertake a supervisory
function, as the Fed does, and its Chairman can only serve one term. Under Dodd-Frank,
the Fed has become a monolithic regulator, and I believe that this policymakiugfregulatory
role stands in clear conflict with the Federal Reserve's function in setting monetary policy.
Simply put, the Fed has its hands in far too many pots. You could fairly say that the Fed
now has not a dual mandate, but a triple mandate given its beefed-up supervisory role.
How many mandates are too many? How can you ensure that Fed's various functions do
not conflict?
Like many other central banks around the world, the Federal Reserve participates with other
agencies in supervising and regulating the banking system. The Federal Reserve's involvement
in supervision and regulation confers two broad sets of benefits to the country.
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First, the financial crisis has made clear that an effective framework for fmancial supervision and
regulation must address both safety-and-soundness risks at individual institutions and
macroprudential risks--that is, risks to the financial system as a whole. All individual fmancial
institutions that are so large and interconnected that their failure could threaten the functioning of
the fmancial system must be subject to strong consolidated supervision. Both effective
consolidated supervision and addressing macroprudential risks require a deep expertise in the
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areas of macroeconomic forecasting, financial markets, and payments systems. As a result of its
central banking responsibilities, the Federal Reserve possesses expertise in those areas that is
unmatched in government and that would be difficult and costly for another agency to replicate.
Second, the Federal Reserve's participation in the oversight of the banking system significantly
improves its ability to carry out its central banking functions. Most importantly, the Federal
Reserve's ability to effectively address actual and potential financial crises depends critically on
the information, expertise, and powers that it gains by virtue of being both a bank supervisor and
a central bank. In addition, supervisory information and expertise significantly enhance the
safety and soundness of the credit the Federal Reserve provides to depository institutions by
allowing the Federal Reserve to independently evaluate the financial condition of institutions that
want to borrow from the discount window as well as the quality and value of the collateral
pledged by such institutions. Finally, its supervisory activities provide the Federal Reserve
information about the current state of the economy and the financial system that, particularly
during periods of financial crisis, is valuable in aiding the Federal Reserve to determine the
appropriate stance of monetary policy. These benefits of the Federal Reserve's supervisory role
proved particularly important during the financial crisis that emerged in 2007.
In addition, international developments suggest that a central-bank role in supervision can be
important. For example, many have suggested that the problems with Northern Rock in the
United Kingdom were compounded by a lack of clarity regarding the distribution of powers,
responsibilities, and information among the Bank of England, the U.K. Financial Services
Authority, and the U.K. Treasury. In response, the Bank of England was given statutory
responsibilities in the area of financial stability, its powers to collect information from banks
were augmented, and many have called for it to be given increased supervisory authority. In the
European Union, a new European Systemic Risk Board is being established under which national
central banks and the European Central Bank will playa central role in efforts to protect the
financial system from systemic risk. More broadly, in most industrial countries today the central
bank has substantial bank supervisory authorities, is responsible for broad financial stability, or
both.
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Further development of these ideas is provided in "The Public Policy Case for a Role for the
Federal Reserve in Bank Supervision and Regulation," a white paper produced by the Board in
January 20 I 0 and available at http://www.federalreserve.govlboarddocs!rptcongress!supervision
!supervisionJeport.pdf.
142
Questions for The Honorable Ben S. Bernanke, Chairman, Board of Governors of the
Federal Reserve System, from Representative Maloney:
1. Close to 450,000 mes were reviewed by tbe independent consultants in connection with
the independent foreclosure review. Please indicate how many of those mes were of New
York Residents.
The Independent Foreclosure Review ("IFR") required by the regulators' enforcement orders
against the major mortgage loan servicers included a borrower outreach procedure that allowed
borrowers who were in foreclosure during 2009 and 2010 at the covered servicers to submit a
request to have their foreclosure reviewed by an independent consultant. As of December 31,
2012, the deadline for submission of requests for review, about 500,000 borrowers out of the
total eligible population of over 4.2 million had submitted requests for review. In addition, at
Federal Reserve-regulated servicers, approximately 60,000 files were slated for review as part of
the separate review of certain types of borrower files by independent consultants that was part of
the IFR - the "look-back." Data for the files slated for review as part of the "look-back" was not
maintained on a state-by-state basis.
As you know, the IFR ceased at the 13 servicers participating in the agreement in principle
announced by the Federal Reserve and Office ofthe Comptroller of the Currency ("OCC") in
January. As a result of the agreement, each of those 4.2 million borrowers will receive some
direct compensation and may benefit from additional assistance that we are requiring from the
servicers, including all eligible borrowers from New York, regardless of whether their file would
be reviewed as part of the IFR.
2. There are still 4 million borrowers who were in foreclosure between 2009 and 2010.
With an $8 billion settlement, how far do you believe it will go? Will the payment match
the harm?
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With the OCC taking the lead, we undertook strong enforcement actions in 2011 to help the
millions of affected borrowers in foreclosure during 2009 and 20 I 0 and to correct mortgage
servicing deficiencies. Our goals were, and continue to be, to require the major lenders and
servicers to correct their foreclosure practices and maintain practices that ensure that no
consumer is wrongfully foreclosed upon or wrongfully denied access to available loan
modification programs, and to assist borrowers subject to improperly administered foreclosure
practices. Our enforcement actions required the servicers to immediately correct foreclosure
practices. When it became clear that the reviews of individual files to identifY injured borrowers
required by our enforcement actions - the IFR - would significantly delay getting remediation to
borrowers, the OCC and the Federal Reserve, after consulting consumer groups, chose to change
course with respect to that requirement of our enforcement actions. Although none of the
available options were ideal, we accepted the agreement, which provides some immediate
assistance to all in-scope borrowers, because that approach will result in money being paid to
more borrowers in a shorter time frame than would have occurred if the file reviews had
continued. This approach also preserved the rights of borrowers to obtain full remediation for
any injury.
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3. Who gave the order that no money wonld be paid to borrowers while close to $2 billion
in fees was generated?
The process of carefully reconstructing and reviewing the hundreds of thousands of files to
ensure consistent treatment took the servicers and independent consultants substantial time and
required significant resources. As the IFR proceeded, it became clear that the process of
identifying injured borrowers and determining the type and amount of remediation due them was
proceeding much too slowly, largely due to this complex and labor-intensive process. The
regulators, after consulting with community groups, chose to change course. Although none of
the available options were ideal, we accepted the agreements to pay all in-scope borrowers and
provide other foreclosure prevention assistance because that approach will result in money being
paid to more borrowers in a shorter time frame than would have occurred if the file reviews had
continued.
4. We have been told that there was agreement that institntions wonld not compensate
injured borrowers until all institntions were ready to do so.
a. Were you aware ofthis agreement?
Please see response for 4 (c).
b. Do yon believe it was appropriate to allow the process to be conducted in that
manner?
Please see response for 4 (c).
c. Wouldn't it have been more effective to compensate borrowers where harm
was found and documented rather than wait for the entire process to be
completed?
We are not aware of any such agreement and, in fact, encouraged institutions subject to the
Federal Reserve's jurisdiction to make payments to borrowers as soon as practicable. The IFR
required the identification of injured borrowers by the independent consultants and then the
submission by the servicer of an acceptable plan to provide remediation to those borrowers.
Processes were being developed to assure that all borrowers who suffered similar financial
injuries were treated consistently in the remediation they received. The Federal Reserve
contemplated that, once an institution's remediation plan was completed, we would have
required the servicer to carry out the remediation without regard to whether other institutions
were ready to provide remediation.
5. Please shed some light on the decision to halt the independent review. Were there
specific reports from the Ie's that led you to believe you weren't going to find what you
expected to find?
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As noted above, as the IFR proceeded, it became clear that the process of identifying injured
borrowers and determining the type and amount of remediation due them was proceeding much
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too slowly, Jargely due to its complex and labor-intensive nature. The regulators, after
consulting with community groups, chose to change course. Although none of the available
options were ideal, we accepted the agreements to pay all in-scope borrowers and provide other
foreclosure prevention assistance because that approach will result in money being paid to more
borrowers in a shorter time frame than would have occurred if the file reviews had continued.
6. Do you believe that injured borrowers will be rightly compensated for the financial
harm they suffered?
Please see response to question 2.
7. How have practices at the institutions that you supervise changed since the consent
orders were signed?
The provisions of the Federal Reserve's mortgage servicing-related Consent Orders required
servicers to fix what was broken to ensure a fair and orderly mortgage servicing process going
forward, and the Federal Reserve continues to expect servicers to fully correct these practices
and policies. In the time since issuing our orders, progress has been made in implementing better
controls, and improving systems and processes designed to ensure the errors leading to our
enforcement actions do not recur. The Federal Reserve is examining servicers to monitor and
test these improvements and examiners will continue to work to ensure complete compliance
with the Federal Reserve's enforcement actions and to verifY the corrective actions taken by the
servicers. In addition we are coordinating very closely with the Consumer Financial Protection
Bureau ("CFPB") on the implementation of standards that help improve mortgage servicing
across the industry.
8. Please provide information about how the fee structures between the Ie's and the
financial institutions were determined and what role the Federal Reserve played in that
determination, as well as whether the resulting total had any impact on the final figure that
was agreed to on January 7.
The independent consultants were retained by the servicers and work for the servicers, subject to
the oversight of the Federal Reserve and OCC. Accordingly, the fee arrangements between the
independent consultants and the servicers were negotiated by those parties. Consistent with our
standard practice, the Federal Reserve did not participate in those negotiations. The Federal
Reserve reviewed each consultant to a servicer we regulate to ensure that the consultant would
not be reviewing any work product that the consultant had previously provided to the servicer
and to ensure that the consultant would be able to review borrower files without influence by the
servicer that retained them.
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9. There have been concerns expressed that outreach efforts to borrowers by lenders about
available restitution and a suggestion that efforts were inadequate. Specifically, I would
like to know what efforts will be made to contact the 5% of the 4.2 million borrowers who
were not reached with the initial mailing?
145
- 4Serviceable addresses exist for the vast majority of the in-scope population as many borrowers
have existing relationships with the servicers or their addresses have been identified through
other means. The regulators have required substantial efforts to locate current addresses for the
remaining borrowers. These efforts included several rounds of address searches using the
national change of address database and third-party consumer databases, which contain
infonnation from sources such as credit bureaus, public records/registrations, utilities, phone
number databases, and similar sources, to detennine borrowers' most likely current address.
Borrowers can continue to update contact infonnation with Rust Consulting, Inc. ("Rust"), the
IFR Administrator and paying agent under the agreement in principle, by calling 1-888-9529105. Finally, the paying agent will also take additional steps to identify current addresses for
borrowers eligible for payment under the payment agreement. There are no additional steps that
eligible borrowers will need to take to receive payment under the payment agreement.
10. While the settlement is national in scope, no state was impacted as severely as New
York with robo-signing, document forgeries and other foreclosure abuses; which has been
well documented. Accordingly, I hope you will be able to inform me how cases of New
York borrowers will be reviewed and administered?
As a result of the payment agreement, approximately 4.2 million "in-scope" borrowers at the 13
participating servicers, including all eligible borrowers from New York State, will receive some
monetary compensation. On April 12, 2013, payments began to these borrowers. Payments will
range from $300 to $125,000 plus equity. As of May 20, 2013, more than 2.4 million checks
have been cashed or deposited totaling more than $2.2 billion dollars.
11. Finally, I am hoping you can let me know the criteria that will be used to determine
how much each individual borrower will be eligible to receive. While I support your desire
to move forward and offer restitution to injured borrowers, I am hopeful that will be done
in a methodical manner.
As noted in the answer to question 10, on April 12, 2013, payments under the payment
agreement began to the 4.2 million borrowers and as of May 20, 2013, more than 2.4 million
checks have been cashed or deposited totaling more than $2.2 billion dollars. Payments will
range from $300 to $125,000 plus equity. In order to detennine the individual payment amounts,
borrowers were categorized according to the stage of their foreclosure process and the type of
possible servicer error. Regulators then detennined amounts for each category using the
fmancial remediation matrix published in June 2012 as a guide, incorporating input from
consumer groups. The Federal Reserve has published the payment amounts and the number of
people in each category on its website at http://www.federalreserve.gov/consumerinfo/
independent-forec!osure-review-payment-agreement.htm.
12. Since signing the consent order, how many borrowers in New York state have had their
files reviewed, and what were the results of those reviews?
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The Federal Reserve has made available on our website data on the number of borrowers who
have submitted a request to have their mortgage reviewed by an independent consultant as part
of the IFR. As noted above, the payment agreement replaces the IFR at the 13 participating
146
-5-
servicers with a broader framework that allows all borrowers covered by the agreementwhether or not their file was slated for review as part of the IFR - to receive compensation
significantly more quickly than under the IFR. As a result of the recent agreement, servicers
must provide monetary compensation to all borrowers within the scope of the original
enforcement actions; borrower files will no longer be subject to individual review as part of this
process.
13. What efforts have been made to find borrowers that have not yet been contacted or
those who have not responded to mail or telephone attempts, and how many of those are
estimated to live in New York?
Please see response to question 9. The Federal Reserve does not have data on a state-by-state
basis on the number of in-scope borrowers who were not able to be contacted in connection with
the IFR.
14. What assurances will borrowers have that any information they provide to servicers
will not be used in the foreclosure process?
The Federal Reserve and the OCC have directed servicers to use contact or personal information
provided in cormection with the IFR only for purposes relating to the IFR process. The privacy
policy governing the IFR, which remains in effect following the payment agreement, is available
online on the IndependentForeclosureReview.com website under the privacy policy section.
15. What assurances will New York state borrowers have under the new settlement that
they will not be dual tracked with a foreclosure proceeding while the claim is being
pursued?
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While the payment agreement with the participating servicers itself does not automatically
forestall or prevent foreclosure actions from continuing, the Consent Orders entered into by the
servicers expressly address efforts to prevent dual tracking, for example, by requiring servicers
to improve coordination between their foreclosure activities and their loss mitigation efforts in
order to prevent unnecessary foreclosures and keep borrowers in their homes whenever possible.
In addition, the Federal Reserve and the OCC have issued guidance to the servicers subject to the
Consent Orders directing a review before foreclosure sales for all pending foreclosures. These
reviews also help prevent avoidable foreclosures by ensuring that foreclosure-prevention
alternatives are considered and foreclosure standards are met. In addition, the federal banking
agencies have been working closely with the CFPB to develop national mortgage servicing
industry standards that limit a servicer's ability to dual track borrowers. Such industry standards
were issued in January by the CFPB and become effective in January 2014. The Federal Reserve
is committed to enforcement of our Consent Orders and of these standards.
147
Ouestions for The Honorable Ben S. Bernanke, Chairman, Board of Governors of the
Federal Reserve System, from Representative Mulvaney:
1. The Congressional Budget Office (CBO) projections offuture interest rates published in
their report titled "CBO Budget and Economic Outlook Fiscal Years 2013-2023" in tables
B-1 and B-2 are displayed below. Are the Federal Reserve's projections for future interest
rates for similar products and time frames consistent with CBO's projections? If the
Federal Reserve does not agree with the CBO projections, please provide your pr9jections,
explain the reasons for the difference of opinion, and articulate why the Federal Reserve
believes its numbers are a better gauge of future interest rates.
Finally, how will the CBO projected interest rates, and if different, the Federal Reserve's
projected interest rates, affect or alter the Federal Reserve's exit strategy? What are the
impacts to the economy ofthe exit strategy using these projected rates?
The CBO projections of interest rates published in their report titled "CBO Budget and
Economic Outlook Fiscal Years 2013-2023" in tables B-1 and B-2 are as follows:
Projections by calendar year:
10-year Treasury note: 2012: 1.8% 2013: 2.1% 2014: 2.7% 2015: 3.5% 2016: 4.3% 2017:
5.0% 2018: 5.2% 2019: 5.2% 2020: 5.2% 2021: 5.2% 2022: 5.2% 2023: 5.2%
3-month Treasury bill: 2012: .1 % 2013: .1 % 2014: .2% 2015: .2% 2016: 1.5% 2017: 3.4%
2018: 4.0% 2019: 4.0% 2020: 4.0% 2021: 4.0% 2022:4.0% 2023: 4.0%
Projections by fiscal year:
10-yearTreasury note: 2012: 1.9% 2013: 1.9% 2014: 2.5% 2015: 3.2% 2016: 4.1% 2017:
4.9% 2018: 5.2% 2019: 5.2% 2020: 5.2% 2021: 5.2% 2022: 5.2% 2023: 5.2%
3-month Treasury bill: 2012: .1 % 2013: .1% 2014: .1 % 2015: .2% 2016: 1.0% 2017: 2.9%
2018: 4.0% 2019: 4.0% 2020: 4.0% 2021: 4.0% 2022: 4.0% 2023: 4.0%
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The Federal Reserve does not publish official forecasts of interest rates, in part because the level
of rates now and in the future is influenced by Federal Reserve policy actions that have not yet
been decided upon. That said, FOMC participants--the seven Federal Reserve Board governors
and 12 Reserve Bank presidents--prepare individual economic projections four times each year.
As part of those projections, FOMC participants project a path for the federal funds rate based on
their own evaluation of the economic outlook and judgment regarding the appropriate path of
monetary policy. That information is published as an addendum to the FOMC minutes. The
most recent projections were prepared for the June FOMC meeting and are available at
[hrtp:llwww.federalreserve.gov/monetarypolicy/files/fomcprojtabI20 130619.pdf]. Although the
individual projections vary, the central tendency of these projections for the path of the federal
funds rate is qualitatively similar to the path shown above for the CBO projections of the threemonth bill rate. In particular, most FOMC participants expect the funds rate to remain quite low
through 2015.
148
-2-
The trajectory for the path of short-tenn interest rates has implications for longer-tenn yields.
Specifically, longer-tenn yields will tend to move higher as investors perceive that the date after
which the FOMC is expected to begin raising short-tenn rates is drawing closer. This effect is
evident in the CBO projections for the ten-year Treasury yield; it begins to move higher in 2013
and 2014 even though the CBO projects the three-month bill rate to remain quite low throughout
2015. In addition to this effect operating through expectations regarding short -tenn rates, the
nonnalization of the size of the Federal Reserve's balance sheet should put some additional
upward pressure on long-tenn rates by raising the tenn premiums embedded in yields on longtenn securities.
In short, in most economic forecasts, short and long-tenn rates rise gradually over time as the
economy continues to recover. A discussion of this and related issues is included in a recent
speech by Chainnan Bemanke entitled "Long-Tenn Interest Rates" and available at
http://www.federalreserve.gov/newsevents/speechibemanke20130301a.htm.
2. In the Subcommittee on Monetary Policy and Trade hearing entitled "Near-Zero Rate,
Near-Zero Effect? Is 'Unconventional' Monetary Policy Really Working?" on March 5,
2013, two witnesses, Dr. Joseph Gagnon and Mr. David Malpass, expressed conflicting
views on the Federal Reserve's ability to influence short-term interest rates during its exit
from quantitative easing because of a lack of short-term Treasury bills. Dr. Gagnon
argued that the Federal Reserve could enter into repurchase agreements on its long-term
securities and have the same effect as selling Treasury bills. Mr. Malpass responded that
this would not be a viable option because the market for repurchase agreements could not
sustain the maguitude of repurchase agreements the Fed would need to manipulate the
short-term interest rate. Does the Fed have the practical ability to manipulate short term
interest rates through repurchase agreements, and what would be the implication to the
repo market if the Federal Reserve engaged in this activity? Does the increasing size of the
Federal Reserve balance sheet reduce the efficacy of using repurchase agreements to affect
short-term interest rates?
As discussed in the minutes of its June 2011 meeting, the FOMC will rely primarily on changes
in the FOMC's target federal funds rate to remove policy accommodation at the appropriate
time. During the nonnalization process, adjustments in the interest rate on excess reserves and to
the level of reserves in the banking system will be used to bring the funds rate toward its target.
The Federal Reserve has developed tools, including tenn deposits and reverse repurchase
agreements (RPs), that could be used to drain reserves at the appropriate time if necessary. By
issuing tenn deposits and reverse RPs, the Federal Reserve will be able to reduce the quantity of
reserves in the banking system as needed.
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Such draining tools may also have a secondary effect by directly putting upward pressure on
money market rates. For example, conducting three-month tenn reverse RP operations will drain
reserves and put upward pressure on the overnight federal funds rate, but such operations will
149
-3also put some upward pressure on the three-month term RP rate. The extent of the latter effect is
difficult to gauge, but would also work in the general direction of tightening financial conditions.
The Federal Reserve can also drain reserves and tighten financial conditions by selling assets, if
necessary. In short, the FOMe is confident that it has the tools necessary to withdraw policy
accommodation at the appropriate time.
3. Chairman Bernanke, in your testimony before the Committee on Financial Services on
February 7, 2013, you said "Federal Reserve analysis shows that remittances to the
Treasury could be quite low for a time in some scenarios, particularly if interest rates were
to rise quickly." In fact, a chart in the January 2013 Federal Reserve staff report
referenced in your testimony shows that remittances drop to zero as interest rates rise
when the Federal Reserve continues to make asset purchases to expand its balance sheet
through 2013, a program it has already begun. What it doesn't show, however, is how
much the Federal Reserve is losing as interest rates rise. In each ofthe scenarios explored
in your staff report, and at the current pace of purchasing $85 billion per month of
securities over 2013, what is the expected profit or loss from your unconventional policy
measures? In your response, please distinguish between the profit or loss from interest
paid on reserves and the profit or loss from balance sheet assets. Also, please provide an
update of how much you have made from quantitative easing to date, how much you expect
to make, and how much you estimate that you will lose as interest rates rise at the end of
unwinding the Fed's balance sheet.
The Federal Reserve has a dual mandate of fostering price stability and maximum employment,
and the large-scale asset purchases have been undertaken in pursuit of that mandate. Any profits
or losses from the policy are incidental to the ultimate goals of policy. Indeed, a more rapidly
growing economy benefits the fiscal position of the federal government substantially more-through reduced expenditures on unemployment benefits and increased tax receipts--than any
variation in the Federal Reserve Board's earnings.
From 2009 through 2012, the Federal Reserve remitted almost $300 billion to the U.S. Treasury,
an average of over $70 billion per year. Prior to the financial crisis, the Federal Reserve would
typically remit between $20 and $25 billion to the Treasury per year.
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The staff working paper projects--under a variety of assumptions--how the Federal Reserve's
income might evolve over coming years. That analysis includes both the possibility of realized
losses from asset sales as well as the expense of paying interest on reserve balances. In the
scenarios analyzed, when assessing the effects on Federal Reserve earnings over the entire period
of asset purchases, the average annual remittances to the Treasury exceeds the typical annual
remittances prior to the crisis. That averaging combines periods when remittances are
substantially above historical averages, as they have been since 2009, with periods when
remittances fall, perhaps to zero. http://www.federalreserve.gov/pubs/feds!2013!201301
lindex.htmI
150
Questions for The Honorable Ben S. Bernanke, Chairman, Board of Governors of the
Federal Reserve System, from Representative Ross:
1. Why does the Board continue [to] see things only through a bank-centric, one-sized-fits
all approach? Can you explain to this committee why you are moving to take away, usurp,
or simply ignore the authority of state regulators to set minimum capital requiremeuts or
what purpose it serves?
Section 171 of the Dodd-Frank Wall Street Refonn and Consumer Protection Act (Dodd-Frank
Act) requires the Board to establish consolidated minimum risk-based and leverage capital
requirements for depository institution holding companies, which includes savings and loan
holding companies with insurance operations, that are "not less than" the minimum capital
requirements for insured depository institutions. Capital requirements for insurance companies
are imposed by state insurance laws on a legal entity basis, rather than a consolidated basis. On
June 7, 2012, the Board and the other federal banking agencies proposed to revise their riskbased and leverage capital requirements in three notices of proposed rulemaking (NPRs),
consistent with this statutory requirement.
The NPRs proposed flexibility to address the unique character of insurance companies through
specific risk weights for policy loans and non-guaranteed separate accounts, which are typically
held by insurance companies, but not banks. These specific risk weights were designed to apply
appropriate capital treatments to assets particular to the insurance industry while complying with
the requirements of section 171 of the Dodd-Frank Act.
The Board is carefully considering the comments it has received regarding the application of
section 171 of the Dodd-Frank Act to savings and loan holding companies and bank holding
companies that are significantly engaged in the insurance business. We will continue to consider
these issues seriously, as well as the potential implementation challenges for depository
institution holding companies with insurance operations, as we detennine how to move forward
with respect to the proposed capital requirements.
2. I often wonder how much monetary policy is trumped by excessive rules and regulatious
that impose unnecessary costs and burdens on businesses that provide something as vital as
homeowners insurance in Florida. As I mentioned, the Board's rule requiring GAAP
financial filings in addition to SAP filing is going to be costly. Please tell me exactly what
new, relevant, important information will you [and} the Board glean from these new
regUlations that will justify the rate increases Florida homeowners could see.
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Section 171 of the Dodd-Frank Act requires the agencies to establish consolidated minimum
risk-based and leverage capital requirements for depository institution holding companies,
including savings and loan holding companies, that are no less than the generally applicable
capital requirements that apply to insured depository institutions under the prompt corrective
action framework. The "generally applicable" rules use generally accepted accounting principles
(GAAP) as the basis for regulatory capital calculations.
151
- 2The proposed requirement that savings and loan holding companies calculate their capital
standards on a consolidated basis using a framework that is based on GAAP standards complies
with section 171 of the Dodd-Frank Act and would facilitate comparability across institutions.
In contrast, the statutory accounting principles (SAP) framework for insurance companies is a
legal entity-based framework and does not provide consolidated financial statements.
The Board received many comments on the proposed application of consolidated capital
requirements to savings and loan holding companies, including on cost and burden
considerations for those firms that currently prepare financial statements based solely on SAP.
The Board will consider these comments carefully in determining how to apply regulatory
capital requirements to bank holding companies and savings and loan holding companies with
insurance operations consistent with section 171 of the Dodd-Frank Act.
3. Since I was not on the committee during the passage of Dodd-Frank, could you speak to
your logic behind the development of this rule since much of it was not part of the Collins
Amendment and could be in direct conflict of McCarran-Ferguson?
As discussed above, the agencies proposed revisions to the regulatory capital rules consistent
with various provisions of the Dodd-Frank Act, including section 171, which requires the Board
to establish consolidated minimum risk-based and leverage capital requirements for depository
institution holding companies that are not less than tlle generally applicable capital requirements
that apply to insured depository institutions. This requirement applies to all depository
institution holding companies, including savings and loan holding companies primarily engaged
1
in the insurance business.
The Board has received some comment letters that discuss the McCarran-Ferguson Act and will
take these comments into consideration.
4. Lastly, do you believe that if these rules were in place, they would have prevented the
AlG collapse?
While it is difficult to say with certainty whether the proposed rules would have prevented the
events at AIG, the proposed rules would have imposed consolidated capital requirements on all
savings and loan holding companies, including AIG, that were not in place in the period leading
up to the crisis. The risk measurement and reporting requirements associated with the
consolidated regulatory capital requirements that would have been in place, had the proposed
rules been applicable to AIG at the holding company level several years ago, likely would have
required AIG to hold significantly more capital against its riskier transactions and possibly
constrained its behavior. They also would have provided a basis for consolidated supervision of
the company's capital adequacy and may have allowed supervisors to identifY and address some
of the riskier activities undertaken by certain entities within the AIG structure.
VerDate Nov 24 2008
See 15 U.s.C. 5371(a)(3) and (b)(I), (b)(2).
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I
152
Questions for The Honorable Ben Bernanke, Chairman, Board of Governors of the Federal
Reserve Svstem, from Representative Royce:
Entitlements and Long-Term Fiscal Concerns
1. During the recent hearings in the House in Senate, Mr. Chairman, you heard a number
of concerns expressed regarding our fiscal position and the national debt. You repeatedly
stated that we need to make changes in the long-run or long-term. My question,
Mr. Chairman, is when does the long-run end? Or to use your words from the Senate
hearing, when do we get to "the point where the debt really begins to explode?" Would you
agree it is mathematically impossible to keep tax revenue at its historical average and not
address entitlements without an explosion of deficits?
Fiscal policymakers confront daunting challenges, and the economy's performance will depend
importantly on the choices that are made about the course of fiscal policy. I believe that fiscal
policymakers should keep three objectives in mind as they face these decisions. First, to
promote economic growth and stability, the federal budget must be put on a sustainable long-run
path that first stabilizes the ratio of federal debt to GDP, and, given the current elevated level of
debt, eventually places that ratio on a downward trajectory. Second, as fiscal policymakers
address the urgent issue oflonger-run fiscal sustainability, they should avoid unnecessarily
impeding the current economic recovery. Third, policymakers should make these policy
adjustments with an eye toward tax and spending policies that increase incentives to work and
save, encourage investments in workforce skills, advance private capital formation, promote
research and development, and provide necessary and productive public irrfrastructure.
Under current CBO projections, the ratio of federal debt to GDP remains near current levels over
the next five years and then begins to rise over the final five years of the projection, and based on
their longer term outlook, debt mounts rapidly after 2023 owing to the effects of population
aging and the continued rise in health care costs. In CBO's scenario, taxes are near their longterm average and non-interest outlays rise well above their long-run average and thus deficits
widen. It is critical that policymakers address these long run imbalances between spending and
taxes by lowering the trajectory for outlays, raising taxes above their long-run average, or some
combination of the two. A credible fiscal plan that addresses these longer-run challenges could
help keep longer-term interest rates low and boost household and business confidence, thereby
supporting economic growth today.
Contradictory Impact of Quantitative Easing (QE) on Growth
2. Chairman Bernanke; despite the Federal Reserve's $3 Trillion -and growing- balance
sheet today, isn't the real effect of quantitative easing at this point in our economic cycle,
after the crisis, contradictory with respect to real growth and job creation, despite an
accommodative monetary policy?
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The Federal Reserve and many other central banks around the world are expanding their
balance sheets to the favor of government, housing finance, and big banks, yet growth is
marginal and jobs aren't being created fast enough by new ventures and small businesses.
153
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Isn't the impact of QE to reallocate credit to the government and housing without
expanding it in other parts of the private sector where it is needed? Is the central bank's
traditional transmission mechanism broken and having a negative impact, instead of its
intended beneficial impact? If it isn't broken after four years of unprecedented monetary
policy accommodation, then why is growth so low and job creation not growing faster?
The U.S. economy continues to face headwinds; these include not only the tax increases and cuts
in government spending enacted earlier this year, but also still-tight credit conditions for many
small businesses and for households that have less-than-pristine credit records. While monetary
policy cannot fully offset these headwinds, there is substantial evidence that the Federal
Reserve's monetary policy--including its purchases oflonger-term securities--have reduced
interest rates, helped improve financial conditions more broadly, and contributed to growth of
economic activity and employment. Low interest rates have boosted private demand for goods
and services, giving businesses a reason to expand production and create jobs. Low mortgage
rates are helping to strengthen the housing market, contributing to rising sales and construction
of new homes, and to increased employment of construction workers, many of whom work for
small businesses. Low interest rates also have contributed to rising home prices, putting more
homeowners in a position to refinance and benefit from lower mortgage payments. Low rates for
car loans have spurred sales of motor vehicles and thus raised employment in the U.S. auto
industry. While the purpose of our monetary policy is to promote maximum employment and
price stability, it also has helped improve the health of the banking system; the combination of a
stronger banking system and a stronger economy has increased the amount of credit flowing to
American households and businesses, helping to support the economic recovery.
Ad Hoc Monetary Policy
3. Mr. Chairman, businesses and investors are increasingly interested in when the Fed will
begin to raise rates. Which indicator is relevant for these businesses and investors today?
Is it through mid-2015 as announced last September and reflected in the FOMC's forward
guidance? Is it as long as unemployment is above 6.5% (and inflation below 2.5%) as
announced in December? Or should investors be focused on the rule Fed Vice Chairman
Janet Yellen believes should be followed in normal times, which suggests rates should begin
to rise before 2015?
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In its most recent statement, the Federal Open Market Committee indicated that the current
exceptionally low level of short-term interest rates will be appropriate at least as long as the
unemployment rate remains above 6-112 percent, inflation between one and two years ahead is
projected to be no more than a half percentage point above the Committee's 2 percent longer-run
goal, and longer-term inflation expectations continue to be well anchored. As you note, this
quantitative approach to describing its policy outlook replaced the date-based guidance that the
Committee had employed until last fall. Under the date-based guidance, the Committee had
indicated that it anticipated that economic conditions would warrant exceptionally low levels of
interest rates at least through mid-20l5. It is worth noting, however, that the Committee, in its
December statement indicated that the new quantitative thresholds were consistent with the
154
-3earlier date-based guidance. With regard to the economic indicators that would be relevant for
businesses and households in evaluating the likely stance of monetary policy going forward, the
Committee has indicated that in addition to the unemployment and inflation rates, it considers
other information, including additional measures oflabor market conditions, indicators of
inflation pressures and inflation expectations, and readings on financial developments.
TBTF fixed globally?
4. Last week, Governor Tarullo presented a paper at Cornell law school on the
international cooperation in financial regulation, which arguably is a good thing given the
global impact of financial crises in modern times. Yet, how can we say we have solved the
policy of "too big to fail"-TBTF) and are enhancing financial stability, especially if there is
no binding mechanism in place today for the cross-border resolution of large failing,
globally active banks or means for cross-border dispute resolution? The Financial
Stability Board's recommended principles from 2012 are nice to have, but have no legally
binding impact on the United States or any other G20 nation.
David Wright, the Secretary General of IOSCO, late last year, reviewed the case for a
binding international agreement or treaty - such as we have in other policy areas like trade
(WTO), health (WHO), or airplane safety - for things like the cross-border resolution of
large failing global banks. Until we have some kind of treaty or agreement in place, even if
limited to cross-border resolution and dispute settlement, how can we convincingly say that
we truly have ended TBTF under either the bankruptcy code or Dodd-Frank and thereby
enhanced financial stability?
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•
providing for an orderly resolution process for systemically significant non-bank fmancial
institutions;
•
requiring living wills to help guide institutions and regulators to improve resolvability of
significant financial firms;
•
requiring enhanced prudential supervision and capital requirements for large, systemically
significant financial firms;
•
bringing previously unregulated, systemically-important financial entities under the
regulatory umbrella;
•
providing a new financial sector concentration limit and giving the Fed new authority to
consider financial stability in merger and acquisition proposals by banking firms; and,
•
central clearing of derivatives to help reduce interconnectedness.
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The Dodd-Frank Act provides a number of tools that did not exist prior to the recent fmancial
crisis to address the too-big-to-fail problem. These include:
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Although these new statutory tools are in various stages of regulatory implementation, the Fed
has already strengthened its oversight of large, complex banking firms and has worked with
these firms to materially improve their capital adequacy and capital planning through our 2009
SCAP exercise and our annual CCAR exercise since 2011. We have also now released our
proposals to implement enhanced prudential standards for large U.S. and foreigu banking firnls
and FSOC-desiguated nonbank firms. The proposed rules, which increase in stringency with the
systemic footprint of the covered company, would provide incentives for covered companies to
reduce their systemic footprint and require covered companies to internalize the external costs
that their failure or distress would impose on the broader financial system.
In addition, I note that the FDIC's orderly liquidation powers are effective today and their core
regulatory implementation architecture is in place. More work remains to be done around the
world to maximize the prospects for an orderly SIFI resolution, but the basic framework is in
place in the United States.
We have made significant progress towards eliminating too big to fail, and ratings actions taken
over the past two years by Moody's with respect to our largest banking firms are a reflection of
the progress we have made on that front. More work remains to be done, but eliminating too big
to fail is a core objective as we implement Dodd Frank and Basel 3 reforms.
Too Much Leverage, Not Enough Capital Formation and Investment
5. Mr. Chairman, we have a monetary policy (QE) that encourages borrowing by the
government and housing industry especially based on the Federal Reserve's purchases on
its balance sheet, and at the same time we have a fiscal policy in this country, through the
national budget and both corporate and individual tax codes, that also rewards leverage
(by_ credits and other tax expenditures for borrowing) and penalizes capital formation and
investment.
What do we need to do with respect to both monetary policy and fiscal policy to achieve a
better balance, where capital formation and wealth generation for investment aren't
penalized and borrowing isn't rewarded as much as it has been historically? On both
fronts, how [do] we get from where we are today - too highly leveraged a nation - to a
more responsible position where capital formation and investment in growth and jobs is
rewarded and not penalized (or demonized)?
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The financial crisis, the deep recession that followed, and the subsequent slow recovery has
presented substantial challenges for monetary and fiscal policy. For monetary policy, the
primary challenge has been to accommodate exceptionally weak aggregate demand--which has
caused employment to fall to an unacceptable level--and stave off an unwelcome disinflation in
an environmcnt where the eqUilibrium real rate of interest has been historically low. In striving
to meet this challenge, the Federal Open Market Committee (FOMC) first lowered the target
federal funds rate to its effective lower bound in latc 2008, then began communicating its
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intention of holding the federal funds rate at an exceptionally low level as long as
macroeconomic conditions warrant. It also initiated substantial purchases of longer-term
government securities to put further downward pressure on market interest rates. These
monetary policy actions were needed to provide much-needed support to aggregate demand and
to keep overall price inflation from falling too far below the FOMC's longer-run objective of
2 percent per year. In part because of monetary policy, U.S. macroeconomic performance and
labor market conditions have continued to improve gradually, and overall economic activity and
employment appears likely to continue rising this year and, according to the central tendency
forecasts produced by the FOMC in March, is expected to accelerate over the next two years.
Fiscal policy, at all levels of government, also has been and continues to be an important
determinant of the pace of economic growth. Federal fiscal policy, taking into account
discretionary actions and so-called automatic stabilizers, was, on net, quite expansionary during
the recession and early in the recovery. Although near-term fiscal restraint has increased, much
less has been done to address the federal government's longer-term fiscal imbalances, which, in
large part, reflect the effects of the projected aging of our population and anticipated increases in
health care costs, along with mounting debt service payments. To promote economic growth and
stability in the longer term, it will be essential for fiscal policymakers to put the federal budget
on a sustainable long-run path. Importantly, the objectives of effectively addressing longer-term
fiscal imbalances and of minimizing the near-term fiscal headwinds facing the economic
recovery are not incompatible. To achieve both goals simultaneously, the Congress and the
Administration could consider replacing some of the near-term fiscal restraint currently in law
with policies that reduce the federal deficit more gradually in the near term but more
substantially in the longer run.
Housing Prices
6. How do you evaluate the role the Federal Reserve has been playing to provide liquidity
to the housing market? Some observers suggest that the increase in house prices against
normal seasonal patterns may be building to another house price bubble down the road.
Those who believe in a stock valuation model of discounted cash flows approach to house
prices suggest that the inevitable normalization of rates will deflate house prices as a result
and thus the current valuation gains are illusory. What do you think the result of the
normalization of rates will be for equity in homes?
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Recent purchases of agency mortgage-backed securities are one way through which the Federal
Reserve has sought to provide support to the housing market. These purchases have contributed
to historically low mortgage interest rates in recent years, which have increased housing
affordability for homeowners eligible for new mortgages. The Federal Reserve's actions may
have contributed to the recent increases in house prices, although this connection is not wellestablished and will be a topic of much research in the years to come. Concerns that recent
increases in house prices are the beginnings of "another housing bubble" ought to be tempered
by the fact that mortgage credit is tight for all but the highest credit quality households and
aggregate mortgage debt outstanding continues to contract.
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As you note, standard pricing models support the notion that rising interest rates will put pressure
on house prices. The magnitude of the effect is difficult to gauge because of uncertainty over
how much rates will rise and because the precise relationship between house prices and interest
rates is not well-established. Many economic models suggest that rising interest rates will lead
to a deceleration in the pace of house price growth but should not derail the recovery in housing
markets. Indeed, expectations for a housing market recovery may be justified by relatively low
price-to-rent ratios as well as by strong pent-up housing demand.
Cost and Benefits of Dodd-Frank Rules
7. Mr. Chairman, what is the impact ofthe 400 new Dodd-Frank rules on economic
growth and job creation? Is the net impact positive or negative in your view?
!fno one - including the Federal Reserve - has attempted to do it, shouldn't some
organization take a hard, independent, and objective look at the impact on our financial
system and our economy? Wouldn't some kind of methodical, regnlar economic impact
assessment of these new rules be a good thing to know?
Many of the Dodd-frank Act provisions are still in the early stages of implementation making it
difficult to accurately assess the impact of the Act at this point.
Overall, we expect a safer financial system to contribute to higher levels of economic activity
and employment, on average. Most importantly, it is clear that distress within the fmancial
system can lead to notable contractions in economic activity and employment, and regulatory
reform, by reducing the probability of such severe financial strains, should lead to higher levels
of economic activity and employment. Indeed, analyses of portions of the revised regulatory
framework - while falling short of a comprehensive analysis of all reforms associated with
Dodd-Frank and related efforts - suggest such benefits from reform.
That said, it is difficult to envision an effort to assess the macroeconomic effects of the combined
set of reforms. Economic models of the macroeconomy typically do not contain the type of
detailed modeling of the financial system needed to provide such a systematic assessment and
detailed data are not available regarding many of the macroeconomic effects. In our
implementation efforts, we consider the economic impact of proposed changes, and engage with
our fellow regulatory agencies, private-sector groups, consumer advocacy organizations, and the
broader public to gain as full an understanding as possible of how implementation of DoddFrank reforms will affect the economy.
Financial Stability Defined
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8. Mr. Chairman, in the Federal Reserve's new role as the chief regulator for financial
stability purposes under Dodd-Frank, you have issued or will issue uew rules that hinge ou
the importance of financial stability without really defining what we mean - in Dodd-Frank
for example - by the "financial stability ofthe United States."
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The Office of Financial Research (OFR) defined "financial stability" in its first annual
report as: "Financial stability' means that the financial system is operating sufficiently to
provide its basic functions for the economy even under stress." Is that definition
subscribed to by the Federal Reserve, yes or no?
If not, what is yours, and what are the implications for new policies like the FSOC
designation of nonbank financial institutions as systemically important or the enhanced
prudential standards in Dodd-Frank Sec. 165, which are still pending? Wouldn't you
agree that we all need to agree on some basic definitions and their implications, not only for
financial regulation but also their potential impact on the real economy? Please elaborate.
In its final rule on nonbank designations, the Council said it will consider a "threat to the
financial stability of the United States" to exist if there would be an impairment of financial
intermediation or of financial market functioning that would be sufficiently severe to inflict
significant damage on the broader economy." The Federal Reserve considers this the relevant
standard for designations.
FSOC Process
9. Please update us on how the FSOC and the Fed through your representation on the
FSOC is approaching the analysis of firms being considered for nonbank SIFI designation.
Are different metrics being applied in the evaluation of different business models? Are
those metrics being applied in a consistent manner across all business models (i.e. asset
managers, insurers, broker dealers, etc)?
What do you generally believe the timeframe is for the first nonbank SIFI designations to
occur?
Will designations occur before prudential standards are established for nonbank SIFls? If
so, designated firms would face uncertainty, why not wait for rules to be in place before
designations are made?
In September of last year, the GAO issued a report that contained specific
recommendations to strengthen the accountability and transparency of FSOC and OFR's
decisions and activities as well as to enhance collaboration among FSOC members and with
external stakeholders. I ask that you submit a statement for the record that details the
progress made with respect to each of the recommendations.
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The report also suggested working to rationalize rulemakings and using professional and
technical advisors including state regnlators, industry experts and academics to assist
FSOC. What has been done in this regard?
159
-8In considering which nonbank financial firms should be assessed for potential designation as
systemically important, the Council is using a combination of quantitative and qualitative metrics
that facilitate comparative analysis across firms while also considering the unique factors
specific to a firm and its industry. In laying out this approach, the Council issued a final rule and
interpretive guidance that describes a three-stage process leading to a proposed determination.
The first stage applies uniform quantitative thresholds, the second stage analyses identified firms
based primarily on existing public and regulatory information, using industry- and companyspecific quantitative and qualitative information, and the third stage entails contacting nonbank
financial companies that merit further review to collect firm-specific information that was not
available in the second stage.
The Council has made significant progress in its designation work since finalizing its rule and
guidance -- particularly by advancing an initial set of companies to the third and final stage of
the designations process starting in September oflast year. The Council staff are currently
undertaking a detailed analysis of each company, and providing the companies opportunities to
provide information regarding their businesses and operations. It is critically important that we
take the time to get the analysis right, and staff is moving as quickly as possible in doing so.
Various rulemakings under Dodd-Frank are being conducted by the regulators at the same time
as the Council's designations process. The Council's ongoing collaboration with regulators,
including the Federal Reserve, will foster consistency between the designations process and
those rules. The Council does not believe it is necessary or appropriate to postpone the
evaluation of companies for potential designation until these other regulatory actions are
completed. These rulemakings are not essential to the Council's consideration of whether a
nonbank financial company could pose a threat to U.S. financial stability.
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Regarding the GAO report, in November 2012, the Council and the OFRjointly provided a
response to Congress and the GAO with a description of the actions planned and taken in
response to each of the recommendations in the report. Since the GAO issued its report, the
Council and the OFR have further leveraged outside expertise in several ways. Most notably, in
November 2012, Treasury announced the members ofa new Financial Research Advisory
Committee, which will work with the OFR to develop and employ best practices for data
management, data standards, and research methodologies. The comrnittee is made up of 30
distinguished professionals in economics, finance, financial services, data management, risk
management, and information technology. Members include two Nobel laureates in economics;
leaders in business and nonprofit fields; and prominent researchers at major universities and
think tanks. The committee held its inaugural meeting in December 2012 in Washington, D.C.,
and has been active through subcommittees that are focused on research, data, technology, risk
management, and other issues. In addition, through the OFR's ongoing work and symposia, the
Council is able to draw on the insights and expertise of various industry experts and academics
on cutting edge systemic risk and financial stability analyses and methods.
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Section 165 Rules for Foreign Banks with US Operations
10. In your open meeting to propose the Section 165 rules for foreign banks with U.S.
operations, the Federal Reserve staff indicated that there was little chance of retaliation
against U.S. firms based on this proposal. Recently in a speech, EU Commissioner Barnier
seemed to articulate a strong contradictory view.
a. Do you still feel there is little chance of similar constraints being put on U.S. firms in
foreign markets?
The Board is carefully considering the potential that its action might affect the environment for
U.S. banking organizations operating overseas. U.S. banking organizations already operate in a
number of overseas markets that apply Basel risk-based capital requirements to their local
commercial banking and investment banking activities. In addition, the U.K., which is host to
substantial operations of U.S. banking organizations, applies local liquidity standards to
commercial banking and investment banking subsidiaries of non-U.K. banks operating in their
market.
b. Will you take in to account this possibility of retaliation when considering changes to the
rule?
Please see previous response.
c. Congress at different times has established express statutory authority for the Fed to
supervise bank holding companies and also intermediate holding companies for the
financial activities of commercial firms. Can you please identify the express statutory
authority for establishing the intermediate holding company structure for foreign banks?
Title I of the Dodd-Frank Act requires the Board to impose enhanced prudential standards on
banking organizations, including foreign banking organizations, with $50 billion or more in total
consolidated assets. Section 165 contains certain required standards and also gives the Board
authority to adopt additional standards it considers appropriate. 1 Section 168 grants the Board
specific rulemaking authority to implement subtitles A and C of Title I of the Dodd-Frank Act.
The Board also is authorized by the Bank Holding Company Act, the Federal Deposit Insurance
Act, and the International Banking Act to ensure that bank holding companies and foreign
banking organizations operating in the United States conduct their operations in a safe and sound
manner. The proposal would adopt the U.S. intermediate holding company requirement as an
additional standard in furtherance of the stated objective of section 165 to "mitigate risks to the
financial stability of the United States that could arise from the material financial distress or
failure of ongoing activities, oflarge, interconnected fmancial institutions.,,2 The U.S.
intermediate holding company requirement would apply risk-based capital requirements,
leverage limits, and liquidity requirements on the foreign banking organization's U.S. bank and
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12 USC. § 5365(b).
12 U.S.C. § 5365(a)(I).
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1
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nonbank subsidiaries on a consistent, comprehensive, and consolidated basis in a manner similar
to those applied to U.S. banking organizations.
162
Questions for The Honorable Ben S. Bernanke, Chairman, Board of Governors of the
Federal Reserve System, from Representative Stivers:
1. With all of the recent discussion centering on systemic risk and "Too Big to Fail," do
you believe U.S. regional banks are a systemic risk?
The Dodd-Frank Act ("DFA") identified all bank holding companies with assets in excess of$50
billion as firms that need to be subject to enhanced prudential standards. In implementing the
requirements of the DFA, the Federal Reserve has proposed the establishment of enhanced
prudential standards for this entire popUlation of firms, but has proposed to gradate application of
the enhanced prudential standards so that the firms with a greater systemic footprint face more
stringent standards. While regional banks are important contributors to economic growth and
development within certain geographic areas, the risks to broader financial stability posed by
U.S. regional banking firms are materially less than the financial stability risks posed by the
largest and most complex U.S. banking firms.
2. Do you believe the $50 billion asset threshold is the right proxy for determining systemic
risk?
a. Wouldn't the ll-point Test in Title 1 of the Dodd-Frank Act for non-bank systemically
important financial institutions (SIFls) be a better way to determine bank SIFIs?
Determining whether a financial institution poses systemic risk requires a complex assessment.
In designating a nonbank financial company as systemically important, the Dodd-Frank Act
requires the Financial Stability Oversight Council ("FSOC") to consider: (1) the extent of the
company's leverage; (2) the extent and nature of the company's off-balance-sheet exposures;
(3) the extent and nature of the transactions and relationships between the company and other
significant nonbank financial companies and significant bank holding companies; (4) the
importance of the company as a source of credit for households, business, and State and local
govermnents and as a source ofliquidity for the U.S. fmancial system; (5) the importance of the
company as a source of credit for low-income, minority, or underserved cormnunities, and the
impact that the failure of the company would have on the availability of credit in such
cormnunities; (6) the extent to which assets are managed rather than owned by the company; (7)
the nature, scope, size, scale, concentration, interconnectedness, and mix of activities of the
company; (8) the degree to which the company is already regulated; (9) the amount and nature of
the company's financial assets; (10) the amount and types ofliabilities of the company; and (11)
any other risk-related factors that the FSOC deems appropriate.
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By contrast, Title I of the Dodd-Frank Act requires the Board to apply enhanced prudential
standards to any bank holding company with total consolidated assets of $50 billion or more.
Because bank holding companies with only $50 billion in consolidated assets may not pose
systemic risk, the Board expects to use the authority it has under Dodd-Frank to tailor the
application of the enhanced prudential standards based on systemic risk-related factors such as a
firm's capital structure, riskiness, complexity, financial activities, and size.
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b. What are your thoughts on a proposed framework for defining SIFls through factors as
detailed in a 2009 study by the Cleveland Federal Reserve (attached)?
The proposed framework would define a systemically important financial institution in terms of
its size; whether its failure would transmit distress to other fmancial firms; whether its condition
is highly correlated with that of other financial firms; and whether it is a dominant participant in
key financial markets or activities. While somewhat more general than the list of considerations
the FSOC is required to take into account under Title I of the Dodd-Frank Act, the proposed
framework would likely require an assessment of many of the same issues. It is also noteworthy
that the financial firms designated as systemically important by FSOC will be disclosed in its
Annual Report, which is consistent with one of the 2009 study recommendations.
3. There are recent concerns that the administrative burden from some of the newly
written rules stemming from the Dodd-Frank Act is going to have a substantial impact on
regional and community banks that are not systemically important. How do we ensure
that we don't harm these traditional institutions in our efforts to protect the economy from
those that are truly systemically important?
The Federal Reserve recognizes that regional and community banks playa critical role in the
U.S. economy and, accordingly, has taken a number of steps to reduce the regulatory burden on
those institutions. For example, the Board has established a subcommittee to focus on
supervisory approaches to community and regional banks to help ensure that their views on the
supervisory process are considered. A primary goal of the subcommittee is to ensure that the
development of supervisory guidance is informed by an understanding of the unique
characteristics of community and regional banks and consideration of the potential for excessive
burden and adverse effects on lending. As an additional example, the Board created the
Community Depository Institutions Advisory Council ("CDIAC") to provide input on the
economy, lending conditions, and other issues of interest to community banks. Members include
representatives of banks, thrift institutions, and credit unions serving on local advisory councils
at the 12 Federal Reserve Banks. One member of each of the Reserve Bank councils is selected
to serve on the CDIAC, which meets twice a year with the Board. These and other forms of
outreach are an important means of helping to strike the right balance between promoting safety
and soundness throughout the banking system and keeping compliance costs for smaller banks as
low as possible.
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With respect to the changes we will see in the financial regulatory architecture as a result of the
Dodd-Frank Act and the recent implementation of the Basel III capital framework, it is important
to emphasize that these reforms are principally directed at our largest, most complex financial
firms, including nonbanks. Many of the requirements arising from the new Basel III rules-which establish an integrated regulatory capital framework designed to ensure that U.S. banking
organizations maintain strong capital positions--will not apply to smaller banks. In fact, most of
the significant changes from the proposed capital rules that were made in the final version of the
rules were in response to concerns expressed by smaller banks. For example, the new rules
maintain current practices on risk weighting residential mortgages and provide community
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banking organizations the option of maintaining existing standards on the regulatory capital
treatment of accumulated other comprehensive income and pre-existing trust preferred securities.
Our aim with these changes was to reduce the burden and complexity of the rules for community
banks while preserving the benefit of more rigorous capital standards. Indeed, most banking
organizations with less than $10 billion in assets already meet the higher capital standards, and
the new rules will help preserve the benefits of stronger capital positions these banks have built
since the financial crisis.
Community banking organizations also will not be subject to the Federal Reserve's additional
enhanced prudential standards that larger banking firms face or will face, such as capital plans,
stress testing, resolution plans, single-counterparty credit limits, and capital surcharges.
Furthermore, most of the major systemic risk and prudential provisions of the Dodd-Frank Act-such as the Volcker Rule, derivatives push-out, derivatives central clearing requirements, and the
Collins amendment--will have a far smaller impact on community banks than on large banking
firms. In focusing on the largest, most complex financial firms, the Dodd-Frank Act reforms aim
to require those firms to account for the costs they impose on the broader fmancial system and
soak up the implicit subsidy these fums enjoy due to market perceptions of their systemic
importance, ultimately creating a more level playing field for financial institutions of all sizes.
4. What is the legal authority for the Federal Reserve to use Quantitative Easing?
As you know, the Federal Reserve is charged by Congress with promoting the goals of maximum
employment, stable prices and moderate long-term interest rates. See 12 U.S.c. § 225(a). The
Federal Reserve works to accomplish these monetary policy goals in part through the conduct of
open market operations authorized under section 14 of the Federal Reserve Act. See 12 U.S.C. §
355. Quantitative Easing is the popular term used to refer to the Federal Open Market
Committee's program for providing monetary policy accommodation to the economy by
purchasing and holding longer-term Treasury securities and mortgage backed securities
guaranteed by the Government National Mortgage Association (Ginnie Mae), the Federal
National Mortgage Association (Farmie Mae) and the Federal Home Loan Mortgage Corporation
(Freddie Mac).
Section 14 of the Federal Reserve Act specifically authorizes the Federal Reserve to purchase
and sell obligations of or guaranteed by the United States or any agency of the United States,
such as Ginnie Mae, Fannie Mae and Freddie Mac. Purchases of these securities should put
downward pressure on longer-term interest rates, support mortgage markets, and help to make
broader financial conditions more accommodative. These financial developments, in tum,
should help to strengthen the economic recovery and to ensure that inflation, over time, is at the
rate most consistent with the mandate from the Congress.
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o
@FedFRASER