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For release on delivery
10:00 a.m. EDT
July 15, 2008

Statement of
Ben S. Bernanke
Chairman
Board of Governors of the Federal Reserve System
before the
Committee on Banking, Housing, and Urban Affairs
United States Senate

July 15, 2008

Chairman Dodd, Senator Shelby, and members of the Committee, I am pleased to present
the Federal Reserve's Monetary Policy Report to the Congress.
The U.S. economy and financial system have confronted some significant challenges thus
far in 2008. The contraction in housing activity that began in 2006 and the associated
deterioration in mortgage markets that became evident last year have led to sizable losses at
financial institutions and a sharp tightening in overall credit conditions. The effects of the
housing contraction and of the financial headwinds on spending and economic activity have been
compounded by rapid increases in the prices of energy and other commodities, which have
sapped household purchasing power even as they have boosted inflation. Against this backdrop,
economic activity has advanced at a sluggish pace during the first half of this year, while
inflation has remained elevated.
Following a significant reduction in its policy rate over the second half of 2007, the
Federal Open Market Committee (FOMC) eased policy considerably further through the spring
to counter actual and expected weakness in economic growth and to mitigate downside risks to
economic activity. In addition, the Federal Reserve expanded some of the special liquidity
programs that were established last year and implemented additional facilities to support the
functioning of financial markets and foster financial stability. Although these policy actions
have had positive effects, the economy continues to face numerous difficulties, including
ongoing strains in financial markets, declining house prices, a softening labor market, and rising
prices of oil, food, and some other commodities. Let me now tum to a more detailed discussion
of some of these key issues.
Developments in financial markets and their implications for the macroeconomic outlook
have been a focus of monetary policy makers over the past year. In the second half of 2007, the
deteriorating performance of subprime mortgages in the United States triggered turbulence in

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domestic and international financial markets as investors became markedly less willing to bear
credit risks of any type. In the first quarter of 2008, reports of further losses and write-downs at
financial institutions intensified investor concerns and resulted in further sharp reductions in
market liquidity. By March, many dealers and other institutions, even thosl! that had relied
heavily on short-term secured financing, were facing much more stringent borrowing conditions.
In mid-March, a major investment bank, The Bear Steams Companiles, Inc., was pushed
to the brink of failure after suddenly losing access to short-term financing markets. The Federal
Reserve judged that a disorderly failure of Bear Steams would pose a serious threat to overall
financial stability and would most likely have significant adverse implications for the U.S.
economy. After discussions with the Securities and Exchange Commission and in consultation
with the Treasury, we invoked emergency authorities to provide special financing to facilitate the
acquisition of Bear Steams by JPMorgan Chase & Co. In addition, the Federal Reserve used
emergency authorities to establish two new facilities to provide backstop liquidity to primary
dealers, with the goals of stabilizing financial conditions and increasing the availability of credit
to the broader economy. 1 We have also taken additional steps to address liquidity pressures in
the banking system, including a further easing of the terms for bank borrowing at the discount
window and increases in the amount of credit made available to banks through the Term Auction
Facility. The FOMC also authorized expansions of its currency swap arrangements with the
European Central Bank and the Swiss National Bank to facilitate increased dollar lending by
those institutions to banks in their jurisdictions.
These steps to address liquidity pressures coupled with monetary easing seem to have
been helpful in mitigating some market strains. During the second quarter, credit spreads

1 Primary dealers are financial institutions that trade in U.S. government securities with the Federal Reserve Bank of
New York. On behalf of the Federal Reserve System, the New York Fed's Open Market Desk engages in the trades
to implement monetary policy.

-3generally narrowed, liquidity pressures ebbed, and a number of financial institutions raised new
capital. However, as events in recent weeks have demonstrated, many financial markets and
institutions remain under considerable stress, in part because the outlook for the economy, and
thus for credit quality, remains uncertain. In recent days, investors became particularly
concerned about the financial condition of the government-sponsored enterprises (GSEs), Fannie
Mae and Freddie Mac. In view of this development, and given the importance of these firms to
the mortgage market, the Treasury announced a legislative proposal to bolster their capital,
access to liquidity, and regulatory oversight. As a supplement to the Treasury's existing
authority to lend to the GSEs and as a bridge to the time when the Congress decides how to
proceed on these matters, the Board of Governors authorized the Federal Reserve Bank of
New York to lend to Fannie Mae and Freddie Mac, should that become necessary. Any lending
would be collateralized by U.S. government and federal agency securities. In general, healthy
economic growth depends on well-functioning financial markets. Consequently, helping the
financial markets to return to more normal functioning will continue to be a top priority of the
Federal Reserve.
I turn now to current economic developments and prospects. The economy has continued
to expand, but at a subdued pace. In the labor market, private payroll employment has declined
this year, falling at an average pace of 94,000 jobs per month through June. Employment in the
construction and manufacturing sectors has been particularly hard hit, although employment
declines in a number of other sectors are evident as well. The unemployment rate has risen and
now stands at 5-112 percent.
In the housing sector, activity continues to weaken. Although sales of existing homes

have been about unchanged this year,

s~les

of new homes have continued to fall, and inventories

of unsold new homes remain high. In response, homebuilders continue to scale back the pace of

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housing starts. Horne prices are falling, particularly in regions that experienced the largest price
increases earlier this decade. The declines in horne prices have contributed to the rising tide of
foreclosures; by adding to the stock of vacant homes for sale, these foreclosures have, in tum,
intensified the downward pressure on horne prices in some areas.
Personal consumption expenditures have advanced at a modest pace so far this year,
generally holding up somewhat better than might have been expected given the array of forces
weighing on household finances and attitudes. In particular, with the labor market softening and
consumer price inflation elevated, real earnings have been stagnant so far this year; declining
values of equities and houses have taken their toll on household balance sheets; credit conditions
have tightened; and indicators of consumer sentiment have fallen sharply. More positively, the
fiscal stimulus package is providing some timely support to household incomes. Overall,
consumption spending seems likely to be restrained over coming quarters.
In the business sector, real outlays for equipment and software were about flat in the first
quarter of the year, and construction of nonresidential structures slowed appreciably. In the
second quarter, the available data suggest that business fixed investment appears to have
expanded moderately. Nevertheless, surveys of capital spending plans indicate that firms remain
concerned about the economic and financial environment, including sharply rising costs of inputs
and indications of tightening credit, and they are likely to be cautious with spending in the
second half of the year. However, strong export growth continues to be a significant boon to
many U.S. companies.
In conjunction with the June FOMC meeting, Board members and Reserve Bank
presidents prepared economic projections covering the years 2008 through 2010. On balance,
most FOMC participants expected that, over the remainder of this year, output would expand at a
pace appreciably below its trend rate, primarily because of continued weakness in housing

-5markets, elevated energy prices, and tight credit conditions. Growth is projected to pick up
gradually over the next two years as residential construction bottoms out and begins a slow
recovery and as credit conditions gradually improve. However, FaMe participants indicated
that considerable uncertainty surrounded their outlook for economic growth and viewed the risks
to their forecasts as skewed to the downside.
Inflation has remained high, running at nearly a 3-112 percent annual rate over the first
five months of this year as measured by the price index for personal consumption expenditures.
And, with gasoline and other consumer energy prices rising in recent weeks, inflation seems
likely to move temporarily higher in the near term.
The elevated level of overall consumer inflation largely reflects a continued sharp run-up
in the prices of many commodities, especially oil but also certain crops and metals? The spot
price of West Texas intermediate crude oil soared about 60 percent in 2007 and, thus far this
year, has climbed an additional 50 percent or so. The price of oil currently stands at about five
times its level toward the beginning of this decade. Our best judgment is that this surge in prices
has been driven predominantly by strong growth in underlying demand and tight supply
conditions in global oil markets. Over the past several years, the world economy has expanded
at its fastest pace in decades, leading to substantial increases in the demand for oil. Moreover,
growth has been concentrated in developing and emerging market economies, where energy
consumption has been further stimulated by rapid industrialization and by government subsidies
that hold down the price of energy faced by ultimate users.
On the supply side, despite sharp increases in prices, the production of oil has risen only
slightly in the past few years. Much of the subdued supply response reflects inadequate

2 The dominant role of commodity prices in driving the recent increase in inflation can be seen by contrasting the
overall inflation rate with the so-called core measure of inflation. which excludes food and energy prices. Core
inflation has been fairly steady this year at an annual rate of about 2 percent.

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investment and production shortfalls in politically volatile regions where large portions of the
world's oil reserves are located. Additionally, many governments have been tightening their
control over oil resources, impeding foreign investment and hindering efforts to boost capacity
and production. Finally, sustainable rates of production in some of the more secure and
accessible oil fields, such as those in the North Sea, have been declining. In view of these
factors, estimates of long-term oil supplies have been marked down in recent months. Longdated oil futures prices have risen along with spot prices, suggesting that market participants also
see oil supply conditions remaining tight for years to come.
The decline in the foreign exchange value of the dollar has also contributed somewhat to
the increase in oil prices. The precise size of this effect is difficult to ascertain, as the causal
relationships between oil prices and the dollar are complex and run in both directions. However,
the price of oil has risen significantly in terms of all major currencies, suggesting that factors
other than the dollar, notably shifts in the underlying global demand for and supply of oil, have
been the principal drivers of the increase in prices.
Another concern that has been raised is that financial speculation has added markedly to
upward pressures on oil prices. Certainly, investor interest in oil and other ,;ommodities has
increased substantially of late. However, if financial speculation were pushing oil prices above
the levels consistent with the fundamentals of supply and demand, we would expect inventories
of crude oil and petroleum products to increase as supply rose and demand fell. But in fact,
available data on oil inventories show notable declines over the past year. This is not to say that
useful steps could not be taken to improve the transparency and functioning of futures markets,
only that such steps are unlikely to substantially affect the prices of oil or other commodities in
the longer term.

-7Although the inflationary effect of rising oil and agricultural commodity prices is evident
in the retail prices of energy and food, the extent to which the high prices of oil and other raw
materials have been passed through to the prices of non-energy, non-food finished goods and
services seems thus far to have been limited. But with businesses facing persistently higher input
prices, they may attempt to pass through such costs into prices of final goods and services more
aggressively than they have so far. Moreover, as the foreign exchange value of the dollar has
declined, rises in import prices have put greater upward pressure on business costs and consumer
prices. In their economic projections for the June FOMe meeting, monetary policy makers
marked up their forecasts for inflation during 2008 as a whole. FOMe participants continue to
expect inflation to moderate in 2009 and 2010, as slower global growth leads to a cooling of
commodity markets, as pressures on resource utilization decline, and as longer-term inflation
expectations remain reasonably well anchored. However, in light of the persistent escalation of
commodity prices in recent quarters, FOMe participants viewed the inflation outlook as
unusually uncertain and cited the possibility that commodity prices will continue to rise as an
important risk to the inflation forecast. Moreover, the currently high level of inflation, if
sustained, might lead the public to revise up its expectations for longer-term inflation. If that
were to occur, and those revised expectations were to become embedded in the domestic wageand price-setting process, we could see an unwelcome rise in actual inflation over the longer
term. A critical responsibility of monetary policy makers is to prevent that process from taking
hold.
At present, accurately assessing and appropriately balancing the risks to the outlook for
growth and inflation is a significant challenge for monetary policy makers. The possibility of
higher energy prices, tighter credit conditions, and a still-deeper contraction in housing markets
all represent significant downside risks to the outlook for growth. At the same time, upside risks

-8to the inflation outlook have intensified lately, as the rising prices of energy and some other
commodities have led to a sharp pickup in inflation and some measures of inflation expectations
have moved higher. Given the high degree of uncertainty, monetary policy makers will need to
carefully assess incoming information bearing on the outlook for both inflation and growth. In
light of the increase in upside inflation risk, we must be particularly alert to any indications, such
as an erosion of longer-term inflation expectations, that the inflationary impulses from
commodity prices are becoming embedded in the domestic wage- and price-setting process.
I would like to conclude my remarks by providing a brief update on some of the Federal
Reserve's actions in the area of consumer protection. At the time of our report last February, I
described the Board's proposal to adopt comprehensive new regulations to prohibit unfair or
deceptive practices in the mortgage market, using our authority under the Home Ownership and
Equity Protection Act of 1994. After reviewing the more-than 4,500 comm·ent letters we
received on the proposed rules, the Board approved the final rules yesterday.
The new rules apply to all types of mortgage lenders and will establish lending standards
aimed at curbing abuses while preserving responsible subprime lending and sustainable
homeownership. The final rules prohibit lenders from making higher-priced loans without due
regard for consumers' ability to make the scheduled payments and require lenders to verify the
income and assets on which they rely when making the credit decision. Also, for higher-priced
loans, lenders now will be required to establish escrow accounts so that property taxes and
insurance costs will be included in consumers' regular monthly payments. The final rules also
prohibit prepayment penalties for higher-priced loans in cases in which the consumer's payment
can increase during the first few years and restrict prepayment penalties on other higher-priced
loans Other measures address the coercion of appraisers, servicer practices, and other issues.
We believe the new rules will help to restore confidence in the mortgage market.

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In May, working jointly with the Office of Thrift Supervision and the National Credit
Union Administration, the Board issued proposed rules under the Federal Trade Commission Act
to address unfair or deceptive practices for credit card accounts and overdraft protection plans.
Credit cards provide a convenient source of credit for many consumers, but the tenns of credit
card loans have become more complex, which has reduced transparency. Our consumer testing
has persuaded us that disclosures alone cannot solve this problem. Thus, the Board's proposed
rules would require card issuers to alter their practices in ways that will allow consumers to
better understand how their own decisions and actions will affect their costs. Card issuers would
be prohibited from increasing interest rates retroactively to cover prior purchases except under
very limited circumstances. For accounts having multiple interest rates, when consumers seek to
pay down their balance by paying more than the minimum, card issuers would be prohibited
from maximizing interest charges by applying excess payments to the lowest rate balance first.
The proposed rules dealing with bank overdraft services seek to give consumers greater control
by ensuring that they have ample opportunity to opt out of automatic payments of overdrafts.
The Board has already received more than 20,000 comment letters in response to the proposed
rules.
Thank you. I would be pleased to take your questions.